Apple still looks juicy

I've been a fan of AAPL for many years, and I see no reason to stop now. Apple continues to innovate, both on the hardware and software front, they are a recognized leader in their market, and they capture the lion's share of industry profits.

Although Apple was late to the game with a bigger smartphone, it's now once again the leader of the pack. No competitor can match Apple's design, quality, reliability, ease of use, and integration. I know quite a few people who are lusting for an iPhone 6, and I'll be getting one for sure (but I'll probably get the 6 because I think the 6 Plus is too big for my tastes). It's got great new features (e.g., a much better camera, incredible video capabilities, a better quality screen, NFC, faster WiFi, and VoLTE). And of course there is iOS 8, which will be released next week and will bring delightful new features to most of the iPhones already out there in the world. Similar software advances are on track for Apple's industry-leading laptops and desktops, due out next month. No other competitor makes it so easy to upgrade your smartphone or your computer with the latest and greatest version of its operating system.

I was immediately struck by the beauty of the new Apple Watch, which is not just an amazing gadget but also a piece of jewelry that will be coveted by many. I'm sure I'll get one myself when they come out next year.

Even though Apple is the most valuable company in the world, it has only recently eclipsed the record high valuation of MSFT set in early 2000—over 14 years ago—and only by about $15 billion or so. Like Microsoft, Apple sells products and services to the entire world. Unlike Microsoft, Apple's products and services are highly regarded in the biggest and fastest growing part of the world (e.g., China).

When Apple's PE ratio fell to 10 early last year, it was a clear sign that the market thought its best days were behind it. Backing out Apple's significant overseas cash hoard, its PE ratio was approaching a miserable 8. 

The only way to make sense of that was to figure the market expected no further increase in earnings going forward, and a strong likelihood that earnings would decline. And indeed, Apple's earnings have been essentially flat for the past 2 ½ years.

Today, however, Apple's PE ratio is back up to just over 16, so that implies that the market worries much less about declining earnings. But even at a PE of 16 the market is still looking at Apple with skeptical eyes. Back out the overseas cash (and assume Apple pays onerous taxes on it), and you get a cash-adjusted PE today of 13-14, which is substantially below the S&P 500's PE ratio of 18. So today's pricing only makes sense if you assume that at best Apple's earnings will never rise meaningfully and may well stagnate or decline in coming years.

While that may prove to be the case (it's always tough to argue that the market is wrong about the future), after yesterday's announcements it's clear that Apple has two new sources of revenues in the pipeline: the Apple Watch and Apple Pay. The Apple Watch is a handsome piece of jewelry that is also a watch and a high-powered computer, yet costs only half of what the average Swiss watch costs. (Perhaps Jony Ive wasn't exaggerating when he said "Switzerland is f*cked"). The Apple Watch is by far the best-designed and most functional of all the "smart watches" on the market. Fitness buffs could go crazy for its built-in sensors, and Apple's HealthKit could find lots of traction in the healthcare field. Why couldn't Apple sell tens of millions of watches per year? The Swiss sold over 20 million last year.

And then there's Apple Pay, which has the potential to revolutionize how the world buys things. If the service is successful, Apple could get a tiny piece of potentially tens of billions of credit and debit card transactions each year all over the world. Based on my understanding of how it works, it has all the ingredients for success: it's super-easy to use and it's far more secure and private than the current system, which we know is deeply flawed. There will be millions of iPhones that could start using the system beginning next month—as many as 80 million by year end—and Apple has already signed up the biggest players in the credit card industry.

There's still lots to like about Apple.

Full disclosure: I am long AAPL as of the time of this writing, and have been for many years.

UPDATE: Here's a terrific review of the Apple Watch by the watch pro Benjamin Clymer (HT: John Gruber). It helps you appreciate the tremendous amount of work and detail that Apple has put into this. The variety and beauty of the watch cases and straps is simply amazing. This is much more than just a digital watch.