Thanks to the Weak Market, Apple Stock Actually Looks Cheap

Despite my roots as a value manager, in recent weeks I have been a fairly aggressive buyer of Apple (AAPL) shares. Such an investment may not seem appropriate for a value investor but as the stock has steadily fallen, dropping below $250 per share, it has actually become quite undervalued. And not just relative to its growth rate, but the broad market as well.

Flush with $45 billion in cash and investments ($50 per share) and no debt, Apple sports an enterprise value of about $190 per share. Compare that to $15 of earnings this year and enough catalysts to make next year’s estimate of $18 seem easily attainable, and you have a stock that actually trades at a discount to the S&P 500. And therein lies the core explanation for my heightened interest recently. How can Apple trade at a discount to the market after factoring in their balance sheet?

While some feel that the company’s recent momentum may be fading, there appear to be plenty of catalysts left to play out over the next couple of years. The iPhone has been a runaway success, even though it still has not been released by the largest cell phone provider in the United States (Verizon). A launch by VZ, expected within the next six months, is sure to reignite the iPhone’s momentum here in the States.

There are other reasons to be bullish as well. According to several press reports, the iPad seems to be catching on in the corporate world far faster than most had expected. Many companies are buying iPads instead of laptops or net books for their employees. Analysts expected most of the early growth to be consumer-related so any stronger than expected success in the corporate market will only add to the bottom line, as corporations typically go with Windows machines.

Not only that, but I continue to expect that Mac sales will continue to grow. It is true that some iPad sales could cannibalize the laptop business at Apple, but I fully expect Apple’s overall share of the global PC market to continue to edge higher in coming years. The only downside is likely to be deceleration of iPod sales, but with the company having both successfully entered (cell phones) and pioneered (tablets) new markets in recent years, there is little reason to think the company will fail to continue above average growth for several years to come.

Even if management remains stubborn about allocating its $50 per share in cash in more productive ways, there is no doubt in my mind that Apple shares will once again trade at a premium to the market in the not-too-distant future. If that happens, Apple stock around $240 per share (today’s price) will likely prove to be a great buy a year from now. My personal target is $300 and it does not take overly aggressive assumptions to get there.

Full Disclosure: Long shares of Apple at the time of writing, but positions may change at any time.

That Was Fast… Hewlett Packard Loses Its Luster in Three Weeks

It is always interesting how quickly the investor community can turn its back on a company. Technology giant Hewlett Packard (HPQ) has seen its support wither after its CEO Mark Hurd resigned over questionable behavior earlier this month. HP’s stock has cratered nearly 20%, from above $46 to around $38 per share, and all of the sudden investors insist that HP has lost its way. The loss of Hurd is definitely a negative, but should the tables be turning on HP this dramatically already?

Fueling that argument is the news this week that HP decided to enter a bidding war with Dell over 3PAR (PAR), a small data storage company. After initially being courted by four companies, Dell and HP were the finalists to acquire 3PAR but HP had been previously unwilling to outbid Dell’s $18 per share offer. However, after Dell and 3PAR announced the deal HP decided to bid $24 and try to steal it from their competitor. Sporadic behavior on HP’s part? It sure seems like it, as the critics were quick to point out, but maybe HP simply had a change of heart. Maybe Mark Hurd was against a higher offer and now that he is gone, top management at HP decided they really should acquire the company. Who knows.

What we do know, however, is that HP has lost their CEO and is now willing to pay at least $1.6 billion to fill out its product line. Are these actions worth a nearly 20% hit to HP’s stock price? Given that HP shares were cheap to being with, I think the sell-off is overdone, as is the bearish sentiment towards the company all of the sudden. At $38, HP stock trades at merely 8.5x fiscal 2010 earnings estimates (there are only two months left in their fiscal year, so readers need not complain that I am failing to use trailing earnings, which would make the P/E ratio 10.7). And yes, using 2011 estimates of 11% profit growth (to $5 per share), HP’s forward P/E stands at just 7.7 times.

