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Adil Reghai, head of quant research, equity markets, Natixis

After strong gains for Apple Inc. (NASDAQ:AAPL) shares over the past few months (possibly due to the lead up of the iPhone 5 release this fall), one cannot help but wonder what the future holds for it. Looking back through recent history, tales of innovative companies suffering sudden reversals of fortune are not difficult to find. Adil Reghai, head of equity markets quant research at investment bank Natixis, analyzes the numbers to ask whether the company will continue to expand or whether the cycle of positive gains nears its end.

Apple and innovation

Apple Inc. (NASDAQ:AAPL) was created in the vision of two Steves: Jobs and Wozniak, and the company’s growth has always been based on emblematic and innovative products. From the first Apple I, the revolutionary interface of the Macintosh to today’s iPhones, iPads and MacBooks, each of Apple’s products has created a new standard for the technology sector. Consumers expect Apple to offer new and pioneering products that set the bar for other companies. Apple has established its product range on a lasting basis, and while the products may undergo marginal changes, there are no radical changes of concept.

The gamble on television (which for the time being is just a rumour) may possibly create a new market segment for Apple. However, the firm could then find itself in a similar situation to Philips and Sony Corporation (NYSE:SNE) when they launched the new HD-DVD and Blu-Ray standards.

But like any fast-growing company, Apple’s valuation and therefore its share price are very sensitive to changes in market expectations for the company’s growth rate.

The company’s strengths and weaknesses can be determined by looking at the events that impact its growth rate. These include: its success in China and other emerging countries; its ability to offer new products that will drive real growth; the preservation of its likeability and premium image; how it will take advantage of its position as a leader in both software and hardware; and the profit it receives from the “captive” nature of its clients. Other risk factors simmering under the surface are fundamental shifts in demand in the worldwide mobile phone industry and legal risks concerned with patents.

It also has solid fundamentals. With a sizeable cash position of $100bn in March this year, this gives it the capacity to adjust to shifts in the marketplace.

New markets

The recent growth in China offers new sources of revenue for the company – Apple Inc. (NASDAQ:AAPL) expects to generate nearly 12% of its 2012 revenues in China.

iPhone sales increased fivefold in China in 2011, enabling Apple to show exponential growth in this country. Between October 2011 and March 2012, Apple generated sales of $12.4bn in China, making the country the second-largest contributor to the iPhone market.

Pattern matching analysis REPORT

One of the aims of quantitative analysis is to model market and company performance in order to determine possible developments and related risks.

Using a “pattern matching” technique based on mathematical concepts used in bioinformatics research, analysts are able to find similarities between two time series. We designed and applied such a tool to look for similarities between Apple’s current share price and those of a panel of stocks.

For each share in the panel we worked from, we superimposed Apple’s recent share performance on that of its closest neighbour in terms of historical share performance.

Reasons to anticipate a cycle end

Our pattern matching algorithm showed a strong similarity between the current behaviour of the Apple share and that of the Nintendo share when the Wii was launched, the Sony share when the PlayStation 2 was launched, the Nokia Corporation (NYSE:NOK) share when the group merged with Siemens in 2006, and also the Research In Motion Limited (NASDAQ:RIMM) share when it developed the BlackBerry 4. In each case, the share’s performance high was followed by a sharp fall.

Similar to the cases of Nintendo and Sony, Apple is currently in an extremely competitive market where standards and consumer expectations are undergoing rapid change.


Reasons to expect an expansion

However, growth similar to that of Apple’s was also found in the historical share performances of Microsoft Corporation (NASDAQ:MSFT) and HP: when Microsoft launched Windows 95 and when HP strengthened its range of PCs in the late 1990s. If it turns out that the market has adopted Apple’s mobile tools on a lasting basis, the company’s future could be like that of Microsoft after the launch of Windows 95.

Keep in mind too, that the success of the iPhone has made it possible for Apple Inc. (NASDAQ:AAPL) to promote the full range of its products to users, opening up a broad clientele that result in consumer loyalty. The market share of Mac OSX was 9% in April 2012, according to Wikimedia.


Investment strategies

The pattern matching algorithm tells us that there could either be a continued rise in the share price, or that there will be a brutal end to the cycle.

For the first scenario to occur there needs to be continued growth in innovation and consumer confidence and loyalty in Apple. Also, the existence of growth in China and other emerging countries would benefit the share price, as well as lawsuits won against Samsung and Google, for example. For investors expecting the share price to rise, being long in apple shares seems to be the best strategy – given the stock’s liquidity level.

On the other side of the possible outcomes, there would be an end to the cycle if there are poor earnings in China and other emerging countries, Apple TV proved unsuccessful, or there are legal problems with patents, agreements with manufacturers, etc. For those investors expecting the cycle to come to an end for Apple, we would choose a put spread that limits exposure to volatility (although there would still be a “skew” risk). This means the investor does not have to pay too much for the time value (5.57% of the spot price vs. 9.5% when buying an at-the-money put). In exchange, the gain is capped.

These strategies are just a couple of examples – other strategies are of course possible depending on investors’ risk criteria.

Adil Reghai, is the head of quant research, equity markets for Natixis. Natixis which employs over 22,000 people is located in close to 70 countries. The company trades on the Paris stock exchange.