Apple Is Worth More Than 8X RIM, But...

 |  Includes: AAPL, BBRY
by: Joseph Levy

My June 28, 2010, article, questioning if Apple (NASDAQ:AAPL) is worth 8 times more than RIM (RIMM), resulted in numerous comments that my analysis was flawed. I just wanted to comment on the comments.

Many Apple supporters point to all the negative stories floating around on RIMM.

The fact that there is a consensus of negative sentiment against RIMM, by itself, is not a turnoff for me. Historically, the consensus among “pundits” is wrong at turning points, either up or down. Thus, just before market selloffs the “experts” are extremely bullish and when the markets are at their bottom, the consensus is overwhelmingly bearish and the smart money is buying.

A classic example of this is when Jim Cramer wrote and gave a speech about “The Winners of the New World” in February 2000, just weeks before the Nasdaq reached an all time bubble high of 5,132.52 and then crashed. Most of his recommendations were selling at ridiculous multiples of sales (many at more than 20 times annual sales) and with substantial operating losses. Anyone that invested in those “10 Winners” of the New World and held those stocks until today would be down substantially more than the 41% decline from the March 2000 Nasdaq bubble peak (5,132.52) to the June 30, 2010, closing Nasdaq price of 2,109.24 (I thought investments were supposed to grow over time...).

Thus, I often discount the advice of so called “experts” and consensus sentiments, when making my own investment decisions. If I think RIMM is a good investment today, should I be concerned that Cramer may like AAPL and not like RIMM? I think not.

The gist of the other arguments were that historical numbers don’t mean much and it is the unknown "future" numbers that determine current and future stock prices. I agree that the unknown future numbers (or their perception) are a key ingredient that determines current and future stock prices.

Let me be clear, I don’t buy stocks just as value plays. My primary criteria for buying stocks are:

  1. I have to believe the company will have above average future growth in operating results (sales, earnings, EPS, cash flow from operations) and a sound balance sheet that gets better over time.
  2. The price I pay for the shares must be reasonable in relation to the fundamentals (in 1 above).

The legendary investor Peter Lynch believes that it is necessary to understand financial statements in order to be a successful investor. This is in addition to knowing what is selling at the malls, which is also very important. The financial statement numbers are the “language” of business and are a "report card" of how management has performed in the past. Also, historical data (including the trends they show) is one element in assisting an investor looking to project what may happen in the future.

Some of the RIMM historical numbers that caught my eye include: sales/net income/cash flow from operations/ EPS, etc., all of which grew sequentially by more than 30% each year from the fiscal year ending in 2004 (sales of $595 million and net income $52 million) through the fiscal year ending 2010 (sales of $15 billion and net income $2.5 billion). However, if RIMM’s future is confined to being another Nokia (NYSE:NOK), which had declining sales and earnings in the years 2007-2009 or Motorola (MOT), which has reported declining sales since 2006, then I wouldn’t give RIMM a second glance.

AAPL supporters argue that RIMM has no future because they no longer are innovative, essentially being a one product company. Do those who believe RIMM is a "walking ghost" know the amount spent by RIMM on R&D? The R&D expenditures from fiscal years ending from 2007 through 2010 have been as follows: $236 million in 2007; $360 in 2008; $685 million in 2009 and $965 million in 2010. Does anyone believe that a company who spent $101 million on R&D in fiscal 2005 and increased those expenditures each year thereafter reaching $965 million in fiscal 2010 is not going to launch some new and exciting products in the future? RIMM's historical performance does not suggest that type of inefficiency.

The RIMM R&D expenditures have been over 6% of annual sales dating back more than five years. When you consider the size difference between RIMM and AAPL, the relative differential in R&D expenditures is surprisingly small. In the last four fiscal years ending in September 2009, Apple reported R&D expenditures of $712 million in fiscal 2006, $782 million in fiscal 2007, $1.11 billion in fiscal 2008 and $1.33 billion in fiscal 2009.

Apple’s R&D expenditures have been averaging just about 3.2% of its sales in recent years. One reason for the lower percentage in relation to sales is because of Apple’s retail sales, but this doesn’t negate that RIMM has a proportionately higher R&D budget when compared to Apple. RIMM probably should be spending more on their sales and marketing efforts, as Apple reins supreme in developing loyal customers bordering on a cult following.

A point raised by Apple supporters is that the market cap differential between the two companies has to do with Apple’s hoard of cash and investments, which totaled $41.7 billion at 03-27-10 versus only $3.3 billion for RIMM at 05-29-10. RIMM’s operating cash flow is strong and has been increasing. For the 12 months ended 05-29-10, they generated operating cash flow per share of $6.35 versus Apple’s $14.62 in the 12 months ended 03-27-10. RIMM’s cash and investments increased from $2.2 billion at the end of February 2009 to $3.3 billion on 05-29-10.

Also, RIMM has been using cash to buy back its shares, which resulted in the share count dropping from 593.1 million diluted shares outstanding at the end of February 2005 to 558.2 million diluted shares outstanding as of 05-29-10. Meanwhile Apple’s diluted shares outstanding have increased from under 800 million diluted shares outstanding at the end of fiscal 2004 to 923 million diluted shares outstanding on 03-27-10. This difference in philosophy in buying back shares partially explains why cash and investments at RIMM have not grown as fast as Apple’s. Even if cash and investments were deducted from both companies’ market caps, the relative market caps differential between the two companies would still be approximately 7.9 to 1.

Apple is a great company and I have enormous respect for Steve Jobs and what the company has accomplished. I think RIMM is a very good company, which also happens to be a good investment because of its current valuation. As mentioned in my article I don’t have an investment opinion on Apple. Generally, I’m trying to find the next Apple when its sales are under $100 million and the “experts” know nothing about them. Of course, that is very easy to say but very tough to do.

Anyone wishing the worksheets showing the RIMM and AAPL numbers email

Disclosure: Author long RIMM