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Steve Jobs

Morningstar, the safety-first investment-research firm, recently added technology darling Apple to its exclusive five-star stock list.

Chicago-based Morningstar covers more than 1,700 stocks and only 45 receive five-star rankings. That number has increased, quite a bit, in the past few weeks as the equity market has slid. Morningstar says Apple – which earlier this week was trading below $315 (U.S.) from a 52-week high of $365 – is now at an attractive discount price.

During the second quarter, Apple roughly doubled its operating income and boosted sales 83 per cent. Such growth is remarkable, especially considering the company already has a market value of $290-billion. iPhone revenue surged 126 per cent, Mac revenue climbed 32 per cent, iTunes revenue increased 23 per cent, software sales stretched 17 per cent and peripherals sales advanced 23 per cent. iPod sales declined 14 per cent. The iPad, Apple's latest disruptive-technology product, has no year-over-year comparison, but it delivered $2.3-billion of quarterly sales. Put simply, business is booming.

Commentators spouting off about the beleaguered American consumer should take a gander at Apple. Its recent move to sell the iPhone through Verizon is providing a nice tailwind as its iPad 2 cannibalizes PC sales from the likes of Hewlett-Packard. The one unit receiving little attention, despite outstanding growth, is the Mac business, which is stealing market share at a steady clip. Two other positives: Apple's stock is extremely cheap, on a peer and historical basis, and it carries nearly $66-billion of net cash (cash minus debt). Morningstar's thesis: Apple is a safe, cheap growth stock, likely to outperform.

Morningstar has a fair-value target of $475 on the stock, suggesting a return of close to 50 per cent. Unlike the sell-side, Morningstar doesn't link its targets to a specific time frame. Piper Jaffray forecasts a 12-month advance to $554 and Credit Suisse predicts a rise to $500. Apple receives positive reviews, comprising "buy," "outperform" and "overweight" rankings, from a disproportionate 91 per cent of researchers in coverage. That share renders the stock the fourth-highest-rated in the benchmark S&P 500 Index. With an operating margin, at 29 per cent, in the 99th industry percentile, it's obvious why Apple is analysts' favourite tech stock.

Morningstar says Apple has a "widening economic moat." Economic moat, or sustainable competitive advantage, is the key to Morningstar's rating system. The researcher favours companies that can keep competitors at bay. Still, Morningstar may be underestimating just how wide Apple's moat is. Although, in theory, other hardware companies could build a better iPhone, so to speak, Apple's customer base is, arguably, the most loyal in the world, and its record of manufacturing seamless, user-friendly and innovative products has garnered goodwill. Research In Motion , maker of business go-to BlackBerry, has learned how tough it is to square off with a consumer darling. Its stock is down 39 per cent in a month.

Once the uncontested business mobile device, BlackBerry is being pressured by iPhone. And RIM's recently debuted tablet, the Playbook, hasn't won many fans. However, a qualification for Morningstar's view of Apple is the potential for departure of co-founder and CEO Steve Jobs. The 56-year-old has been on a medical leave of absence and battled cancer in the past.

Morningstar believes that "anything that tarnished the brand could quickly undo what it took the past decade to achieve ... investors are right to be concerned about the potential for Steve Jobs' permanent departure." Still, forecasting 75 million units of iPad sales by 2014, Morningstar sees major upside to Apple shares. It also believes that the launch of a Mac App Store will accelerate market share gains in the PC market and unlock value in Apple's stock.

Conservatively, Morningstar expects Apple's market share in smart phones to top out at 15 per cent by 2015. That may prove too low as the iPhone is still seeing rapid adoption, now that it is carried at Verizon. Apple's stock fell 2.8 per cent intraday yesterday as tech stocks continued to struggle amid the market correction. Shares have depreciated 2.2 per cent in 2011 and are down 5.9 per cent in four weeks. Despite recent downgrades in GDP growth from the International Monetary Fund, S&P 500 profits are expected to rise year-over-year this quarter and, more pertinently, growth is expected to reaccelerate in the second half of the year. Double-dip fears are overblown.

Recently, Apple investors were dismayed by the departure of retail-concept innovator Ron Johnson, who was poached by J.C. Penney. The square-footage sales and profit proportion at Apple stores dwarf almost every retailer's. Johnson's leave raised a red flag. On the other hand, Apple's retail model is perfected and an expansion into China, slated to be 20 to 30 stores over the next few years, is now in question. In reality, the expansion will commence as replication, not innovation, is all that's required. Reacting to this news, JPMorgan noted, "It could be a bumpy start to summer, which brings opportunity." The bank rates Apple "overweight."

JPMorgan cites the iPhone 4 refresh and "increasing traction" of the MacBook Air as reasons that Wall Street earnings estimates may prove too low. Apple's latest so-called big idea, explained at the World Wide Developers' Conference, was iCloud, an integrated service, providing remote storage and push of photos, music and documents between linked Apple products. The basic service will debut this fall. Though unexciting, relative to a gadget unveiling, this service is likely to attract a swath of users as it has obvious relevance for those with multiple devices. OS X Lion, Apple's latest operating system, was also just unveiled.

Noting that Apple is trading at just 13-times forward earnings, compared to a three-year average of 18, JPMorgan says it "is trading like a value stock and not as the high-growth story in large-cap equities." JPMorgan expects shares to hit $450. Indeed, Apple is unanimously considered cheap. The stock has a median target of $458.03, implying a return of 46 per cent.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 0:34pm EDT.

SymbolName% changeLast
AAPL-Q
Apple Inc
-1.23%171.18
MORN-Q
Morningstar Inc
-0.22%307.48

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