Why Apple’s bubble could burst in 2022

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TInvestors in technology and growth stocks are likely aware of the sell-off that has affected small and mid-cap stocks in the face of inflation. Lots of names all over NASDAQ are down 30%, 50%, 75% from their highs.

The consumer electronics giant Apple (NASDAQ: AAPL) is near the 52-week high and is up 40% in the past twelve months, a sign that investors are selling smaller, riskier stocks and buying big and established stocks like Apple. Be warned: herd mentality can be dangerous for your portfolio. Because of this, Apple could be the biggest disappointment of 2022.

What is a bubble?

It doesn’t sound right to refer to Apple as a bubble stock. After all, it has a market value of nearly $ 3 trillion, its products are loved by almost everyone, and its business has revenues of hundreds of billions of dollars. But bubbles don’t necessarily come from a bad stock or company; they come from consensus. If everyone in the room agrees, then you should be the most careful.

Image source: Getty Images.

How is the stock market feeling right now? Let’s explore this a little. The market seems to be very divided at the moment. If you look at the broader indices, things seem to be fine. The NASDAQ is around 15,100, not too far from its all-time highs and has risen significantly over the past year.

However, only 26% of NASDAQ’s stocks are currently above their 200-day moving average, which is the average of a stock’s closing price over the last 200 trading sessions. Almost 75% of stocks are below this threshold, which means that general price action is unhealthy for most stocks on the NASDAQ.

With so many stocks struggling, why does the index compare so well? Investors have primarily sold the majority of NASDAQ-listed stocks and have risen to a select handful of mega-cap stocks that carry the index higher because they are a heavier weight in the index.

Apple is the largest stock on the NASDAQ. If we look below we will see that the price history for NASDAQ and Apple was similar:

^ IXIC diagram

^ IXIC data from YCharts

The heavy weight and sustained surge in Apple stock price could explain why the NASDAQ is holding up so well while many of its components struggle beneath the surface.

Identify Apple as a bubble stock

Apple has continued to rise, gaining a whopping 40% in the past twelve months. But as investors continue to buy stocks, share price outperforms business and Apple’s valuation has skyrocketed in recent years.

The price-to-earnings (P / E) ratio of the stock has increased to 31, roughly double the stock’s historical average of 15.

AAPL P / E chart

AAPL PE ratio data from YCharts

Investors should look for reasons why a stock deserves a revaluation when it is significantly different from its historical average. In other words, we need to be able to justify why Apple should double its rating. Otherwise it will be difficult to stay at this higher price in the long term; it could eventually return to its historical “normality”.

Apple has two main factors that counteract this. First, as a business gets bigger, it can get harder to grow. Going from 0 to 10 is often easier than going from 100 to 1,000. Apple’s market cap is approaching nearly $ 3 trillion, which is roughly an eighth of the entire US economy. The company is expected to generate sales of nearly $ 400 billion in 2021. Apple is just a huge company and an even bigger stock, which makes it very difficult to keep growing rapidly.

Second, this reality is increasingly reflected in analyst expectations. Analysts estimate Apple’s earnings per share (EPS) will grow at an average of 12% per year over the next three to five years; it’s a slowdown from Apple’s average EPS growth of 19% annually for the past decade. If growth is slowing but valuation is twice the historical average, how can investors support that higher price over the long term?

Why the bubble could burst in 2022

Inflation has risen dramatically this year, driving up the cost of goods and services in the United States. Raising the key interest rate is one of the most important tools the Federal Reserve uses to “cool” the economy and curb inflation.

US inflation rate chart

US inflation rate data from YCharts

The Federal Reserve currently uses a target rate of 0% to 0.25%, which means that borrowing is very cheap. It is a tool used to stimulate economic growth and often increases valuations on the stock market.

If the US Federal Reserve were to raise its key interest rate in 2022, it would likely have the opposite effect of making borrowing more expensive, cooling the economy, and lowering stock valuations. In Apple’s case, the stock is currently an outlier from its historical norms, making it susceptible to correction in a market with higher interest rates.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends the following options: long calls in March 2023 at $ 120 to Apple and short calls in March 2023 at $ 130 to Apple. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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