Apple common (AAPL)
Last month I started writing under the pen name of Veblen on pecuniary.wordpress.com. That blog was supposed to mark my conversion from a “value investor” to just an investor–with the new belief that fundamental value is only one datapoint in the process of picking securities. Well, I’ve decided to repost my work here in order revive Stableboyselections.com.
Below is my writeup of Apple Inc. Just a few days after posting this I found out that David Einhorn had taken a position in the stock.
There is no momentum in the money management business. If I net 40% in a year, this has no bearing on how much I will net next year. In some businesses, though, momentum works in powerful, self-sustaining ways. Take Apple Inc. as an illustration. When the iPod came out in 2001, competing digital music players had at most one-fiftieth the storage capacity and syncing with computers was a hassle. As more and more people got iPods, Apple’s fixed costs didn’t look so big. And it got volume discounts from its component manufacturers–Toshiba made the hard drives, Sony made the batteries, etc. So Apple could sell the iPod at exactly the same price as inferior competing products and still earn similar gross margins. Satisfied iPod users spread word of the marvelous device to the point where Apple’s advertising was just done as a matter of course. Sony’s Walkman business evaporated in about a year, and so did Apple’s many short sellers.
Here we are almost ten years later, and Apple’s momentum is still strong. The iPod has no competition, everyone wants an iPhone even though it has frequent dropped calls and the iPad is just beginning to disrupt the laptop market. Apple is taking on more share of mind in every country, even in Japan, where the best gadgets are supposed to be invented. Individuals aren’t the only ones in the trend; corporations and universities are spending more of their IT budgets on Apple hardware.
The decline of Dell, Sony, Microsoft, Motorola, Research in Motion, etc., reminds me of the American automakers over the past three decades. For years they ran their business just going through the motions and ignoring cues from the market, namely, declining share of mind.
Now Apple controls the destiny of its competitors in a way that would make David Ricardo proud and trust busters miserable. Most of the components in Macbooks, iPods, iPhones and iPads are manufactured by other companies. (See here: http://texyt.com/iphone+manufacturer+supplier+assembler+not+apple+00113) Since Apple has the most critical mass in the electronics business, it can decide which manufacturers will thrive and which will perish. (A good source of short sale candidates might be OEM’s that Apple is avoiding.) It still gets the lowest prices on components per unit.
So what is my valuation of Apple common? I’m not going to fool myself into thinking that there’s any science involved in answering this question. (In my experience the “science” of valuation is lost on companies with extreme competitive advantages.) All I know is that there are a lot of people in the world. A lot of these people like to own Apple products, whether for status, utility or plain fascination. There is a high probability that Apple will be earning a lot more five years from now that it is currently. I think we will look back and think that today’s price is very cheap.
Disclosure: Long AAPL.
Hi please do keep an eye out for Android, it’s catching on pretty fast
For now Apple has the top shelf in people’s minds all around the world. Just visit an Apple store here in the city and see how foreigners who can’t yet buy the iPhone back home are absolutely blown away. This gives you a big margin of safety as far as earnings power is considered. I am watching out for everything coming from the Android camp. If they start invading Apple’s share of mind, I will sell the stock.
Disappointed to see you ignore valuation here. Apple is indeed a great company, but that doesn’t mean it is infinitely valuable. At 230 billion dollars, where is the margin of safety? What if Apple can “only” grow earnings by 8% per year for the next 10? Doesn’t that make this fairly valued at best? The earnings growth will slow at some point, won’t it?
I haven’t abandoned the valuation approach altogether. I do believe that intrinsic value can be estimated within a wide range based on the probabilities of various outcomes. But this framework is very easy to abuse. The worst offenders are Graham-Dodd types who haven’t realized that the world has changed since Security Analysis was first written. You can’t just buy a stock for less than book value and expect good returns. The stock is probably cheap because the business has bad prospects or managers. This is the same reason that low p/e stocks have tended to become capital traps in recent years. The market gets more efficient over time.
