On December 31, 2000, Apple (AAPL) closed at, split adjusted, $7.44 a share. Ten years later it closed at $322.56 a share. What will it close at ten years from now? Market forces and size make a repeat performance impossible -- please do not expect Apple to have a ten trillion dollar market cap on January 1, 2021. That being said, it is shocking to see how much head room Apple as a company has to continue to grow.
- The macro environment: Apple has grown in spectacular fashion through the worst recession since the Great Depression. For the last three fiscal years ending September 30, the company posted sales of $32.5 billion, $32.9 billion and $65.2 billion. According to Durban capital, in the calendar year 2010 up through October, 60%-65% of the entire growth in dollars spent by US consumers went to Apple. Bottom line: the New Frugal, my thesis on a permanent shift in US spending patterns, has firmly taken hold and a weak economy, even one that enters a double dip in the second half of this year, will not slow Apple’s growth in a meaningful way.
- The marketplace: Apple’s market share of laptops, desktops and of all smart electronic devices continues to grow in every market it chooses to sell products. At the beginning of 2010, according to IDC, Apple had a worldwide market share in computers of just 6.4%. It dominates smart phone sales in the US but has less than 5% of the worldwide market in cell phones. The iPad owns the tablet market but has less than 1% of the overall smart device market that is not a computer and including cell phones. Yes, Apple sells more music than any distributor in the world and more apps than all other distributors combined but growth is still in serious double digits. Bottom line: there are no market saturation issues limiting Apple’s growth for the foreseeable future.
- Revenues, margins, cash: Apple has grown revenues based on product sales without sacrificing margins. In the last three fiscal years, gross margins were 34% (2008), 39% and 40% despite revenue almost doubling. Net margins – what others call profits – were 14.8% (2008), 19.1% and 21.5%. Cash? The company ended FY 2008 with $20.5 billion in cash, 2009 with $31.2 and 2010 with $46.7 billion in the bank. Bottom line: the company has more than enough cash to do whatever it wants, from acquisitions to tinkering with prices to declaring dividends.
The measure most important to the future is margins – high gross margins fund development and marketing of new products and underpin the ability to take market share in existing market segments or create new products to take share in the larger markets, such as all computing devices or all smart non-computing devices and so on. Here is where AAPL compares with erstwhile competitors.
The three major names lined up against AAPL are looking at declining margins.
Why did this happen and can it continue?
- Apple makes better products far more in touch with customer needs than its competitors – and charges them for that quality. Steve Jobs is asked the same dumb question at every analyst meeting – why don’t you cut prices to grab share. Answer – quality and margins are more important than share. An even more illuminating question - why don’t you make a netbook? Answer from Jobs - Apple cannot make one at a competitive price with an acceptable level of quality. Bottom line: there is no reason to expect this discipline to change.
- There are deep flaws in competitors’ product architecture. Analysts hoping to get on CNBC cite Google (GOOG) and Microsoft (MSFT) as Apple competitors. They are not - -they compete with Apple operating systems and if push comes to shove, Apple will do on the iPhone and iPad what it did with the Mac, make the hardware compatible with these operating systems. The real competitors are hardware suppliers such as Dell Inc. (DELL) and Hewlett-Packard Co. (HPQ). Neither company controls its own operating system for core products. The operating system they use is “open" creating technical conflicts and problems that will always create a consumer experience inferior to that within the Apple universe. “Open systems,” with the development cost spread across operating system and applications suppliers, were the key to success when I had brown hair and worked in Silicon Valley, are now an impediment to long term success.
- The cloud is here and growing. Cloud computing is a reality and will eventually overwhelm server based computing for core applications in many businesses. Cloud computing asks users to have Internet access, perhaps some local storage and a facile interface. The shift to cloud systems also pushes down central costs – big apps and big servers – and frees up money for a better user experience. All of this points to Apple products gaining share in the business marketplace. For example, I configured my iPad to access my Exchange based mail server in a few seconds and I am hopeless at things like this. Cloud based server apps will replicate this ease of use across the application spectrum.
