Wednesday, October 10, 2012

Apple After The Riot, Shortage, Strike, Etc.

Seeking Alpha has published a new Jaded Consumer article: "Apple After The Riot, Shortage, Strike, Etc.: Still A Buy?".  It's been designated an Editor's Pick.  Enjoy!


angry listmaker said...

So what should AAPL be worth? my normal investment strategy is to estimate a company's value and invest when the price is significantly below my calculated value. If I didn't know AAPL was AAPL, looking at their earnings growth and pristine balance sheet, i would say there is no good reason they shouldn't trade at book value plus a 30x P/E for this year or a solid 20x P/E on next years estimate (i think those are conservative multiples given the enormous growth rate). But, that all too obvious valuation would put aapl between 875 and 950. Why has AAPL never approached a fair value? I have (stupidly) never invested because rapid growth terrifies me; especially in company as "cool" as Apple. AAPL seems to be a stock that breaks the mold of standard valuation methods. So, Jaded, what value would you assign to AAPL?

Jaded Consumer said...

@Angry Listmaker:

First, I disagree that a non-purchase decision based on concerns you don't understand a company or its industry is a decision made "stupidly". You are acting conservatively, and there is a vast gulf of difference. People who chase "smart money" frequently end up losing theirs. Buffett backs your position: he famously avoided tech even when tech was doing extraordinarily well, and he's done just fine avoiding risks he didn't get. The key is, he found risks he _did_ get and invested in those.

As for next year's estimates, I find it distasteful to fix value on future speculations when good data exist. Based on actual trailing earnings, Apple has traded this year from about 13 to about 16 P/E (not adjusting for cash; if you subtract the cash and divide, the numbers look even more conservative). Apple recently put about $10B in cash onto its asset list in one quarter, and it hasn't any debt. Based on its recent historic growth, there's little basis to expect that today's prices will yield a trailing P/E next year of 20 or 30, unless Apple's sales don't just falter, but plummet off a cliff. The current evidence is the opposite: Apple can sell every smartphone it can make and based on currently-quoted shipping times, still has weeks of backlog. And unlike every other PC maker, it's growing. And the iPad business appears to be exploding, particularly in China where Apple is enjoying enormous growth rates.

Viewing the current P/E and the sales and earnings trends, I view today's prices as looking cheap next year. The exact prices Apple will trade next year are not really my realm of expertise to guess – I like investing over multiple-year periods – but I don't think the numerous people clamoring for a four-digit price tag are all smoking crack. I expect double-digit earnings growth even if the economy remains in a hospital bed, based on ongoing and outstanding growth in China.

Look at a P/E chart for the last 10 years, and you'll see Apple really did have much higher P/E at some points. At present, I think people are reacting to sticker shock instead of valuation metrics. It's like when I decided not to buy BRK at $4k in the early 80s, because $4k was a ton of money for one share of stock. Well, look at it now ....

(Not that AAPL is BRK.A, but the sticker-shock principle certainly seems to apply.)

angry listmaker said...

I am sure that Sticker shock has affected me personally. Your analysis touches on a lot of points that I have considered, you do seem to look at it from a slightly different angle than I. I generally agree with your use of current data vs future speculation, however I would contend that aapl earnings estimates over the next couple of years are going to be in the ballpark of actual earnings and so they are informative. To reference Buffet again, "I would rather be approximately right than exactly wrong." So I use earnings estimates to get a feel for what to expect over the next few years.

I don't need to know exactly what AAPL should trade for, I just want to know what about what it's fair value is and then buy or sell with that value in mind. I am just dumbfounded that with such incredible growth rates and an impeccable balance sheet, that the market could assign a discount P/E to AAPL. I don't understand it. If it's valuation had gone become irrationally high and then dropped to irrationally low, that would make sense to me. I just don't understand why it seems to stay low. I worry that it will never reach my estimated "fair value" only because it never really has. I also worry that earnings misses, which I normally ignore, will have a disproportionately large effect on aapl. I just don't understand how in this case, the stock price could be so disconnected from the business it represents. your analysis of ACAS is second to none and based on that analysis it is very easy to see why ACAS is undervalued. It has a relatively opaque balance sheet and easily misunderstood business. AAPL suffers no such handicaps. It makes one of the best products in it's market and has a loyal fan base. It also enjoys substantial margins on sales of those products. Apple has also made it difficult for users to switch to competing products. The world knows this story and aapl still trades at a substantial discount. why? So my question for you is, at what price today, would you say "I think apple is fairly valued and I might be able to find better value elsewhere"

how can Apple valuations be reconciled against even wonderful companies such as Amazon, Microsoft, McDonalds? Sticker shock is a possible explanation, it just like too simple a problem for the billions of dollars looking for a parking place to not figure out. (tired and have been drinking Pale Horse from No Label Brewery, excellent btw, hope my arguments have been coherent)

Jaded Consumer said...

