Edmond Jackson's Stockwatch: Apple

Does Carl Icahn's taking a reputed $1 billion (£640 million) to $1.5 billion stake in Apple underpin its shares such that, with a major products' refreshment cycle kicking in from September, risk is increasingly on the upside?

The consumer electronics and software group's basic fundamentals have looked attractive for much of this year: a single-figure price/earnings (P/E) multiple now risen to a still relatively modest 12.5 times with the shares about $500 in a one-year range of $385 to $705p; a dividend yield now just shy of 3%; and a very strong balance sheet with nearly $147 billion cash in context of a market capitalisation just over $450 billion.

While Apple has already succumbed to another activist investor, David Einhorn, actually suing the company to improve distributions to shareholders such that chief executive officer Tim Cook has declared a plan for $100 billion in dividends and buybacks by 2015, Icahn wants the company to go a step further: borrow $150 billion at 3% interest to increase buybacks and avoid tax. Icahn suggests Apple could trade up to $700 with an enhanced buyback, compared with the current analysts' consensus target of $525 - for what that is worth. A year ago, analysts targeted much higher prices than last September's $705 peak, then adjusted targets down with market sentiment - with Citibank as low as $350. Maybe they all just have their fingers in the wind.

The market price festered in the first half of this year due to fears that Apple simply can't innovate as successfully in a post-Steve Jobs era, when competition is increasing. Smartphones have become a crowded market, with the iPhone being undercut on price; and demand for tablets has cooled. Apple's revenue grew 13.8% over the past 12 months compared with 45%, 66% and 52% during the previous four fiscal years. No brand new product line has been launched since the first iPad in 2010 and a new mapping service for iPhones and iPads received criticism for errors. A culture of near paranoia about this has even, reportedly, reached Apple's boardroom. An 8 August story alleged the board is worried lest the company has the right products in the pipeline and whether the chief executive innovating enough.

In fairness - and why Icahn's timing is shrewd - Apple is very soon to commence a major refreshment cycle of its products: the industry rumour mill has spread onto websites suggesting the new iPhone 5S and probably a cheaper '5C' variant will be launched on 10 September then go on sale from 20 September - allowing a full week of sales before the end of Apple's quarter and financial year on 28 September. The next 10-inch iPad is expected to have a similar screen, size and weight as the iPad mini which will also be updated before Christmas. A TV product is also expected later this year and an iWatch in 2014. Mind the aspect of speculation as it is also possible these new products don't meet hopes. Icahn's initiative makes Apple an intelligent bet however, reinforcing attention on shareholder returns. You can't be sure of getting lucky here but the odds are improving.

Trading status changes like this, long and short, can be very rewarding. With 'growth' players selling out as the company missed high expectations, Apple over-extended down to a single-figure P/E which brought out the 'value' investors - and activist hawks. Ultimately a share's value is its discounted cash returns, which become attractive at a certain price whether based mainly on reinvestment for capital growth or payouts if the business is relatively mature. I drew attention last October at just over $600 when the P/E rating had de-rated from the 20s to low teens, concluding cautiously that better buying opportunities might be ahead. It appears that David Einhorn was buying in around this time and experienced a drop, which galvanised his demands for higher payouts (to support the shares).

Aspects of income and capital growth are potentially a winning combination. The company's cash hoard reflects strong ongoing cash generation besides historic success; but it should be returning cash and investing more vigorously like its key competitors (see table). If Apple's net cash of about $130 billion was divided among its 900 million shares this would only amount to about $144 a share before taxes - hence Icahn's enhanced buyback proposal. Yet some in the market may still prioritise whether Apple is shining at innovation and marketing. Can management retain and extend, what is arguably the most loyal customer base of any business today?

Recent results for Apple's third quarter to end-June slightly beat expectations and sparked a rally from about $420 over $460. Stronger-than-anticipated iPhone demand helped offset declining iPad and Mac sales, however this means the next quarterly report may trend lower as consumers possibly delay purchases with the new phone soon to appear. It explains why the alleged 20 September sales launch is likely hoped to give a one-week boost to mitigate any drop. The real issue for value however is evaluating how various new launches are received in the next six months and longer - a crunch time (excuse the pun) for Apple watchers.

For more information see apple.com.