The risks here appear to be both obvious and less than dramatic. Could the absence of Mark Hurd send the company into an operational tailspin which would reduce market share and hurt profits? Possible, but unlikely. Hurd’s top lieutenants remain at the company and are very likely to continue the management style and game plan he has had in place for several years.

Could overpaying for 3PAR hurt the company’s finances dramatically? No chance, as HP has cash on hand of $14.7 billion.

Could Dell adding 3PAR to its arsenal materially cut into HP’s business? Unlikely. 3PAR generates only about $200 million in annual sales, a drop in the bucket for a company the size of Dell ($60 billion in sales) or HP ($125 billion in sales annually).

Could the empty CEO job cost HP some customers? Unlikely. As a CTO, would you switch vendors if you have had good experiences in the past, simply because the company’s previous CEO allegedly charged personal expenses to the company in what could have been an attempt to woo a female contractor? You would probably agree with me that giving him the boot should suffice.

To me it is pretty clear that HP stock is getting unfairly punished lately. As a long term value opportunity, I think it looks attractive.

Full Disclosure: Long shares of HPQ at the time of writing, but positions may change at any time.

First Niagara Deal Sets Bar for Regional Bank Valuations

One of the cheapest areas of the market for a while now has been the banking sector. In the face of economic uncertainty and elevated loan losses, normalized bank valuation metrics have (temporarily, I believe) gone out the window. As a result, many of the stocks (even some quality names) languish near or below book value and despite this, very few non-FDIC assisted deals have been announced. However, today we got a rather sizable bank deal. First Niagara (FNFG) has agreed to acquire NewAlliance (NAL) for $14.06 per share in stock, or about $1.5 billion. This represents a 24% premium, and most importantly for value investors, amounts to 1.63 times tangible book value per share. Banks typically sell for 2-3 times book in normal times, or 1.5-2.0 times tangible book (excluding goodwill and intangible assets), so this transaction shows us that normal bank metrics are not dead.

Interestingly, I had never heard of First Niagara until early last year when they agreed to buy dozens of branches from PNC Financial (PNC) as part of PNC’s purchase of troubled National City. PNC remains one of my favorite bank stocks (and the big local bank here in Pittsburgh) but First Niagara has remained in strong financial shape throughout the crisis and is certainly using that strength to expand while other competitors are retrenching (a smart move on their part). This NewAlliance deal gives them a footprint in New England, and like the PNC branch deal, likely bodes well for their future.

The takeaway for me is that, no, I have not lost my mind. Solid banking institutions selling at or below book value does make little sense. The odds of heightened takeover activity are slim with 9.5% unemployment, but over the longer term I fully expect bank valuation to rise back to more historical levels, for quality franchises anyway. Opportunities abound.

Full Disclosure: Long PNC and no position in FNFG or NAL at the time of writing, but positions may change at any time.

Forbes Investor Team Recommends Genentech Stock, Even Though It Stopped Trading 16 Months Ago

File this away as the most amusing item of the day. I always get a kick out of some of the investment articles I see on various finance-related web sites. Now, I am sure I have made a few mistakes over the years on this blog, but never anything like what the Forbes Investor Team posted on their site today. In a piece written by John Reese of Validea Capital Management, there are four stock recommendations, including Genentech. Here is what John says about the company:

The South San Francisco-based biotech firm ($100 billion market cap) has averaged a 22.1% ROE over the past three years, has increased EPS in six straight years, and has almost three times as much net current assets as long-term debt. It isn’t cheap, selling for almost 30 times trailing 12-month earnings, but my Lynch-based model thinks it’s worth it, given its 41.6% long-term growth rate. (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) Another reason the strategy is high on Genentech: the firm’s conservative financing. It has a debt/equity ratio of less than 20%.

Of course, this is amusing because Genentech was acquired by Roche more than a year ago, in March 2009, and the stock has not traded since. I have to question this manager’s “Peter Lynch-based model” given that it flashes buy signals on stocks that do not even exist anymore. Hilarious.