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Apple (NASDAQ:AAPL) management has always been notorious for issuing low earnings guidance. This tendency to “sandbag” the earnings forecast has led many research analysts to dismiss management guidance as meaningless. See this CNBC clip where Bernstein analyst, Tony Sacconaghi, says Apple's guidance has "historically been so conservative as not to be helpful." Instead, analysts (as well as many investors in the Seeking Alpha community) craft their own internal estimates for each quarter by breaking down Apple’s product lines and applying a growth rate and margin.

Although bottom-up forecasts constructed by research analysts do produce estimates that are closer to actual EPS than management guidance, the “conservative” guidance can also be used to extrapolate a “realistic” EPS estimate. In fact, on a statistical basis, an extrapolation using Apple’s guidance has historically been more consistent than consensus estimates-- suggesting that it may be better to fully dismiss the analysts and rely solely on Apple’s guidance.

That management might know Apple better than analysts is hardly surprising. Although Apple has consistently provided overly conservative results, they surely have more insight into their market demand and supply chain than any external analyst could ever hope to achieve. For the better part of a decade, Apple management has provided the same conservative guidance, each quarter, by a very consistent margin. The highly precise guidance is typically 30% lower than the actual EPS result. Thus, the notion that we should dismiss the forecasts provided by Apple is entirely erroneous.

Over the past 25 quarters, the management-provided EPS guidance has consistently averaged around 71% of the actual EPS number reported three months later. In contrast, analyst estimates have averaged around 82% of the actual EPS number. Although analyst estimates are always closer to the reported number, they (on average) have exhibited far greater variation and often proven to be quite far from the mark. Despite having an additional three months to refine projections, it appears that analysts are actually worse at predicting earnings results than a simple extrapolation from the management guidance issued in a previous quarterly release.

The table below displays management guidance, consensus research estimates, and actual EPS results for Apple over the past 25 quarters.

Quarter

Apple EPS Guidance

Analyst EPS Estimate

EPS Actual

Apple Guidance %

Analyst Estimate %

1Q2012

$9.30

$9.75

*$13.02

4Q2011

5.50

7.39

7.05

78.0%

104.8%

3Q2011

5.03

5.85

7.79

64.6%

75.1%

2Q2011

4.90

5.37

6.40

76.6%

83.9%

1Q2011

4.80

5.40

6.43

74.7%

84.0%

4Q2010

3.44

4.08

4.64

74.1%

87.9%

3Q2010

2.36

3.12

3.51

67.1%

88.9%

2Q2010

2.12

2.45

3.33

63.7%

73.6%

1Q2010

1.74

2.09

3.67

47.4%

56.9%

4Q2009

1.21

1.42

1.82

66.2%

78.0%

3Q2009

0.98

1.17

1.35

72.2%

86.7%

2Q2009

0.95

1.09

1.33

71.4%

82.0%

1Q2009

1.21

1.39

1.78

68.0%

78.1%

4Q2008

1.00

1.11

1.26

79.4%

88.1%

3Q2008

1.00

1.08

1.19

84.0%

90.8%

2Q2008

0.94

1.07

1.16

81.0%

92.2%

1Q2008

1.42

1.62

1.76

80.7%

92.0%

4Q2007

0.65

0.85

1.02

63.7%

83.3%

3Q2007

0.66

0.73

0.92

71.7%

79.3%

2Q2007

0.56

0.64

0.87

64.4%

73.6%

1Q2007

0.73

0.78

1.14

64.0%

68.4%

4Q2006

0.48

0.50

0.62

77.4%

80.6%

3Q2006

0.43

0.44

0.54

79.6%

81.5%

2Q2006

0.38

0.44

0.47

80.9%

93.6%

1Q2006

0.46

0.50

0.65

70.8%

76.9%

4Q2005

0.32

0.35

0.50

64.0%

70.0%

*EPS implied for Q1 2012 based on historical management guidance

(Source: company reports, IBES estimates)

