Apple Stock Soars Before Earnings Report, but Growing Pains Lie Ahead

Apple's earnings are expected to impress Wall Street as usual when the report for the latest quarter is released after the stock market closes Tuesday.

Analysts predict earnings of $2.44 per share for the period ended March 31, 36 percent more than the same three months of 2009. Apple's stock (AAPL) hit an all-time high above $250 last week, no doubt aided by investors looking to front-run the good news.

Whatever number Apple announces, and whatever elaboration is offered in the company's subsequent conference call, will produce a flurry of after-hours trading and maybe a big move up or down in the stock. The earnings and the reaction they provoke will be dealt with in a post soon after the report is issued.

While we're all still calm and have our wits about us, let's consider the outlook for Apple over the long term - beyond the next day and a half - including some potential negatives that could knock the high-flying stock back to a much lower orbit.

Apple continues to get bigger and stronger as consumers snap up iPhones, iPads, iPods, iMacs and snippets of entertainment from the iTunes Store. Apple's growth has been astounding, but the company may be reaching a size that leaves it neither here nor there.

Apple is no longer the upstart represented by the cool guy in the anti-Microsoft commercials, but it's not yet a member of the Establishment at the top of the various heaps in which it plies its trade. Apple dominates the market in digital music players, where it accounts for three-fourths of units sold in the United States, but it's still looking up at Microsoft in software, Dell and Hewlett-Packard in personal computer hardware, Symbian and Research in Motion in smart phone operating systems and so on.

Earnings Growth Is Likely to Cool Off
Wall Street recognizes that Apple's growth will flatten. Its earnings, after having risen at an astounding 47.5 percent a year for the last five years, are projected to increase during the next five years at a more leisurely pace of 18.3 percent.

That seems to reflect a healthy understanding of the law of large numbers, but the large number that is Apple's share price says otherwise. It has more than doubled in the last year, racing ahead of earnings growth.

The stock had been hit by the severe bear market, like almost every other one. But the comparative strength is also one sign among many of excessive optimism.

Of 42 analysts who follow Apple and are tracked by Thomson/First Call, 36 have ratings of "buy" or "strong buy" and just one recommends selling the stock. Such near unanimity of regard leaves little scope for positive surprises that drive the stock higher (will business be so good that analysts upgrade it to "really strong buy"?), while setting it up for a fall if the news is not quite as wonderful as expected.

Comments about Apple have become noticeably overheated in recent weeks with the introduction of the iPad. Asif Suria, a software company owner, refers to "the iPad revolution" in a recent blog post. Others have announced the arrival of "the touch screen era."

The War of Independence was a revolution and the Renaissance was an era. A small electronic device that lets people watch television and read books by using their fingers instead of a manmade implement like a mouse is a neat gadget, nothing more.

Looking at the iPad strictly as an appliance, some reviewers have raised legitimate doubts about its capabilities, although they have been all but drowned out by the Apple-can-do-no-wrong majority. Fred Wilson, a blogger with a background in technology venture capital, concisely remarked: "I think the iPad is stuck in a difficult place between the smart phone and the laptop and it's not nearly as convenient as a phone or as powerful as a laptop."

Apple may not be all that big, but it displays unhealthy self-aggrandizement. Management is acquiring a reputation for capriciously pushing around designers of iPhone and iPad applications and is embroiled in a well publicized spat with Adobe in which Apple has refused to support Adobe's otherwise ubiquitous Flash software on the iPhone.

But the Cool Guy Isn't So Cool Anymore
Such control freakery is unseemly for a business renowned for innovation and creativity. Where did that cool guy go?

Maybe he has become a grumpy middle-aged guy confronting some uncomfortable realities. Some of the business segments in which Apple has thrived are changing in ways that will do the company no favors.

Purveyors of music and video are shifting away from direct sales and toward models based on advertising. Look at Hulu - as many people do. How successful will iTunes be as the marketplace changes?

A bigger and harder-to-ignore Apple also faces a threat from makers of smart phones and tablet computers, who can't help but notice how successful Apple has been at selling iPads (maybe) and iPhones (definitely).

As Apple evolves, its growth will continue to slow, and rivals will attack the company's image and markets more vigorously and probably with a lot of success. Apple's advantages in key lines of business will become harder to maintain as the company morphs from being the challenger to the challenged.

So while Apple has been a wonderful small company, it may become just an ordinary big one. If that view starts to take hold on Wall Street, the stock could be in for a bleak run. It's priced for big; it's not priced for ordinary.

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