In my article "Research In Motion (RIMM) & QNX: Today's version of the Emperor's new clothes", I wrote:
If I was ever to teach in business school, two books would be required reading in my class - "The Emperor's New Clothes" (H.C. Andersen) and "The Three Little Pigs."
By now, you may have already figured out why Research in Motion (RIMM) shareholders may have found reading "The Emperor's New Clothes" would have helped them avoid the painful ride down. Only time will tell if RIMM's Thorsten Heins really does have new clothes!
My mom used to read me the story of the "Three Little Pigs". Back then when there wasn't an Xbox or an iPad or 600 channels to occupy us, parents actually took the time to read us bedtime stories and had time to listen to what our day was like! Can you imagine reading these types of stories to your kids today? They will just look at you and say "seriously dad"?
The tale of the "Three Little Pigs and the Big Bad Wolf" was written around the 1890s and is a story about the little pigs sent out to the world by mommy pig to seek their fortunes. The first little pig builds a house of straw, but a wolf blows it down and eats the pig. The second pig builds a house of sticks, with the same ultimate result. The third pig builds a house of hard bricks, which the wolf fails to blow down. He then attempts to trick the pig out of the house, but the pig outsmarts him at every turn. Finally, the wolf resolves to come down the chimney, whereupon the pig boils a pot of water in which the wolf then lands and is cooked! At the end of every bedtime story, my mom would always ask... so, "what is the moral of the story?".
Now, how does this relate to Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOG) you say? I've added Microsoft (NASDAQ:MSFT) as a frame of reference. If you've got some time to spare, read on...
Let's pretend the 3 little pigs all operate businesses selling lemonades. They serve different communities and they use the profits from their lemonade stand to build their dream homes. Based on their recent earnings reports:
Click to enlarge
Based on their performance over the past six years, the 3 little pigs have done a swell job growing their businesses. You will note that, while all of them have been successful, the 3 little pigs experienced more robust growth year over year as compared to Microsoft. Did you know that, based on Apple's recent quarter, its annualized iPhone and iPad revenue ($33.5B) will most likely eclipse the combined revenue from Amazon and Google?
Do you remember when I wrote about the macro drivers for Apple going forward here? It is unfolding as planned (FYE 2011 is yellow, orange is FYE 2010); I would not be surprised if that region surpasses Europe next year.
Over the same time frame, you will also notice that one of these enterprising piglets has been consistent in growing its earnings regardless of the socio-economic malaise in the country. It is also interesting to note that the combined 2011 EPS of Amazon, Google, and Microsoft almost adds up to that of Apple!
What usually happens within the dynamics of a family when one sibling is more successful than the others? Unfortunately, it attracts envy, resentment and fleas! Not only will you have "copycats" and the raiding of skilled talent but you will almost always have lawsuits too! Would this be rampant in a dying industry?
A few weeks ago, Apple released its sixth Annual Supplier Responsibility report. Not surprisingly, it was criticized as "not having done enough". While it raised enough stink for Tim to provide his thoughts on the subject, I would expect that he is smart enough to understand the media's appetite for sensationalism - don't feed the Hyenas anymore!
I applaud Apple for publicly listing its suppliers, its effort to continue to publish the report (is it the only one doing this?), and its resolution to cut off repeat offenders. I guess we should expect the Vatican (who doesn't pay any taxes) to open its vault and help increase the minimum wage in these factories! We seem to be willfully ignorant and forget that the standard of living for these "low wage" countries would have been far worse without our "exported" jobs.
MARGINS and VALUATIONS
The following chart below shows the relationship between YOY earnings growth (orange bar) against P/E (blue bar) over time. Bizarre, isn't it? P/E decreasing as YOY EPS growth continues to outstrip the expectations consistently over time (minor blip in 2008).
When it came to Amazon , the opposite effect can be observed. It is also interesting to note that despite Amazons' high P/E, its historical YOY earnings growth have never kept pace (except for 2007) with those lofty expectations.
Regardless of P/E ratios (or whatever bias you have), various trading opportunities can present themselves (like our short thesis with Research in Motion (despite its low P/E ratio here and with other stocks like what I am doing here with the "Moneyball" series). Always remember that "Bulls make money; Bears make money... pigs can get eaten by the big bad wolf!".
