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Apple: A Cautionary Tale

by Mitch Feierstein about 4 years 11 months ago

Great products but still a tech company.

Great products but still a tech company.

Apple Inc. is a phenomenon. One of the most remarkable companies in history. It makes products which I personally adore. It has revolutionized so many consumer markets, it’s hard to overstate the company’s effect on our lives. Steve Jobs once said he wanted to put a ding in the universe. And, in his unkindly shortened life, he did that and more.

So I’m an Apple-fan. An Appleholic. But I’m a professional fund manager and I don’t like losing money (which is probably why my investors like me). And despite all my admiration for everything appley, that admiration does not extend to its stock price at these levels.

First the facts. The company’s stock price is, at time of writing, slightly over $629. That gives the firm a market capitalization a shade under $600 billion. The company has just announced its first dividend payment (but is accumulating cash at an astonishing rate all the same). It has a cash pile of around $100 billion.

More important still, the firm trades at a seemingly modest multiple of profits. Thomson Reuters calculates that Apple trades on a forward price/earnings ratio of just 14.3. That means that the firm’s valuation is equal to just over 14 times the profits it is expected to earn in the year ending September of this year. That’s higher than the market more broadly, but then the market isn’t composed of companies growing as outrageously as Apple. It isn’t composed of companies as innovative, as financially solid, or as dominant in their niches.

And meantime, every time the company brings out a new set of financial results, they seem better than anyone ever thought possible. It’s the world’s biggest company and it’s growing like crazy.

No wonder then that there has been speculation about whether Apple could become the world’s first trillion-dollar company. And it could do. Clearly it could. You wouldn’t have to stretch that earnings multiple all that far to see a trillion dollar market cap. It could easily happen — some think it might even happen this year.

But that doesn’t mean you should buy into the story. In part there’s room for real doubt about the degree to which Apple’s results are appropriately conservative. But that’s not the main part of my concern.

Below, I’ve included two graphs. The first shows Apple’s recent price history — basically a steep ascent since 2009, then a parabolic spike this year. It’s the sort of graph which makes you wish you’d bought into the story sooner. (If you’d bought in December 1995, you’d have made 7778 percent.) And those are the sort of facts which might tempt you to think ‘better late than never’ as you plunge your family’s hard earned cash into the stock.

2012-04-04-AAPL1995_2012.jpg

The second graph tells the tale of another stunning company. A technology leader that dominated its market. That sat on top of one of the fastest growing consumer markets in history. That company was Nokia and the graph tells you everything you need to know: a stock price that started at two bucks and something, ran all the way to $40, then fell back and back and (after one further unsustainable boom) ended up at $5 and something.

2012-04-04-Nokia1995_2012.jpg
 

You don’t need much of that competition before Apple’s 44 percent gross margins become utterly unsustainable. You don’t, for that matter, need too much more negative publicity about slave-style labour at Apple’s supplier’s plants in China for production costs to start ramping up.

And these things are already starting to happen. I’ve seen a consumer review for the HTC One X which raved about it. I don’t know if that phone is better or worse than Apple’s more famous version (I’m guessing worse), but I do know that HTC will be using its price advantage to gain market share.

Apple’s enormous margins are one of the most impressive features about the company, but in a competitive marketplace they’re also acting like a huge flashing sign saying, ‘Please Mug Me Now.’ That’s not true of all big companies. Exxon drills for and ships a product of which there is a limited supply and for which there is a near-infinite demand. Much as its competitors would like to ramp up their production to eat Exxon’s lunch, it ain’t that easy. Apple makes a product where supply can be expanded indefinitely and where consumers will, in the end, prefer a nice gadget at a low price instead of a nicer gadget at a high one. That makes it vulnerable.

Me, I’m an Appleholic. I love their products and always will. The stock price though? For me, that’s a punt too far. If the market cap hits a trillion bucks, I’ll be shorting the stock like crazy. I don’t like bubbles — and this one’s looking frothy.

I published this in the Huffington Post and it may be found here.

2 Responses to: Apple: A Cautionary Tale

  1. ADRIAN says:

    Apple stock price is worth every penny, That’s if you are smoking the right stuff.
    The insanity of the speculative markets continue to be cheered by deceptive advocates who have made fortune but don’t acknowledge the actually cost to the United States future which is likely to see a declining standards of living in the year ahead . This is all done for a cause, so that a handful of people can make their billions by manipulating the stock market to show an illusion of prosperity returning to the economy.
    The analysts who are projecting Apple stock to reach $1000 a share are the likely the same expletive, which made though wonderful forecasts about similar bubble stocks during dot com bust.

    I would have like to use the actual word which best describe these analysts, but I probably would be censored.

    The rapid rise in apple stock price has nothing to do with current earnings but is based solely on speculative growth with GREAT EXPECTATIONS that sales growth will increase by 20% annually or more for the next five years. This is why the cheerleader believes apples stock is significantly undervalued even though it has increased by over 250% in the less than 2 years.
    If apple stock price continues to increase, don’t jump for joy. The continually increase is nothing but herd investing which has caused apple’s stock to increase by 56 % since the beginning of the year.
    It was not long ago the herd believed that house prices could never go down but would continue to increase rapidly year over year. Just as the apple cheerleaders believe its stock price cannot decline, but will continue to increase. As long as the herd believes the fairytales being promoted in regards to Apple’s sales growth its stock price will increase. As soon is its earnings and net income do not meet the ridiculous expectations it will drop.
    FACT:
    Apples 2011 net income is reported to be 26 billion on revenues of 128 billion. This is a 185% increase from Apple’s 2010 net income which was 14 billion. A good majority of Apple earnings came in the 4th quarter, I.E holiday season when it s gross earnings increased by about 18 billion from the previous quarters to over 46 billion. Unbelievable wouldn’t you agree?
    The herd believes that Apple can expand it sales by 20% a year for the next 5 years is a deception. To accomplish this apple sales will have to increase to 153 billion in 2012 and by 2016 and have annual sales of 318 billion.
    I don’t know how the herd can believe this fabrication. I guess they are smoking some good dope.

