Investors in tech and growth stocks are probably aware of the massive sell-off impacting small and mid-cap stocks in the face of inflation. Many names across the NASDAQ are down 30%, 50%, 75% from their peaks.
Meanwhile, the consumer electronics giant Apple (NASDAQ: AAPL) is near 52-week highs and has risen 40% in the past twelve months, a sign that investors are selling smaller, riskier stocks and buying large, established stocks like Apple. Be warned: the herd mentality can be dangerous for your wallet. Here’s why Apple could be the biggest disappointment of 2022.
What makes a bubble?
It doesn’t seem fair to call Apple a bubble stock. After all, his market capitalization is close to $ 3 trillion, his products are loved by almost everyone, and his company generates hundreds of billions of dollars in revenue. But bubbles don’t necessarily come from a bad deed or a bad company; they’re from consensus. When everyone in the room is in agreement, you should be more careful.
How is the stock market doing right now? Let’s explore this a bit. The market appears to be very divided at the moment. If you look at the wider indexes, things look good. The NASDAQ is at around 15,100, not too far from its all-time highs and up significantly over the past year.
However, only 26% of NASDAQ stocks are currently above their 200-day moving average, which is the average of a stock’s closing price over the past 200 trading days. Almost 75% of stocks are below this threshold, implying that the overall price action is unhealthy for most NASDAQ stocks.
If so many stocks are struggling, why is the index doing so well in comparison? Investors primarily sold most of the NASDAQ-listed stocks and flocked to a handful of mega-cap stocks carrying the higher index as they represent a larger weight in the index.
Apple is the largest NASDAQ stock. Looking below, we’ll see that the price movement for NASDAQ and Apple has been similar:
The heavy weight and continued rise in Apple’s stock price might help explain why NASDAQ is holding up so well when many of its constituents are struggling below the surface.
Identify Apple as a bubble title
Apple has continued to grow and is now up 40% over the past twelve months. But as investors continue to buy stocks, the stock price is outpacing the company, and Apple’s valuation has skyrocketed over the past two years.
The stock’s price-to-earnings (P / E) ratio rose to 31, roughly double the stock’s historical average of 15.
Investors should research the reasons why a stock deserves a reassessment whenever there is a significant deviation from its historical average. In other words, we have to be able to justify why Apple should double its valuation. Otherwise, it becomes difficult to stay at this higher price over the long term; it could eventually return to its historical “normal”.
Apple has two main factors opposing this. First, a business may have a harder time growing as it grows. It is often easier to go from 0 to 10 than from 100 to 1000. Apple’s market capitalization is approaching $ 3 trillion, which is about one-eighth of the entire US economy. The company is expected to generate nearly $ 400 billion in revenue in 2021. Apple is simply a massive company and an even bigger stock, which makes it very difficult to continue to grow rapidly.
Second, this reality is starting to show up in analysts’ expectations in the future. Analysts estimate Apple’s earnings per share (EPS) growth over the next three to five years at 12% per year on average; this is a slowdown from Apple’s average EPS growth of 19% per year over the past decade. So if growth is slowing but valuation is double its historical average, how can investors justify supporting this price increase over the long term?
Why the bubble could burst in 2022
Inflation has increased dramatically this year, pushing up the costs of goods and services in the United States. Raising the federal funds rate is one of the Federal Reserve’s primary tools to “cool” the economy and slow inflation.
The Federal Reserve currently uses a target rate of 0% to 0.25%, which implies that borrowing money is very cheap. It is a tool for stimulating economic growth and often increases stock market valuations.
If the Federal Reserve decides to raise its rate in 2022, it would likely have the opposite effect, making money more expensive to borrow, cooling the economy and lowering stock valuations. In Apple’s case, the stock is currently an outlier from its historical standards, making it vulnerable to a correction in a higher rate market.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.