Apple Must Innovate Its Way Out of Market Slump

NEWS ANALYSIS: Apple’s falling stock price, sliding price/earnings ratio and disappointing iPhone 5 sales are signs that the company has to start innovating again if it wants to get back on a growth track.

Apple’s price/earnings ratio dropped to 10 while I was on the phone with financial advisor Mark Miller of Wells Fargo Advisors on Jan. 25. Microsoft’s P/E ratio was at 15 at the same time. So why should you care?

Unless you’re an Apple investor, the company’s P/E ratio in and of itself doesn’t matter that much. But what does matter is that a low P/E ratio from a company with strong earnings is a symptom of a company in trouble down the road. And there’s no question that, given its current situation, Apple is heading for trouble. In the long run, that trouble can affect you as a customer.

On the surface, Apple’s low P/E ratio is a sign that investors don’t think the company has a lot of potential for growth. As Wells Fargo’s Miller explained it to me, this is primarily psychological. Big investors want to own parts of a company that they see as staged for strong growth. Because of a number of missteps by Apple, it’s losing its edge.

Part of that perception of loss comes from adverse reports from analysts such as CNBC’s Jim Cramer, who accuses Apple of arrogance in its unwillingness to explain its financial performance. Cramer said that Apple’s $137 billion cash hoard needs to find a use in product development, dividends, buybacks or acquisitions. Right now, there appear to be no plan to use it for anything.

Others point out that Apple’s poor stock performance is due to a number of reasons. Many people, it seems, sold off their Apple stock in the fall of 2012, both to profit from the then-high price, and to turn it into cash before tax rules changed at the beginning of 2013. In addition, big institutional investors have rules that govern the percentage of any stock they can own, and when Apple stock shot up in value, they were forced to unload it.

But the real drag on Apple’s stock and its P/E ratio is lack of confidence in Apple as a company. While nobody expects the company to stop being profitable nor is anyone suggesting that Apple’s in immediate financial trouble, that doesn’t translate into Apple being a great investment. What’s the point, for example, in buying Apple stock if it’s not going up in value consistently, and the company isn’t paying dividends despite its huge profit margins?

Adding to the lack of confidence is the belief that Apple has lost the ability to innovate. The iPhone 5 is a good example of that. At best, the iPhone 5 was an upgrade to the iPhone 4S, with the primary difference being support for LTE and a slightly larger screen. Macintosh computers went for years without an upgrade and when the upgrade was delivered the primary difference was a better display.