My view on Apple, and on the likelihood that "the market" has it right on Apple when it forecasts ho-hum results, is no doubt heavily colored by my experience with Apple when it traded at $20.35 two splits ago. I asked myself whether "the market" knew something about Apple's technology and prospects that I didn't, or whether it was possible I didn't get Apple. So while I didn't exactly "back up the truck" I bought some shares.

Later, after the Mac Cube debacle and Apple's 50%-in-one-day haircut, I asked myself a similar question. Was that one product really all that, to Apple? The market priced Apple as if it were, and as if one misstep proved Apple had lost what had made it valuable after the release of the iMac G3. So I bought.

My biggest problem was getting bored while I was waiting for my thesis to play out: I decided to create some income by writing covered calls, which (as you may surmise from the fact Apple's current price doesn't look like it suffered a 50% haircut from the 50s after a split) caused me to lose most of my shares (at a profit, but not at the profit of a continuous holder).

Currently, I'm looking at a company that's got an outstanding vertical integration program, peerless supply-chain management, outstanding technology ownership and technical expertise at all levels of the product's design, and strong brand acceptance of a sort exactly the opposite of Apple in 1997 when I started looking at it in earnest as an investment (because it had bought the Unix outfit NeXT).

Apple's opaque balance sheet is doubtless intended to keep competitors from identifying the places Apple is subject to pressure (from competitors, or from investors trying to micromanage Apple's pricing strategy).

My question is simple: is there evidence Apple's valuation has become irrational? I look at current earnings and recent earnings trends and I simply don't believe the lowball growth predictions of those who are suggesting next year should look like this year. I believe Apple's growth in China is strongly connected to Apple's product quality and brand strength, which competitors aren't in a position to challenge yet in China or anywhere.

Comparing Apple to Amazon is extremely favorable to Apple. Why Apple should carry a P/E like McDonalds' is a real puzzle given the companies' relative positions. Microsoft has to lose money to enter markets in which Apple has earned profit from its first quarter of entry. Why should Apple trade at a Microsoft P/E?

Send me your email in a message I won't publish. I have some questions about Pale Horse and other things in which I lack expertise :-)

angry listmaker said...

I ended up purchasing apple during one of the recent pullbacks. I think it was the right decision. when I found myself repeatably defending apple's valuations to colleagues. they argued that it's soaring price, misteps with maps, and lack of entirely new and original products recently meant it was no longer a good investment. In explaining why none of that really matters since they are still extremely profitable and will be for the foreseeable future, I confirmed to myself that I should buy shares.

My comparison to Amazon indeed favors Apple as an investment. In fact, I have opened a bear put spread on AMZN because i can't begin to understand it's valuation. My motive for comparisons to MSFT and MCD was to pick solid companies that are industry leaders with relatively low growth. both are quality companies without major risks. I meant to argue that with apple's growth rate, there is no reason Apple should trade at a P/E discount to either of these companies. Now i just have to convice all my friends that they need more ipads and itunes and ipods and iphones.

Jaded Consumer said...

Back when Apple was about iMacs (before the iPod, when I thought it was a turnaround story based on Unix and thoughtful industrial design and improved operations), it was a lot harder to get your friends to buy Apple's products. Now that Apple's lineup has broadened, it's quite a bit better. So good luck with your marketing efforts: we all benefit :-)

As between Apple and Amazon, they're nearly opposites: Amazon is a thin-margin master hoping to expand profit distributing huge(r) volumes to the masses, while Apple is the master of maintaining high margins targeting products to discriminating buyers. The relative P/E of the firms says quite a bit about the market's buy-in of each company's thesis: Apple has room to run, and if anyone decided Amazon would be unable to expand margins or had hit a ceiling in online sales share, it's got much more to lose.

I think part of Apple's issue is the sticker shock of >$500 shares. I would have bought Berkshire Hathaway A shares when they were at $4000 (before there were any B shares) if the company's sticker price were lower. (Buying odd lots in the 1980s was an awful exercise in punitive transactions costs.) So I get it.