by Karim Rahemtulla, Investment U’s Options Expert
Tuesday, December 14, 2010: Issue #1407
If you had to put money on one big winner this holiday season, I suggest you head west.
Specifically, to Cupertino, California, global headquarters of Apple (Nasdaq: AAPL). The tech giant’s shares are still the talk of the town and its smash-hit products will again be found under millions of trees and stuffed inside stockings on December 25 – just as they have for the past decade.
Since the introduction of the iPod, Apple has ruled the Christmas season when it comes to cool gifts. The company seems to come up with one nifty idea after another – from the iPod, to the iTouch, the iPhone, and now the iPad, which is making the rounds this year.
As a result, Apple shares are setting frequent new highs. Which brings us to the key question: Not whether Apple will report record-breaking earnings, but whether the shares can stand the dizzy heights…
The Market’s First Trillion-Dollar Stock?
If a company’s shares should trade based on that firm’s valuation, then if Apple continues to churn out profits at a blistering rate, its shares must rise, too. After all, if that doesn’t happen, the price-to-earnings and PEG (price-to-earnings growth) ratios will be exposed as inaccurate measures when put up against emotions.
But at what point do Apple shares become ridiculously valued?
Last week, Goldman Sachs (NYSE: GS) boosted Apple’s price target to $430. Other estimates have it as high as $500 per share in the coming year. At the $500 level, Apple’s valuation would be around $460 billion, on sales of $80 billion and earnings of around $20 per share.
To put that in perspective, only a couple of times have shares come close to the $500 billion market cap level. Exxon-Mobil (NYSE: XOM) was close once, as was General Electric (NYSE: GE) and Microsoft (Nasdaq: MSFT). All three fell back sharply.
Nevertheless, if those valuations hold up, there should be no stopping Apple’s eventual rise to $1,000 per share and that vaunted trillion-dollar market cap designation. Of course, that means the company would have to continue growing in leaps and bounds.
Do I think Apple will hit those dizzy heights?
No. But only because investors won’t allow it to do so. And consider this: If Apple does approach that valuation, it would represent 7% of today’s U.S. GDP and make the company bigger than 80% of the world’s economies.
Is Apple really worth that much? Time will tell. Until that time, I see no problem with a move past $500 billion in value, since that’s well within the historical achievement of other U.S. corporations.
But if you’ve missed the Apple train so far, there’s still time to jump on board. But a word to the wise: Not with the shares…
A Smart Play on Apple
Apple’s potential share price upside from here is about $100 to $170. But there’s a better way to play this growth story than with regular share investing.
With long-term options.
Right now, for example, you can buy LEAPS as far out as January 2013 – a full two years from now. So if you want to bet on the possibility of a meteoric (not to mention historic) rise in the shares over the next 24 months (and two more Christmas seasons), consider using a LEAP spread.
Simply put, this is where you buy a call option at one strike price and sell another call option at a higher strike price.
For example, you could buy the Apple January 2013 $330 call for $64. As part of the spread, you could sell the Apple January 2013 $480 call (the highest available right now) for $23, which would bring your net cost to about $41 – about 12% of the current share price. The profit potential would be $150 ($480 minus $330).
The beauty of using LEAPS here is two-fold…
- It would significantly reduce your cost in a trade and still give you pretty amazing upside potential.
- As with all momentum/growth stocks, when they fall, they fall hard. So if/when Apple shares do buckle under their own weight, the owners of LEAPS will likely lose far less than shareholders.