Best of Apple, worst of Apple

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Apple Stock Is a Buy Despite Dickensian Earnings

Apple (AAPL) continues to be a story along the lines of  ”It was the best of times, it was the worst of times.”

Apple earnings on Tuesday showed continued strength in iPhone sales; Apple earnings also showed continued weakness in margins, down to 37% from 42% last quarter.

Apple stock trading on Monday involved 7.4 million shares, the third-lowest volume since the dead half session in Christmas eve 2012, and for seven market sessions in a row the stock traded less than 10 million shares — the longest streak below 10 million shares since a similar seven-day run in January 2012.

Apple stock trading today doubled in anticipation of earnings, and Wednesday is sure to be brisk, too.

Apple managed to beat forecasts, even despite headwinds, and will open higher; other tech blue chips like Google (GOOG) and Microsoft (MSFT) missed big and have sold off sharply soon after.

Like I said, downright Dickensian.

But what does it all mean?

Well, if you’re a short-term swing trader it means you can feel free to tie yourself in knots.

If you’re a long-term investor, it means you can buy Apple stock with confidence.

There are many risks to Apple, yes. In it’s April earnings report, AAPL reported its first year-over-year profit decline in over a decade. And for its fiscal third quarter, Apple earnings growth continued to slow. Apple posted $6.9 billion in net income on the quarter, barely topping forecasts of $6.87 billion and down markedly from the $8.82 billion in profits a year ago. Furthermore, Apple posted $35.3 billion in revenue , a meager increase from $35 billion a year ago.

Growth is, in a word, gone.

But there are glimmers of hope. Apple’s iPhone sales beat expectations, at 31.2 million units compared with 26 million a year ago. U.S. iPhone sales were particularly strong, up 51% vs. last year.

Considering Apple pulled this off despite the lack of rumored low-cost iPhones, an iPhone 5S or even an iPhone 6 launch … that’s no mean feat. And the strength both at home and in emerging markets like China add up to a pretty powerful showing of Apple’s brand power in the face of Wall Street skepticism.

The million-dollar question, of course, is where we go from here. Investors in Apple stock know too well the challenges with this growth stock gone wrong, and the importance of realistic expectations.

For starters, I see a huge risk in the fact that Apple expects its margins to stand pat and not erode further despite all the evidence to the contrary. Take this chart, courtesy of Horace Dediu of Asymco, that shows Apple’s historic margin erosion — and the fact that Apple is expecting a flatline going forward instead of continued declines.

applemagins

“The upper bound is probably in the 50% range,” says Dediu regarding AAPL gross margins (the blue line) … and I can’t argue with that assessment. But what is the lower bound? It could be much, much lower than 40%.

There are also continued risks from smartphones powered by Google’s Android, as well as the Amazon (AMZN) Kindle in the tablet space.

But there are also signs of hope, too, that mean the worst could be over for Apple.

Consider that rivals Samsung (SSNLF) and HTC saw a June swoon, but Apple managed to post big-time growth. Could it be clawing back sales?

Consider that Apple beat expectations. Yes, the bar is much lower … but at least Wall Street has adjusted its perspective to the realities of Apple in 2013.

Consider Apple hasn’t unveiled the highly anticipated iWatch or a cheap iPhone or a new iPad or the Apple TV or … well, anything. And it has managed to stabilize the stock just the same.

Consider that the third quarter is typically a slow one for AAPL because new iPhones hit the market in August to October, and consumers are used to waiting for the next model release.

Now bake in the $100 billion in cash dedicated to returning capital to shareholders over the next two years via dividends and buybacks.

Still think it’s the worst of times in Apple? That the smartphone market broadly has matured and that Apple specifically has been up against a ceiling for some time?

Maybe not.

And while it might not be the best of times, either, there certainly is a long-term case to be made for a company posting numbers like this amid negative perceptions — with $140 billion in the bank to boot.

Consider me an Apple bull after this earnings report. And if investors are smart, they will be too.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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