Search This Blog

Saturday, April 16, 2011

examining a trade... AAPL

I have made no secret that AAPL's poor performance has been fucking with my portfolio over the past two weeks.  The only time it was up meaningfully since the beginning of April was when the SP500 was down.

Here is a break down of the examination:

A. Fundamentals - "Fundamentals" is a loaded word with a ton of subjectivity, but an objective look gives an objective perspective. The fundamentals look at the current valuations (ie numbers), product/earnings growth trends and company leadership. Then, an assessment as to how the growth trends and management are being discounted via the numbers

1. the numbers

a. trailing PE - over the past few years AAPL's trailing PE has been shrinking. This is obvious, and expected given the level of growth and increasing size of the company. Over the last few months the trailing PE ranged from 19 to 23. (Conservatively, I have used the PE of 19 to be my valuation guide.)

The current trailing PE is 18.27 with a stock price of 327.46

b. forward trailing PE - when AAPL reports on thurs, they are estimated to produce $5.35eps. Looking a head a few days, and factoring in the 5.35, the trailing PE after Thursday (assuming a stock price of 327) will be 16.41.

Basically, the market is saying AAPL, as an overall company, will have an earnings growth rate of 16.41%. (This is below consensus analyst expectation of a 5yr +20% growth rate.  Analyst expectations mean shit to me, but it just so happens that the evaluation of Apple products jive well with the expectations. This will be explained under 'product trends'. )

c. ex-cash trailing PE - this metric is used to assess the valuation placed on the underlining businesses of the company.  A high cash position can lead to a higher trailing PE because the underlining businesses are assigned a PE more inline with industry and peers.

As of 04/15/2011 via the 10Q on file, Apple's cash position (short and long term securities) totaled $59,707 billion. With a total shareholder count of 921.6M, the cash-per-share is $64.79.  With a stock price of $327, the ex-cash trailing PE is 14.65. (Basically, the street is valuing Apple's businesses with a growth rate of 14.65%.)

If we conservatively assume that Apple will show an increase cash position of $10b on Thursday (as last quarter's increase was +$13b), the cash-per-share will be at apprx.  $75. With a stock price of $327, the PE placed on the businesses will be approximately 14.05.

The numbers above are meaningless until they are compared to the growth trends...

2. earnings/product growth trends

a. The 5-year projected earnings growth for Apples is at 20.78%.

We all know analyst expectations are bullshit. Although Wall Street analysts are kept in check by the really good 'amateur-blogger' analysts that provide fairly accurate assessments. This competition and continued risk of humiliation from the bloggers keep the professionals fairly honest.

These expectations can be used as a basis, but I continuously monitor web-chatter to ensure these expectations are being met.

b. media/web chatter regarding product demand

1. verizon iPhone - iPhone out selling Android in Feb; confirmation of iPhone out selling Android

2. computer demand - nice demand for the MacAir; IDC and Gartner have a 8-9% increase in Mac sales while the general PC industry consolidates (one of the most significant piece of information that may have AAPL beat estimates);

3. smartphone growth - the market will continue to grow, +50% this year. (While iPhone adaption will indicate a clear slow-down in acceleration, healthy growth in the over all market is unquestionably present with Verizon adoption and general market growth.)

4. corporate demand - an indication of the corporate demand for the iPad 2 was this article highlighting European companies delaying their paperless boardrooms until they got the iPad. (Since the iPad was introduced, corporations have been seeking and adopting the device. Analysts are predicting some 45M to be sold this year!)

c. product evolution  (for future growth based on the current chatter)

1. App/Mac Store - iTunes - The Mac Store is seeing a significant revenue generator for developers, with the average top selling price of $11.21 and Apple gets 30%. Subscriptions are gaining traction amongst publishers. (This is a low margin business for Apple, but the scale will become meaningful to the bottom line. Think Walmart, low margin but a shit load of profits.  With the subscription model now in place, this growth will soon become meaningful.)

2. NFC - Near Field Communication embedded within the iPhone 5. Apple will be able to leverage their iTunes billing system to create a payment system. Their approach is still very unclear. We do not know if they will simply utilize the credit card system (lower margins) or create a PayPal approach (higher margins). Regardless of the approach, with 10s of millions of iPhones worldwide, this will be a low margin, but highly profitable business via the huge scale. (There are hurdles to this, like having the NFC tech implanted within the retailers and the banks playing along, but recent chatter has the banks playing along.) 