    Based on last year revenue and the prediction that sale will increase by of 20%, Apple’s net income will not exceed 40 billion in 2012. Apple’s net profit is approximately 20% based on 2011 earnings and net income.
    Sales – cost of goods sold / sales = net profit
    128 billion – 102 billion / 128 billion ≈ 20 %

    2012 revenue if sales increases by a 20%.
    128 billion X 1.20% ≈ 153 billion
    2012 estimated Net Income from gross sales.
    153 X 20% ≈ 31 billion
    Every additional billion of net income will be more difficult to earn, due to its enormous size which is 1000 million. If the analyst’s 2012 forecast are correct Apple’s revenue will increase by 25 billion or 25000 million dollars. This amount of money buys quite a few Ipads, downloads and other apple products. How many more apple product can the market absorb?
    By comparison NASA Space Shuttle operating budget in it last year was 3 billion. I provide this as an illustration, to give the cheerleaders a clued about the staggering amount of income apple currently has.
    Apples net income from the past five years, from 2007 to 2011 is approximately 56.5 billion. A major jump in sale and income came in 2010 to 2011 when its net income increased by 11.91 billion.
    What is never asked is how a company with a net income of 26 billion in 2011 can have achieved a market capitalization of 590 billion. I realize there is a difference between market capitalization and the use of a capitalization rate to determine value. However, market capitalization is a qualitative value not easily determine as it represents the public consensus on the value of a company’s equity and in Apple’s case it has been inflated.
    The use of a capitalization is a quantitative method to determine value from quantifiable data such as income and expenses.
    It is relatively easy to determine Apple value utilizing its net income and a capitalization rate. Apple average net income over the last 5 years is 11.3 billion. This income average would typically be utilized to estimate a value.
    But let’s assume an unlikely scenario that Apple net income is 40 billion in 2012.
    If a typical capitalization of 10% is applied to this net income, a value for the company can be estimated:
    40 billion / 10% = 400 billion.
    But to entertain all the promoter of apple stock let utilize a capitalization rate of 6%. The lower the capitalization rate the less risk involved with the investment, consequently a higher value.
    40 billion / 6% = 666 billion.
    I did not calculate that number on purpose. However it is interest. Maybe, apple stock price is associated with one of the deadly sins – GREED. It certainly appears to be.
    I acknowledge the capitalization rates are assumption, but historically a 10% rate is typically used by investors. By this analysis Apple’s market capitalization appear to be in excess by at least 265 billion.
    Now let get to the 1000 dollar a share price which every analysts and his brother are saying Apple stock will achieve in a relatively short time. This will mean that Apple as a company is worth a Trillion dollars with a the capital recovery of more than 25 years on the money invested as Apple’s net income will likely stagnate at 40 billion, due to the enormity of that sum.

    Apple’s income growth is beginning to slow, but this does not stop the analysts from developing deceptive forecast about Apples future growth citing its relatively low market share of worldwide computer, Smartphone and Tablet sales.
    One must ask who is paying these analysts for these deceptive forecasts. Could it be the herd on Wall Street which severely damaged the US Economy by all the financial instruments which were developed, supposably to limit risk, but were merely another device which allows them to hedge their bets? .
    It’s not surprising that the 70% of Apple’s stock is owned by institutional investors. Apple as company is a great candidate to collude on, due to its incredible growth rate over the last 5 years and the difficulty in evaluating its most important characteristic which is the marketing of its products.
    Marketing is an intangible asset, akin to Goodwill which is very difficult to evaluate There is a reason, Apple’s sales are less than its competitor which is due to their considerably higher cost, which in many cases are functionality no better than their competitors. But if you listen to the experts, it’s like Apple has no competitors or competing products which the consumer can choose, but can only buy Apple products.
    I have several apple products, including an ipad which is nothing more than an oversize iphone. The Ipad functionality and interface are significantly inferior to a lap top. The appeal must be to the herd, which is high on something and give them a convenient place to watch video as its utility is more like a toy than a useful device.
    If Apple wishes to capture more market share of sales it will require developing additional products with lower prices as the more affluent market have been saturated, leaving the less capable market the task of buying all though millions products which are forecast to be manufactured and sold by apple in the coming years.
    Just as computers, big screen TVs and many other electronic devices have been commoditized, so will apple products if they wish to generated more sales. This directly related to Apple’s value and alleged income growth potential. Guess what else is affected by a lower sale price? That right earning and net income will be lower, which is another reason Apple income will stagnate.
    I could go on about why apple stock is a bubble, but it would be in vain as the herd does not wish to sober up as the dope Wall Street is selling is that good. Maybe I need a toke.

  2. Mitch Feierstein says:

    Adrain,
    Thanks for your very detailed comments. They are most appreciated!
    I originally published this piece in the Huffington Post.
    The defensive “Apple worship” factor exhibited in the comments that followed amaze me, did someone put something in the water?
    Anyway, this frothy behavior is typical of bubbles… Thanks again.
    Best
    M