Every quarter in their earnings call, Apple (OTC:APPL) provides forward-looking income statement information. They include revenue, gross margin, operating expense, other income/expense, tax rate and EPS. Everything needed to put an income statement together is given. Recently, I had estimated Q4 2011 EPS of $9.38, which was 71% above Apple’s guidance and 33% above the actual results. In hindsight it seems very obvious that $9.38 was irrationally exuberant. The iPhone release one quarter later than normal, and Tim Cook’s announcement of 250 million iOS units sold to date during the 4S event all pointed to soft iPhone sales for the quarter. Horace Dediu also discusses these points here.
If I had been paying attention to Apple’s guidance, I would have realized that in the last 4 years, the worst guidance given had been in Q2 2010, when Apple had guided EPS of $2.06 to $2.18 with the actual results coming in at $3.33, 57% above the mid-point of their guidance. With my estimate at 71% above guidance, there should have been alarm bells going off.
It wasn’t until I read Horace Dediu’s recent “Apple’s Guidance Deficits” that I realized the peril of ignoring a very important piece of forward looking information from the ultimate authority on Apple, Apple themselves. In his article, Dediu looked at Apple EPS guidance vs. actual results.
Below I take this one step further and look at all of Apple’s forward looking guidance over the last 4 years, compare it to actual results and look for patterns to apply to Q1 FY12. Estimates are shown in red in the below graphs.
Revenue: [Guidance Error = (actual/guidance -1) x 100%]
The above graph shows how much Apple has exceeded their revenue guidance over the last 4 years. The Q1 2012 data point in red (15.4%) is a projection based on an average of the last 2 years excluding the 24% guidance beat in Q3 2011 (assumed outlier in the data). The most recent two years were used because it appears that Apple’s method of providing forward guidance for 2010 and 2011 is much more conservative than their 2008 and 2009 guidance and it appears to have stabilized. The thin solid line is the trailing twelve month (TTM) average and does include the Q3 2011 data point. The TTM average also shows guidance stability for the last two years.
Gross Margin (GM): [Guidance Error = (actual/guidance -1) x 100%]
Again, for Gross Margin, the error pattern over the last 2-years appears the most stabile. The solid line is the TTM average. The projected Q1 FY12 data point in red (6.7%) is an average of the last two years, again excluding the Q3 2011 data point. Based on the projected error and the GM guidance of 40%, the estimated actual GM = 40% x (1.067) = 42.7%.
Operating Expense (OpEx) and Other Income & Expense (OI&E): (Guidance Error = actual – guidance)
OpEx and OI&E guidance errors were fairly consistent through the middle of 2010, but since then have been all over the place. In the past it was good practice to use Apple’s guidance for these terms, and lacking a clear pattern for the last year and a half, the projections are based on a strait average of the entire 4-year series with the high points for OpEx error in Q1 2011 and OI&E in Q3 2011 thrown out. The result is that OpEx guidance (on average) is $13M high and OI&E is $8M high, fairly minor. The net result is a $5M decrease in pre-tax income, which, after taxes, is an insignificant $0.004 impact on EPS. So, for this exercise I will take Apple’s OpEx and OI&E guidance at face value.
Tax Rate: (Guidance Error = actual – guidance)
Although, over the last 4 years, Apple’s actual tax rate has, on average, been 2% below guidance, it appears that actual tax rate has converged around 24%, which likely puts their guidance of 24.3% for Q1 2012 squarely in the ball-park.
Earnings Per Share (EPS): [Guidance Error = (actual/guidance -1) x 100%]
Apples EPS guidance errors have a couple of interesting patterns going on. Excluding the 55% beat in Q3 2011, the first observation is that there is a declining trend from Q4 2010 to the most recent quarter. The second observation is that there appears to be a bi-modal pattern to the above data points. Apple either exceeds EPS guidance by a modest ~30% +/- 5%, or they completely blow away by 45% to 55%. Below is a histogram of the above data points, which confirms the bi-modal nature of the distribution.
There does not appear to be a calendar or product cycle related pattern to when Apple hits earnings at ~50% above guidance, so the I followed the pattern of the lower, declining mode and expect EPS to beat guidance by 26%, or $11.72.
Guided vs. Expected Income Statement.
Below is a side-by-side comparison of Apple’s guidance with the resulting income statement underneath, and, base on the above historical analysis, what could reasonably be expected for Q1 FY12 to the right. You might notice that the expected EPS of $12.05 (29.5%% above guidance) does not match the expected EPS of $11.72 (26% above guidance) just presented in the previous section. The EPS of $12.05 is derived from all the independent assumptions for revenue, GM, OpEx, OI&E and tax rate, thus it is a function of everything above it in the income statement. The $11.72 is estimated directly from Apple’s EPS guidance and historical EPS error patterns. In other words, Apple’s guidance can be used to indirectly or directly calculate an expected EPS.
Profit margin and diluted shares are calculated values. An interesting point to note is the implied guidance on the profit margin of 23.8% vs.. the implied expected profit margin of 26.7%. This 2.9% difference is close to 3.1%, the average of the profit margin guidance errors for the last 4 quarters (ignoring Q3 2011). See the below histogram.
Here are two more observations from the above analysis. Q1 2012 represents the:
1. Highest profit margin (PM) ever guided; 23.8% vs.. 20.9% in Q2 FY11 and,
2. The highest GM ever guided; 40% vs. 39% in Q2 FY10.
It is clear that the record breaking GM and PM guidance implies that Apple is expecting sales on their highest margin product, the iPhone to comprise an every larger percentage of total company revenues.
Based solely on historical discrepancies and recent patterns between Apple’s financial guidance and actual outcomes, Apple may exceed Q1 FY12 guidance as follows:
- Revenue: 15%
- EPS: 26% - 30%
- Profit Margin: 3%
These patterns can be useful when reviewing estimates, whether your own, or someone else’s, and if they significantly deviate you should ask why. I’m not saying the above conclusions should be taken as gospel. There are many reasons why Apple’s guidance may not follow the recent historical patterns, such as:
- Apple changes their guidance process or has errors in their assumptions.
- Disruptive competitors [Amazon (AMZN) Fire].
- Production disruption (factor fires, flooding in Thailand, material issues with batteries).
- Last, but not least, the above interpretations and conclusions are my own. Other investors may view the above patterns and trends differently.
Although they come in low (a.k.a. sandbag), as long as there is some stability in Apple’s guidance, it is not wise to ignore the most informed Apple analyst – Peter Oppenheimer.