The historical data shows that Apple’s guidance is more effective than research estimates in extrapolating the actual EPS number. The standard deviation of guidance accuracy for management (8.3%) is lower than that of analyst forecasts (9.8%), suggesting that an extrapolation using Apple’s guidance numbers is far superior to assumptions based on consensus research estimates alone. In fact, the range of analyst inaccuracy over this 25-quarter sample is far greater than that of Apple management, spanning from hyper-conservative (57% of actual EPS) to overly-optimistic (105% of actual in the most recent quarter). Given the historic uselessness of research estimates for Apple, one could make the argument that we shouldn’t even bother paying attention to analysts at all.

Apple Guidance %

Analyst Estimate %

Average

71.42%

82.01%

Standard Deviation

8.27%

9.79%

Min

47.41%

56.95%

Max

84.03%

104.82%

Min/Max Spread

36.62%

47.87%

A backtest comparing analyst estimates and management guidance (derived using trailing average “conservatism” over the 25 quarters) shows that extrapolating solely from Apple guidance is a better predictor of earnings than analyst estimates.

Implications for the Current Quarter

This brings us to the Apple’s current quarter. The consensus analyst estimate for Q1 2012 is presently $9.75. If trends of upward revision continue and sales projections for the iPhone, iPad, and Mac are increased, the estimate may rise slightly further before the mid-January earnings release. Still, the analyst estimate for Q1 will almost certainly prove to be too conservative, perhaps by an unprecedented margin.

To steal a line from Mr. Jobs, the recent guidance provided by Apple is “simply amazing.” Apple offered staggering guidance of $9.30 for the quarter ending this December. This guidance alone represents mammoth growth of 45% year-over-year. If we factor in the historic conservatism of Apple’s management forecasts, the implied EPS number for Q1 is $13.02. At a year-over-year growth of over 102%, the Q1 earnings level implied by the most recent guidance absolutely crushes all analyst estimates. The astounding difference between guidance-implied EPS and consensus forecasts leaves only two possible scenarios.

1. Analyst estimates for the current quarter are completely off mark and are failing to model somewhere on the order of $3 billion dollars in profit.

  • The most aggressive earnings guidance Apple has ever provided was 84% of actual EPS (Q3 2008 as the economy began to cool). Even at that level, the implied EPS for Q1 2012 is $11.07, far in excess of even the most optimistic current research estimate ($10.68)
  • Using historical variance of management extrapolations, an EPS of $11 per share would be more than two standard deviations beneath the historical average. This 1 in 50 adverse event is still in excess of even the most optimistic estimates
  • In fact, the current research estimate of $9.75 is more than three standard deviations beneath the management guidance-implied EPS, representing an event that has less than a 1/1000th probability of occurring based off historical correlations
  • Since Apple missed estimate numbers in Q4 2011, an EPS “blow out” for Q1 could lead to significant stock price appreciation

2. Alternatively, (and most likely) management has suddenly broken its penchant for “sandbagging” and become much more aggressive and realistic in guiding earnings expectations.

  • Under the new leadership of Tim Cook, this could very well be a possibility, albeit in contradiction to a decade-long precedent
  • It is curious that management made no effort to suggest any hint of a guidance change in the most recent earnings call

Conclusions

Either of these scenarios will have profound implications for Apple. Given the large disparity between guidance-implied earnings and analyst forecasts, the most likely case is that management has radically changed its messaging to stockholders regarding financial performance. Even though it will beat its guidance this quarter (say with EPS in ~$10 range), it will not be by anywhere near the same margin as it has historically. The change in posture raises questions regarding how Apple views its $80+ billion cash position in a post-Steve Jobs era (share buyback, dividend?). Otherwise, if guidance has remained consistent with history, Apple may well be preparing to report its most spectacular quarter ever. Take your bets.

Disclosure: I am long AAPL.

Source: Apple: Guiding The Greatest Quarter Ever?

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