Apple Is No Value Trap

 | Sep 19, 2013 | 11:00 AM EDT
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Earlier this week on CNBC, Doug Kass called Apple (AAPL) a value trap. He said Apple's margins are unsustainable and the company has no growth. He also believes the stock is fairly priced and stuck in a plus/minus $50 range.

While I respect Doug's opinion, I think he is wrong. I think Apple can go much higher.

Most Apple bears pin their argument on sliding market share, the "lack of innovation" and no top line growth. While it's difficult to move the dial on an estimated $169.6 billion in revenue, Apple is managing to do it. With just an estimated 6.5% revenue growth, operating profit will increase 40% to $47.6 billion by next year. That means Apple will produce earnings per share (EPS) above $42.00 and a return on equity of 28%.

In terms of gross margins, Apple is expected to lose only 50 basis points of margin due to pricing pressure. That's not a disaster.

Analysts complain that Apple's new lower-priced phone, the 5c, is not priced low enough to gain market share in China. First, Apple can offer volume discounts for wholesale purchases. There is a difference between list price and the final sales price. Second, nothing says Apple won't lower the price sometime in 2014. Apple has a history of skimming the cream off the top and coming in with a lower price later on.

According to Canalys Research, Apple ranks No. 7 in market share in China. Phones in China are sold unsubsidized and phones priced below $200 are selling strongly.

But, even with a higher price, Sina Tech claims Apple has 42 million iPhones running on China Mobile's (CHL) network. If true, that's more iPhones than are running on Verizon (VZ) and AT&T (T) networks combined. A lower priced iPhone in China could set off an avalanche of upgrades. According to unconfirmed rumors, China Mobile and Apple signed an agreement to sell iPhones on its network. If an agreement has been reached, that could mean an additional "official" 35 million iPhones could be sold in China. China Mobile accounts for 65% of the nation's mobile subscribers.

The bears hate that Apple's market share peaked after the holidays at 24% in 2011. According to Gartner Research, Apple's market share has fallen to 14% last quarter. Those market share numbers are not seasonally adjusted -- yet analysts continue to quote them. Apple's market share will rebound (and the analysts will be surprised) after the holidays.

As for the "lack of innovation," I don't know what innovations people are expecting. Did you think it was going to make you a pizza?

The iPhone 5s is the fastest phone on the market. It has a cool new fingerprint sensor that the phone glitterati should love. The 5c has a better camera and a newly redesigned operating system. Those factors alone should be enough for phone junkies to upgrade.

The iPhone is like the Porsche of phones. In 2012, Porsche only sold 140,000 cars, yet it's one of the most profitable automakers in the world. Nobody squawks about the lack of tow capacity on a Porsche. If you want to tow a boat behind your 911 Carrera, get a truck. Apple has avoided feature clutter and has managed to stay above the fray.

Every hedge fund manager I've spoken with is a bear on the stock. Every one. They all make the same argument that Doug makes. Only time will tell if I'm right, but I have sneaky suspicion that all the hedge fund Apple bears will be wrong. If I were to guess, I would say better-than-expected sales will drive shares to Apple to hit $600 by this time next year.

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