Even to a traditional “value investor” AAPL’s p/e ratio of 15 (after netting out cash) is very low. But I’d rather think about the company’s value a little more intelligently–with a comprehensive view of the qualitative factors. Read Charlie Munger’s speech on Coca-Cola to understand my thinking a bit better.
The world hasn’t changed that much. I bought Apple in the 70′s and held it until the low 200′s, and my thesis the entire time was based on fundamental analysis. Obviously not a Ben Graham net/net type of approach, but Buffett/Munger all the way. At that time (2006-2010) I was comfortable projecting cash flows that I felt were very conservative, and which led to a valuation 50% higher than the market price.
At this time however, you nature of large numbers prevents you from projecting 50% earnings growth far out into the future. The company is NOT going to earn a trillion dollars a year a decade from now.
Speaking of Munger’s KO speech, you can buy both Coke and Pepsi in their entirety for the price of Apple, and you’d get a lot more cash flow out of the deal.
Why would AAPL need to earn a trillion dollars or grow earnings by 50% a year to justify the current price? At a p/e ratio of 15, all it needs to do is grow earnings by a slight amount for the current price to be cheap. Keep in mind they’ve barely started selling products to the rest of the world. The demand is there… it’s just a matter of time. The doubters refuse to accept that Apple has done something no other consumer electronics company has ever done–namely it’s created the de facto device in three huge product categories. Sony never pulled this off, but if it had it would deserve a huge valuation.
Your mention of buying AAPL in the $70′s sounds like Monday-morning quarterbacking. When the stock was that low, the company had only one hit product. It looked expensive based on all kinds of valuation metrics–even more expensive than it is now. The point is that there are qualitative factors that override a simple interpretation of the numbers. Expect more new revolutionary products and exciting updates of older ones. Imagine an iPad with the Retina Display. Or how about a touchscreen Mac? Apple has almost $50 billion in the bank and their R&D spending is up… a bunch of good surprises are on the way.
Yes, there are a lot of people in the world. However, the vast, vast, vast majority of them cannot afford Apple’s bling. Don’t believe me? Then check out the sales figures for iPhones in India and China. BTW, there’s a reason that the figures aren’t easy to find – it’s because they aren’t pretty.
Hmm. iPhone sales in China are low because Apple has just started to play in that market. Did you hear the comments from Lenovo’s CEO a few weeks ago? He said that he felt lucky that Apple didn’t seem to compete very hard for business in China. That’s going to change gradually as Apple opens its second store and then a third and then dominates the country.
Can you think of items that people can’t reasonably afford, yet people buy them anyway? Luxury cars, designer handbags, etc. You can safely include Apple gadgets in that category. I’m just observing human behavior here. If something conveys status, people will desire it and work harder to get it. That explains why Apple is blowing away revenue numbers in the Great Recession. I recommend that you read some of Veblen’s work.
In response to the monday morning quarterback jab:
http://www.gurufocus.com/forum/read.php?2,45784,45813#msg-45813
Look at the second post on that link, January 21st, Apple was trading in the mid-80′s and I’m clearly talking about owning it. I wasn’t active enough online in 2006 to find evidence that I owned it then too, but if you wanted to bet some real money on it, I could produce the tax returns.
Apple doesn’t need to grow by 50% to justify the current price, but “justifying the price” isn’t enough to make the type of returns that I expect of myself – I can buy a CD at the local bank if I want an investment that merely meets its expectations. I want to buy stocks that will perform wildly beyond what the market seems to be predicting, and with thousands of stocks to choose from, I can’t see Apple at $230B being one of the more likely candidates to do so. It was at various points in 2006, 2008, but not now.
Although theoretically the value of a company should equal the net cash value plus earning power, investors rarely ascribe any extra value to public companies with high cash balances – unless they believe that cash will be given back to shareholders or used for an accretive acquisition.