Apple Earnings Make a Mockery of the System - Again

Jan.19.11 | About: Apple Inc. (AAPL)

It’s really not shocking that small investors believe Wall Street is a rigged game. There is, perhaps, no better example of this than Apple’s (NASDAQ:AAPL) quarterly report.

For anyone who isn’t familiar with how the game works I’ll break it down for you. Apple provides an outlook for the upcoming quarter. They set these figures WELL below expectations with the knowledge that they will soundly crush those figures. The analysts, all of whom rely on being able to “sell” Apple, want to stay in management’s good graces. This is important because Apple is widely held by most of their clients. For instance, there isn’t a huge hedge fund on Wall Street that doesn’t own Apple. So, the research firms (which are supposedly independent of their sales and trading arms) are incentivized to ensure that Apple stock continues to rise and perform “better than expected”. The pay-off of course, comes in the form of millions in commission dollars.

This quarter was another sign of the ridiculous lack of value that Wall Street’s “best minds” add. Apple smashed their absurd estimates. Sadly, bloggers provide a better analysis of Apple’s quarterly data than the Wall Street analysts do. It’s not surprising that the investment blogosphere is quickly turning into the preferred place for honest and reliable research.

Over the last few quarters I’ve run an analysis in the last 15 minutes of trading that broke down Apple’s earnings (I didn’t do it this quarter because it’s become a waste of time). I literally do it in less than 15 minutes. There is no fancy analysis involved, calls to management or anything of the sort. I don’t cover Apple in my research and I don’t own the stock. My work is just good old fashioned common sense combined with a graduate degree level understanding of an income statement.

Last quarter Apple missed my EPS estimate by 2.5%. They beat my revenue estimate by 5%. They beat the average Wall Street EPS estimate by 14% and the revenue estimate by 7.5%. I don’t know about you, but if I hired an independent consultant to provide me with a reliable estimate, paid them several thousand dollars and they came back with a product that missed by 14% I would fire them in a heartbeat.

The most absurd portion of the Apple report is that everyone on Wall Street knows that they sandbag their guidance. last quarter I said the following:

Let me translate that $4.80 guidance:

We know you will all set your estimates in the $5-$5.50 range and we will soundly crush that. Thanks for playing Wall Street!


Apple Management

And of course, Wall Street set its estimate at exactly $5.38 and Apple comes in at $6.43 (an embarrassingly absurd miss of 18%). I know this is how the game works, but where is the value added? Millions of small investors pay millions of dollars a year for access to the big wire houses and their research analysts. Millions more are reading reports or listening to talking heads describe how Apple and corporate America in general is performing “better than expected”.

While this might be true so some extent you have to question the analysis when it’s so blatantly clear that the research is not honest. If they can’t provide honest and realistic research then why does anyone trust them and why should anyone ever pay for their services? It makes a mockery of the system and only further erodes the level of trust between Wall Street and Main Street.