Double Standard: How the Analyst Consensus Underrates Apple

Investors often buy or sell a stock on whether a company's EPS for the quarter is above or below street consensus. Analysts forecast their expectations for a company stripping out one time events, such as a tax settlement or loss on a sale. The investing public then compares the earnings to the forecast. Earnings' beats are rewarded. Underperformance is punished.

For instance, Medtronic (MDT) recently came out with GAAP earnings of 22 cents, a humbling 69% drop from the previous year. However, after factoring out a "variety" of one time events such as R&D, litigation, restructuring charges, the company came in with non-GAAP earnings of 82 cents, matching analyst consensus.

Now I'm not going to argue whether or not one time events are material (they are). But I am going to argue that Apple's (AAPL) earnings are unfairly judged.

Other companies' earnings are viewed once "extraordinary" events are removed. The street focuses primarily on their non-GAAP earnings and largely disregards their GAAP earnings.

Street expectations for Apple are judged in terms of its GAAP earnings. There is nothing to strip out. There are no losses from selling weak divisions, no unfavorable tax decisions, no restructuring costs, no write downs. The analyst community (and investing public) keys in on Apple's GAAP earnings.That ignores the prime driver of Apple's growth, the iPhone, which only reports one eighth of its sales profit each quarter. The GAAP numbers miss out the real income growth in the company. Last quarter Apple reported EPS $1.33 (GAAP) while receiving $1.84 (nonGAAP). GAAP earnings are set to once again undervalue the Apple's real earnings when the company reports next quarter. That disparity will be even greater because all iphones sold on or after March 17th will not be included until the new OS 3.0 software is releases in the summer.

It makes no sense to exclude 28% or more of Apple's real earnings when forecasting. Apple's analyst consensus is to earn $1.13 next quarter. It will once again handily beat that GAAP forecast. The real number to look at, however, will be the non-GAAP earnings, a figure that will be substantially higher. That's the number to weigh Apple's performance.

Comments

[Hayweed:]

Best article on Apple in ages.

May 23 07:14 PM

[Moon Kil Woong:]

Apple's GAAP earnings method is a way for them to smooth out earnings. I agree it works against thir share price so why are they doing it? Their method is of their own doing and thus the mispricing is largely them punishing their own shareholders. Certainly, when non-GAAP earnings start dropping from lower iPhone sales (if ever), the analysts will take notice and punish the stock.

So their earnings methodology doesn't really cut it in regards to smoke and mirroring earnings falloffs and revenue smoothing iPhone sales.

Anyway, Apple shareholders shouldn't feel too bad, their stock is still trading on the higher end of its valuation. All is rosy in Cupertino.

May 23 11:20 PM

[Stop Paying...:]

There have been 10s, if not 100s, of articles sounding out the GAAP versus non-GAAP recognition of Apple's earnings.

This company has performed brilliantly during this recession. Working through all their positive numbers and forecasts is nothing but a mathematical playground.

The sheer inertia of progressively overlapping one-eights of iPhone income recognition at each quarterly call that persists through its two year life cycle cannot be ignored forever. We are not even at the last one-eighth of the first iPhone sold. Run a spreadsheet out to say, 12 months from now, using middle-of-the-road iPhone sales projections, and to see gargantuan earnings.

We are not through with the market scare that started last September just yet. Fear is still holding back reasonable valuing of Apple, PARTICULARLY vis-a-vis most any other company, not the least of which its competitors.

May 24 06:13 AM

[mollytjm:]

no matter how Apple chooses to release figures, we can choose to figure out the real numbers and understand Apple's closer value. It's not that hard to project earnings strength. it's interesting that Palm still has buyers since it's a one-trick-pony, as the old Apple was, and projecting any earnings is nearly impossible.
thank you for the article. long APPL

May 24 08:48 AM

[brewer:]

Nice article. I am in agreement with 'Stop paying analysts'.

May 24 10:44 AM

[Neil Anderson:]

Seems to be a gap in many analysts' understanding of GAAP.

May 24 05:57 PM

[ohad bikovsky:]

very Nice article!

May 25 07:58 AM

[Sandman619:]

To be in compliance with the Sarbanes - Oxley legislation, Apple reports its iPhone revenue over the 2-year service contract period. This is also why iPhone OS updates ( OS X ) are free for the iPhone, but for the iPod Touch a minimal charge of @ $10 for each update. iPod revenues are fully reported at the time if sale

Cheers !

May 25 07:56 PM