I concluded that Apple stock was undervalued by 25% or so and said the stock was "hardly a huge bargain" but "a technical oversold panic bottom in the coming weeks should provide an attractive entry point for a long-term investment in Apple stock." We have the makings of this attractive entry point right now.
The reasons are several fold:
-GAAP earnings are a misleading estimate of how much money a company is making yet this measure is adored by stock analysts and investors. What matters in a stock according to the greatest stock picker of all-time Warren Buffett is what he calls "owner earnings" my interpretation of his measure as applied to Apple is operating cashflow minus capex calculated in a special way (for capex I added Payments for acquisition of property, plant and equipment, Payments for acquisition of intangible assets and the "Other" component from the 10-Q) adding back in asset sales (since they represent recovery from old capex).
Apple's owner earnings grew by 30% from the Q4 last year($20.9B vs $16B).
This quarter was simply right in line with my expectation that the compounded growth rate of Apple's owner earnings will slow from the historical 44% from 2006 to 2012 to something more like 25% this year and all the way to 5% over the next years as competition and market maturity drives down its growth rate. I have no delusions that Android competition won't hurt their margins or anything along those lines. Its all part of my model.
-The growth rate in owner earnings was actually higher than 30% because they had 1 week less in Q4 2012 compared to Q4 2011. The actually growth rate (adjusted) was more like 32%.
-Analysts are panicking, downgrading the stock, cutting price targets and all around giving up on the story that the stock is a no brainer. I'm never comfortable being in the same side as Wall Street because I understand they are in the business of profiting not from predictions but from selling services to people.
-Apple can unleash a strong rally if they were to step up their buyback program and they can do that simply because their operating cashflows are so strong (they grew 33% year over year) and if there aren't attractive investment opportunities out there buying back your own stock makes a lot of sense. The combined cash in the balance sheet and a potential increase in the buyback creates a theoretical floor in the stock. Recently we saw that happen when Buffett announced the buyback on Berkshire Hathaway (BRK.B). The stock jumped to $89 but gave plenty of time for people to bet on the upside knowing that the downside was protected by the $50B buying power (cash + bonds) that Buffett has. People just don't appreciate how large buyers can be induced to pay higher prices by High Frequency Trading firms. Berkshire stock was a no-brainer buy at $89; now the stock stands a $97 a share.
-The stock could pull a Hewlett Packard from a technical perspective. HP was hammered by bad news for months, it seemed that no matter what happened the stock it couldn't bottom. After the Autonomy deal (the worst news of the year) was announced along with earnings the stock collapsed on big volume
That was the exact bottom. I believe a similar process in is play with Apple here
Notice how in November a large sell-off on high volume marked the bottom.
-You are supposed to buy when no one wants it and sell when everybody wants it. Apple's sentiment supports a contrarian investment
-Even under my pessimistic assumptions (owner earnings growth slows faster than expected and then grow 1% into infinity) Apple's stock is worth $572.
It's hard to stress how important is to be careful with GAAP when valuing securities. Bill Ackman made more than $1B in General Growth Properties simply because the company had on their books their real estate at values that reflected accounting rules and not market clearing prices as a result the equity had significant value even in bankruptcy.
Lots of short sellers and bears like Reggie Middleton are making victory dances on the back of GAAP earnings growth when the most important metric in my view (and likely in Buffett's view) grew by 30%, these misunderstandings lead to mispricings.
The panic bottom I wrote about earlier seems to be taking place. The key about these bottoms is that they frequently can go much lower than you think, however from a operations perspective the company is still in high growth mode and the stock is currently completely misunderstood by investors and analysts (a point frequently raised by David Einhorn who is long the stock). The cash continues to pile in and the buybacks are in place (with the potential to be increased). I plan to start to average in the stock in the aftermath of this earnings release. I will sell when everybody is in love with this stock again.