- Business people like consumer friendly devices. According to ChangeWave Research surveys, in February 14% of all US businesses will be providing or supporting iPads. In tech land, it takes at least three years for a new category of device or technology to be purchased based on the feature set and price – three years to shake off concerns of using something new. The iPad will hit 14% in a year. In my own work, it is the best email and Internet browsing device ever created – by far – and saves me between 15 and 45 minutes a day, perhaps more, compared with using my laptop or desktop. When I am in my office! Bottom line: without a real corporate sales force and without compromising their products for the business market, AAPL is gaining mindshare and share in the business market where it has unlimited room to grow.
- Apps, music and video will continue to create new demand far faster than anyone. I love collecting various forms of intellectual property – DVDs, books, etc. I am now selling all my DVDs and music due to Netflix (NFLX) and iTunes. Why bother with the hassle, using the space and so on. Users can watch a Netflix movie to TV show on their TV, get interrupted and pick up where they left off on their computer or iPad. This is a form of cloud computing – actually, centralized data storage. This trend pushes people to hardware that most readily supports the use of centralized media storage and to software and services that make purchase and access the most user friendly. And why bother with taking a laptop for a presentation when you can show it on a big screen using an iPhone – or a Blackberry – or an iPad?
Are there risks to the company? The risks are small and they are distinctly different than risks to the stock.
- The health of Steve Jobs. If he retires will the company maintain his discipline and creativity? The odds are about two to one in the company’s favor as his tenure there has been very long and he has obviously created employees and managers who view the world the way he does. Jobs is unique in American business history – Apple One, Pixar (PIXR), NeXT and then back to Apple Two.
- Hubris. Companies often acquire personality traits and the one to avoid at all costs is hubris. So far, so good for Apple – its customer service and product quality rankings are as high as ever and its brand is one of the top five in the world even though you never see its name on a television ad, storefront or whatever. Will Apple overreach? It happens to many companies trying to replicate past success. Short term, nothing on the horizon other than a surprise and stupid acquisition would smack of hubris.
- Government nastiness abroad. The French have messed with iTunes, probably because some senior official’s mistress did not like the terms and conditions of the site. The Chinese will never allow a foreign company to become dominant in a market they crave. And so on. Apple will run into export issues in many countries as market share increases and they have, in the past, shown less than a great hand at dealing with interference from governments. Again, a longer term potential problem.
What about the stock? Ah, herein lies the rub.
- Apple has a $322 billion dollar market cap. Apple has such a large market cap it will be impossible to see the meteoric growth in the stock price seen in the past decade. The stock currently sells at a P/E of 22, one third below its average in the past decade and based on recent and projected growth in revenues and profits the company sells at a sharp discount to the S+P.
- The Apple stock price intimidates individual investors. Individual investors are almost as irrational as professional stock pickers and shy away from high priced stocks even though a stock price is not correlated to its value. The high stock price has reduced demand from individuals and the company, as it should, does not care.
- Expectations for the company are high. Apple always beats the company’s own estimates and usually surpasses Street estimates for revenues, or profits, or unit sales or a combination of all three. Short term, the iPad is gong to continue to surprise Wall Street and so is the Verizon (VZ) iPhone. All of this is well known.
- Expectations for the stock are not high. The median target for the stock among analysts, in 2011, is $380, about an 11% increase and in line with market projections in general. Apple is growing revenues and profits at many multiples of the S+P but is expected to trade alongside the market.
- Earnings are due out on January 18. I expect the company to beat and blow out iPad numbers That being said, in four of the past five years, the stock has run up to earnings, the company has surprised the Street to the upside, then sold off, bouncing back a few weeks later.
Where does this leave investors? In my own service I recommend Apple calls – my service is really about contrarian positions and Apple is the ultimate New Frugal stock, a contrary play on a dead economy. In my own portfolio, I own the stock and write covered calls and sell puts to generate income. There are large premiums on Apple options and if the stock does not move in a year, I can still generate a 10%-12% plus return simply by writing covered calls or selling naked puts. Right now I am not hedged. There are weekly options on the stock and I typically sell something on a Thursday and pick up a few bucks that, when multiplied 52 times, add up to a lot of money.
What to do? Short term, that is up to you. Longer term, as you can see from my own portfolio, Apple is the first of several core holdings I will continue to own, and if necessary hedge based on market conditions, for the foreseeable future.
Disclosure: Long Apple