Zaky: Why Apple's Guidance Is Still Important

Apr.25.11 | About: Apple Inc. (AAPL)

On Thursday afternoon, CNBC's Herb Greenberg argued that because Apple (NASDAQ:AAPL) always sandbags its guidance by beating EPS estimates by an average of 27% over the last several years, Apple shouldn't bother offering guidance anymore. He quotes Bernstein Research analyst Toni Sacconagi as saying, "Apple has historically been so conservative [with its guidance] as not to be helpful." You can watch the video here.

Herb Greenberg says that Toni Sacconaghi is an Apple super-bull, which simply just isn't the case. While he may have a buy rating on the stock, he has actually been historically somewhat bearish on the stock; see here. He was the analyst known to raise the frivolous "missing iPhones debate" a few years ago which led to across the board bearishness in the stock and misled a lot of analysts and members of the press into cutting their earnings expectations; this was later shown to be a huge mistake when earnings clearly demonstrated that the concern was utter nonsense.

By saying Sacconaghi is an Apple super-bull, Herb Greenberg is essentially trying to lend further support to the very flawed and idiotic conclusion that Apple's guidance doesn't matter anymore.

And the fact of the matter is, Apple's guidance is extremely important. Just because Sacconaghi has tremendous difficulty interpreting the subtleties in Apple's guidance doesn't mean the guidance isn't important. Sure, Apple sandbags its guidance, but it does so in the same way quarter after quarter. In fact, one needs nothing more than to merely analyze the trends in Apple's guidance to effectively predict with a very high level of accuracy what it will report in revenue and earnings.

Sacconaghi and Greenberg should really consider applying the lessons offered in Laurie Santos' famous lecture on how humans tend to repeat the same dumb mistakes. There's a reason that three bloggers -- Turley Muller, Daniel Tello and myself -- have outperformed analysts for over 20 quarters straight with a combined accuracy of over 95% in predicting Apple's earnings. We're not obtuse enough to think Apple's guidance doesn't matter.

Now here's why Apple's guidance matters most, and why Apple really should continue to offer guidance despite its conservatism. Apple's management is in the best position to know exactly how the company is performing and how it will perform over the course of any 3-month period. They have extraordinary information to which the general investing public has limited or no access.

Because of this, Apple's management has the best handle on what it will likely earn on any given quarter. If bloggers can consistently nail Apple's EPS within a penny quarter after quarter, Apple probably has a very strong understanding of what it will report. There have been more than 10 quarters where I've personally predicted Apple's EPS within a penny, and a number of quarters where I've predicted Apple's revenue within a 1% accuracy. We're talking an accuracy level of one-half of a day of sales.

In my opinion, Apple's management does an excellent job of relating their "actual" earnings expectations to the investing public through their consistency. It doesn't matter that Apple is conservative as long as they're consistently conservative-- and Apple has been more or less consistently conservative for over 30 quarters straight.

Let's take a look at Apple's guidance this quarter and how investors should interpret that guidance given what we've seen in the past from Apple. Here's a snippet Apple's guidance from the conference call:

We expect revenue to be about $23 billion compared to $15.7 billion in the June quarter last year. We expect gross margin to be about 38%, reflecting approximately $55 million related to stock-based compensation expense. We expect OpEx to be about $2.5 billion, including about $255 million related to stock-based compensation expense. We expect OI&E to be about $70 million and we expect the tax rate to be about 25%. We are targeting EPS of about $5.03.

Lets start with revenue. While Apple's management is stating that Apple will report $23 billion in revenue in Q3 might not mean something to someone like Toni Sacconaghi or Herb Greenberg, but it means something very specific to me. It says to me, "Don't expect Apple to report less than $25.5 billion and much more than $27 billion on the quarter." Why? Because in this $20 billion revenue range, Apple has tended to beat its own guidance by about $2.7-$3.7 billion.

Last quarter, for example, Apple beat its revenue guidance by $2.7 billion while it beat its Q1 $23 billion guidance by $3.7 billion. Investors should expect something along those same lines in this sister quarter to Q2.

That revenue guidance essentially sets the upper and lower boundaries for any rational expectation. Don't expect Apple to report below $25.5 billion and don't expect it to report more than $27 billion. That is precisely what Apple is telling us with its $23 billion guidance. If you're an analyst with an expectation below $25.5 billion or an expectation above $27 billion, you're probably wrong.

The genius in being able to predict exactly where Apple's revenue will fall within that $1.5 billion range comes in analyzing the global smartphone market, unit sale trends, seasonality and intangibles in the quarter as well as all of the appropriate average selling prices. If Apple had offered $22 billion in guidance or $24 billion in guidance, we would have fundamentally different boundaries. And that's exactly what guidance is supposed to be. Its supposed to give analysts and investors an expectation within a general range. Without getting that guidance, we have no boundaries.

Lets talk about gross margin and what it tells me. Apple says it expects gross margin to come in at 38% reflecting blah blah blah nonsense nonsense nonsense. The 38% guidance is all I need to predict with some level of accuracy what Apple will probably report in gross margin, given its history.

It will definitely be above 40% and below 42%. What will give me the number is the mix between my expectations for iPhone sales and iPad sales. But again, this guidance tells me a lot about what Apple thinks will be the main driver of revenue on the quarter. They are relating all of this to anyone who cares to listen. Again, any analyst who thinks Apple's guidance is not helpful is a total imbecile.

Apple expects OpEx to be $2.5 billion. In other words, Apple expects OpEx to be about $2.65 billion. There was a period in Apple's guidance history where, for multiple quarters straight, it offered OpEx guidance exactly $40 million less than what it actually reported (Q3 2007 - Q2 2008). Again, you have to listen to get what Apple's management is saying to us. It's all common sense.

"We expect OI&E to be about $70 million" really means "We expect OI&E to be about $80 million." "We expect the tax rate to be about 25%" probably means Apple expects the tax rate to fall to 23.5%-24.0%. "We are targeting EPS of $5.03" pretty much means "we are targeting EPS in the $6.50-$6.70 range."

Again, all of this is in the pattern of Apple's guidance behavior and is very key information for setting not only a rational basis for projections, but an effective boundary for expectations. Can we still predict Apple's earnings without its guidance? Sure we can. Is it better to make projections without setting boundaries put forth through Apple's guidance? Definitely not.

Disclosure: I am long AAPL.