Apple closed at an all-time high of $459.68 at the time of writing; The S&P500 (NYSEARCA:SPY) is at 1,344.90 and the Dow is at 12,862.23. The Greek debacle seem to have taken a backseat to pretty decent economic numbers here at home. I found the following sentiment from the Greek (you know, the nation that feels that it is entitled to a "job for life") situation interesting:
In a letter to the government Friday, Greek unions and employers said they rejected proposals to slash the minimum wage and further cut annual salaries.
"And one of the main problems of the Greek economy as we have said time and again here is the chronic loss of competitiveness over the past decade."
Imagine getting a limit increase in your credit card every month, spending that limit to the hilt (fancy cars and dinners, big toys and big house, etc...). One day, your income stagnates or starts to go down as the company you work for found a cheaper alternative; you get mad and blame the bank for your debacle! Simplistic analogy or is it closer to the Ugly Truth? Is the US headed towards the same fate?
History is filled with examples of what happens when you combine incompetence, entitlement, and fiscal irresponsibility; here are two striking examples...
United States Postal Service
A few months ago, I read an article about the US Postal Service. It was suggesting that this beloved institution may soon be as extinct as Research in Motions' Playbook! Here is an update of that saga.
The challenges within USPS appear to be:
- Costs. If you cannot balance your budget; you will run a deficit. If you run a deficit; you can only borrow as much before you get in trouble!
- Politics. Long on promises; short on delivery.
- Leadership (or the lack of). Snakes in suits.
- Collateral damage. The perpetrators aren't the ones who suffer the most.
What kind of house do you think the management at US Postal Service built over the years?
During the1980s, Japan's strong economic growth (almost like the US pre-crisis and China in the last five years) fueled a massive wave of speculation & borrowing (assisted by low interest rates) that lead to abnormally high valuation in real estate & security prices within the country and to a certain extent internationally (remember the spillover into the Real Estate prices in Hawaii?).
The party came to a crashing halt when rates were raised around 1989; the bubble imploded and lead to a massive stock market crash. It also led to a debt crisis that was so severe that banks failed and those who remained standing had to consolidate in order to survive as the Government couldn't bail everyone out (sounds familiar?). Today, the official Japanese interest rates stands at 0.1%. It has been 21 years since the Japanese meltdown; it still hasn't fully recovered from the hangover.
Almost everything (at least electronics related) that was used to be "made in Japan" is now either "made in China or Mexico"! Japan lost its competitive edge as well, and may never get it back (notice Hyundai taking market share from Toyota and Nissan?).
The Japanese were craftsmen in the products that they improved on (TV's, stereos, cars, etc...); it is ironic that the financial house that they built imploded as well.
Tim, by the looks of how he is running Apple over the years, must have read the "Three Little Pigs"; Apple's fiscal responsibility and performance is as great as they come. However, only time will tell if it survives the big bad wolf!
Assuming the macro events in Europe continue to be contained, I look at every retracement opportunity in Apple as compelling entry points using LEAPs. Don't let "noise" sway you to think that Apple at $450 (or at any price) could not provide you with any profit opportunities (long or short). Your biggest advantage over the Wall Street herd is your own critical thinking skills. However, don't forget that you are only as good as your last trade!
In closing, I wanted to share an interesting observation on what Apple's share price may be at year end based on its performance in January.
Essentially, I took the closing price of Apple for each year end ($322.56 for December 2010) and compared it with its closing price at the end of January of the following year ($339.32 at the end of January 2011). If the difference was positive, Apple ended up closing higher. Since 1997, this has been accurate 80% (12 out of 15) of the time!
- Given that Apple closed at $405 as at December 2011 and closed at $456.48 as at January 31, 2012; there is an 80% chance that it will end December 2012 higher.
- According to the "January Barometer" (As the S&P500 goes in January, so does the year), there is an 89% chance that 2012 will be a great year, based on this January's approximately 4% gain (its largest since 1997).
- According the "Superbowl Indicator" (with an 80% accuracy since 1967), given that the NFC's New York Giants victory over the AFC's New England Patriot for the Superbowl, 2012, should be a good year for the market.
Of course, take all these interesting tidbits with a grain of salt! As sure as the sun will rise tomorrow, Apple will retrace and there will be those that will say "I told you so". Take advantage of it! I hope I have kept you in the game with Apple amidst last years' gong show!
Till the next earnings report; maybe you will join me and help me refine my "Moneyball" series!