There is a tech stock that has grown its earnings two and a half times faster than Apple (NASDAQ:AAPL) has over the past decade. And, like Apple, this tech stock has no debt on its balance sheet and generates very strong cash flows. Both this company and Apple have generated very similar returns on capital; in 2010 the return on capital generated by our mystery tech stock was 28.5% compared with Apple’s 27.5%. The following F.A.S.T. Graphs™ looks first at Apple, and then our mystery stock, on the basis of earnings growth per share only, since calendar year 2001.
Apple Inc. (AAPL): 10 years 2001- 2010
Since calendar year 2001 Apple has grown earnings at the extraordinary rate of 29.8% per annum. The orange line on the Apple graph below represents a PEG ratio PE of 29.8. As the graph indicates, Apple has no debt on their balance sheet.
(Click charts to expand)
Mystery Tech Stock: 10 years 2001-2010
The following is our graph on our mystery stock, which shows that it has grown earnings at the rate of 77.8% since calendar year 2001. The orange line on this graph represents a PEG ratio PE of 77.8. This is actually 2.6 times faster earnings growth than the extraordinary growth that Apple has achieved. Also, like Apple, this company has no debt on its balance sheet.
Apple Inc. versus Mystery Tech Stock: Last 4 years 2007- 2010
When we compare these two tech stocks over the shorter time period 2007 - 2010, we discover that the growth rate of both companies is remarkably similar. Both companies have remarkably been able to grow earnings at over 50% per annum since 2007.
The Mystery Tech Stock
Investors Buy Earnings
At the end of the day, when an investor buys a common stock, they are in fact purchasing the company's earnings power. One of the most straightforward definitions of the PE ratio is; the price you pay to buy one dollar's worth of a company's earnings. Therefore, if stock A has a PE ratio of 20 when you purchase it, you're paying $20 for each one dollar's worth of stock A’s earnings that you are buying. If stock B has a PE ratio of 10 when you purchase it, you're only paying $10 for each one dollar’s worth of stock B’s earnings that you are buying.
The point is very straightforward. If you take one dollar’s worth of either companies’ earnings to a store in order to make a purchase, it would make no difference to the store which companies’ earnings you tried to spend. Whether it was the $20 earnings of stock A, or the $10 earnings of stock B, both of each companies’ one dollar’s worth of earnings would buy precisely the same amount of merchandise. This begs the question: Then why would you pay more for company A's earnings than you would for company B's?
The only logical answer is that you expect company A's future earnings to be much larger than company B's. But if both company’s earnings are growing at approximately the same rate, then logic would dictate that they should both have approximately the same value. At least for the last four calendar years, both Apple Inc. and our mystery stock have generated very similar levels of earnings growth. Therefore, both of these companies’ stocks should command similar PE ratios. Of course this assumes that we live in a sane world and shop at a sane stock market.
The Mystery Stock Revealed
The mystery stock that we have been writing about is Research In Motion (RIMM), or as it is more commonly known RIMM. As you can see from the earnings and price correlated graph below, RIMM represents our company B example cited above. It currently trades at a PE ratio of approximately 10, and simultaneously trades at one of its lowest historical valuations since it's been a public company. However, as evidenced by the company performance graph, we discover that this company has been an excellent long-term holding for RIMM shareholders, and far superior to the S&P 500. Perhaps if Rodney Dangerfield were still alive, he would say that RIMM gets no respect. Of course, we are saying that it deserves much more than it does get, based on its fundamentals.
Research In Motion LTD. (RIMM): Earnings and Price Correlated Graph
Apple Inc.: Earnings and Price Correlated Graph
On the other hand, Apple Inc. also represents a company that based on fundamentals could be valued higher than it is. Apple Inc. would represent a classic example of our company A cited above. Apple Inc. trades at a PE ratio of approximately 20, which is also historically on the low side of normal.
Google Inc. (NASDAQ:GOOG): Earnings and Price Correlated Graph
We have included our eight year graph on Google Inc. (GOOG) for your additional perspective. Google is another example of a tech stock that is building a strong and growing position in the smartphone market.
Summary and Conclusions
A primary objective of this article was to illustrate how irrational the stock market and investors can be at times. When looked at purely from the perspective of fundamentals, it should be crystal clear that both Apple and Research In Motion are both very fast-growing technology companies with strong fundamentals underpinning them both. The only real difference in their respective valuations has everything to do with psychology and emotions and not fundamental values. In other words, this is a case of perception and reality being misaligned.
The primary reasons that most give for RIMM’s shares being so lowly valued, is the loss of market share to competitors like Apple Inc. with their i products and Google with their Android phones, etc. However, one very important fact gets lost in all of this. Even though RIMM has lost market share for certain, they have lost market share in a market that is expanding at a very rapid rate. The point is that even though they have a lower share of the market today, because the market has grown so dramatically, RIMM’s earnings growth and customer base has continued to expand at a significantly above-average rate.
If you looked at RIMM’s fundamentals in isolation, to include balance sheet, return on capital, return on equity, cash flow generation and of course pure earnings growth, you would have to acknowledge that this is an extraordinary above-average growth story. Just because Apple, Android and others are having success in the market, it has not diminished RIMM’s ability to continue to generate strong and profitable earnings growth. Consequently, we would argue that RIMM is an extremely undervalued technology opportunity at these levels.
Finally, we would additionally argue that Apple Inc. and Google Inc. also represent attractive opportunities for investors looking for high-growth technology holdings. Frankly, we believe there is plenty of room in the marketplace for them all, and feel that each has the opportunity to find their own niche. As evidence of the conviction behind our feelings, and in the spirit of full disclosure, we announce that we currently hold long-term positions in all three.
Disclosure: I am long AAPL, GOOG, RIMM.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.