Apple: Why you should buy the hype

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Apple has climbed 11 per cent in March on positive iPad sales forecasts and increased consumer spending. Still, some investors shun Apple because they expect the shares to drop or consider the stock expensive.

Here are five inhibitions that could be hurting your returns.

1. Aversion to groupthink: The technology bubble of the late '90s and the credit bubble of 2006 have stoked skepticism among investors. They avoid popular stocks because they've been burned by fast-growing names in the past.

Apple repels many investors who question why shareholders are so emotionally attached to the company and its products. As long as you're buying shares based on investment fundamentals, not emotion, Apple is probably a safe bet.

2. Newton's Third Law: Isaac Newton's Third Law of Motion states that "to any action there is an equal and opposite reaction." The Third Law is rarely discussed in finance, but it affects how we purchase stocks. Prices move in two directions. When a stock rises like Apple's has, it seems like a descent looms. The popularity of the Fibonacci sequence, a series of ascent and retracement patterns in technical analysis, has exacerbated this fear of natural corrections.

3. The value proposition: The success of Warren Buffett has made value investing the preferred strategy of many investors. However, many analyze valuation metrics, such as price-to-earnings and price-to-book ratios, without comparing them to peer or market averages. When evaluating a stock, investors much as consider factors such as geographic, economic and industry prospects as well as expected individual growth rates. If you're waiting to "pick your spot" on Apple, you'll have missed out on serious growth.

4. Contrarian myopia: There is a sizable group of short-sighted investors who think they have superior insight. These investors aren't in the market to make money, but to prove their atypical talent. Such contrarians consider themselves to be "ahead of the curve" and scorn popular investment ideas for being banal or simplistic without fully considering their merits. This group fails to recognize that a contrarian predisposition often prevents one from owning lucrative stocks.

5. Premature cognitive closure: A person on a chosen course is likely to stay on that course, regardless of new information. These people are naturally inclined to cling to preexisting opinions. This will prevent them from purchasing Apple shares, except under certain circumstances. If the stock falls or the company declines in popularity, you could see a new wave of investors buying into Apple. In this case, inhibitions provide a stock-price cushion.

Now, here are four fundamental reasons to buy Apple shares.

1. Valuation

Apple trades at a price-to-projected-earnings ratio of 17, a price-to-book ratio of 5.9 and a price-to-sales ratio of 4.5, representing 9.6%, 12% and 76% premiums to industry averages. The stock is also expensive based on cash flow per share. But its PEG ratio, a measure of value based on expected growth, of 0.8 is on par with the industry average and suggests the shares are trading at bargain prices relative to the company's prospects. A PEG ratio that's less than 1 suggests the shares are cheap. Apple is arguably expensive, but certain factors justify a premium.

The company has growth prospects that aren't accounted for in some analysts' forecasts, but are visible in its balance sheet. The company has $40-billion in cash and liquid securities, and no long-term debt. It has enough cash to finance a massive acquisition, or a series of medium-sized deals, and still retain its liquid tilt. It's difficult to account for the growth potential of this cash.

2. Growth rates

During the past three years, Apple has increased revenue 31 per cent annually, on average, and boosted net income 57 per cent a year. Its stock has returned 34 per cent annually since 2007, outperforming U.S. indices and technology peers. The union of software and hardware, a strategy that pushed the company to the brink in the '90s, has been adopted by consumers who eagerly wait for Apple's next product. An army of early-adopting fans buoys initial reception.

Apple's iPad, due for release in April, has suffered criticism from technophiles. Still, a dual-distribution channel, through Apple stores and Best Buy locations, suggests that Wall Street sales estimates could be increased. The ability to sell at two venues also ensures broad geographic distribution and more consumer buzz during the launch. Morgan Stanley recently bumped its 2010 iPad unit sales estimate from 5 million to a range of 8 million to 10 million.

3. Analyst opinions

Analysts are overwhelmingly bullish on Apple, with 39, or 91 per cent, advising clients to buy shares and four recommending they hold the stock.

Tech-focused Cross Research expects the stock to advance 33 per cent to $310, the loftiest price target. Credit Suisse and Citigroup rate Apple "buy" and predict the stock to hit $300, a potential 29 per cent gain. Researchers at Barclays, UBS and Bank of America also rate Apple "buy", but are less optimistic about near-term growth potential.

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In a research note last week, Barclays stressed the importance of growth in Asia for the iPhone, citing demand in Japan and China as positive catalysts. Though iPod sales are experiencing seasonal weakness in the U.S., strong order trends in Asia for Macs, iPod Touch devices and iPhones are likely to offset domestic tapering.

A major component of Barclays' investment thesis is an iPhone upgrade cycle this summer. The company estimates that Apple will sell 5 million iPads this year, with constrained supply in the first quarter.

4. Fundamental superiority

TheStreet's quantitative equity model, which rates stocks based on investment fundamentals and historical performance, gives Apple a growth score of 10.1, making it the fourth-best company out of more than 5,000 we cover.

Apple has also earned a financial strength score of 9.9 out of 10, leading all stocks we follow. Its performance score of 9.1 and volatility score of 3.8 are also better than those of peers. The stock ranks in the top 3 per cent for overall score, our gauge of expected risk-adjusted performance. TheStreet's stock model rates Apple "buy" and projects a share price of $303.06.