3. tv (consumer and enterprise) - The TV chatter is getting louder. If we are simply to assume Apple will combine the AppleTV box with a television, and sell it, that alone is entering a $100B market, and that is the obvious evolution, especially for the consumer market. (Which is not bad, and could provide really nice growth prospects combining the subscription iTunes model and video rentals.) But Apple is rarely obvious.  When I think of the iPad, I think of a mini TV people can interact with.  When I think of the 'concept of the iPad'+'AppleTV' equals a 56in interactive computer that people can use as a TV.  People's living room may not need the interactive functionality, but corporate conference room most definitely will utilize a concept like this to substitute a whiteboard.

There are other things, but those things do not produce sizable or legitimate chatter to incorporate into a realistic analysis.

3. management

As all humans do, the fact remains, Steve Jobs will eventually pass away. But the one thing that strikes out at me when I look at the information above, these trends are not dependent on one man. Apple has a very strong bench, and many who were inspired by the philosophy of Steve Jobs.  These trends will continue to exist for a few years so long as the company's culture is intact. (Anyone attempting to profit from the death of any person does not deserve my respect, and I say 'fuck you' to them.)

Conclusion to the Fundamentals - When I take a step back, and observe the potential macro-growth of the businesses and the demand of the products, I have a very very hard time attempting to justify an ex-cash trailing PE of 14.65 on Apple's businesses.  When I then look at the current growth of their products, in relation to the demand and market growth, and the potential of the relatively known aspects of the new product lines, I have a really really hard time justifying a trailing PE of 16.41 for the company.

The growth and demand does not merit a multiple contraction yet. The macro trend simply does not support a multiple contraction.  Apple's businesses (ex-cash trailing PE) deserve a multiple closer to their growth rate, which is closer to 20 verse 14.  But conservatively speaking, Apple at least deserves the trailing PE to reflect the growth of the company, which is around 19-20.

(AAPL can not be compared to its peers for valuation. Apple is benefiting from a contraction of Window based systems (97% to about 50%). So that means MSFT, DELL, HP, Nokia etc all deserve lower multiples reflecting this contraction.)

B. Mechanics of the Market

In early April, the Nasdaq announced the re-balancing of the Qs. With this announcement, AAPL started to see heavy pressure. The actual re-balancing will take place on April 29th, but the bigger issues are the 'dumb' fund managers or index funds that mimic the Qs. (I have seen numbers between 2-3 thousand funds that mimic the Qs.) This produces a shit-load of selling pressure.

I have evaluated every intraday chart since April 1st. For the most part, AAPL trends similarly to the SP500, but there are times were they clearly diverge, and I believe them to be funds unloading based on their indexing of the Qs. (April 12th and 13this the are the only days I do not see a clear forced or automated selling.)

Overall Conclusion

The market is never perfect. Inefficiencies always exist, but eventually the market removes these inefficiencies. There is an obvious and artificial selling pressure based on the mechanics of mimicking an index. (I do not know how these fund managers are still employed, but the fact remains this dynamic is taking place.) IMO, this re-balancing, along with market weakness, is causing a severe inefficiency.

I do not see a justifiable reason as to why the market would give AAPL a severe multiple contraction, the evidence simply does not exist.  The industry, product and earnings growth trends (mid-to-longer term) are all in Apple's favor.


  1. Thanks, Echo. That was a really well thought out and coherent analysis. It's always fascinating to me how long market participants can seemingly ignore what is staring them right in the face, but I guess that's what creates opportunities, right?

    One question: Do you have thoughts as to what should/might/will be done with a nearly 23% of market cap cash position?

    Thanks again, Dan

  2. Thanks Dan. There is such a dislocation, and multi-year trends still present, Apple should take advantage and announce a buy back. (To me its a really good allocation, but they are not known for such things.) If anything, a massive ($20-30B) buyback should be announced and ready to take advantage of this types of weakness and/or when the inevitable happens.

    With respect to IBM, I know when they see a dislocation they will take advantage, and buy back their shares because of their buyback program. There is a level of uncertainty removed knowing they are there when other players are not. Companies like AAPL and GOOG can instill the same level of certainty if they did this with the cash they know they are not going to use. (They have been in business enough to know how much cash they need a few quarters-to-a-year out, with a comfortable margin of safety.)