Depending on Long-Term Aggressive Growth for Apple is a Gamble

It is no secret that Buffett tends to shy away from technology companies. On one side, people say he simply doesn't understand them and can't predict the future with any degree of certainty or comfort; on the other side of the fence, people say the industry changes too fast and today's leader could be tomorrow's old news.

The Apple Revolution

There is no question about it—people love Apple's products right now. Years ago, the MP3 player hit the market—and then seemed to die almost as quickly. Then came the IPOD—and everyone wanted one.

Building on that, Apple recently released the iPhone, selling 1.4 million phones to date. And the Mac? Brilliant marketing (remember the "I'm a PC, I'm a Mac" commercials) helped bring Mac to the home user. The Mac isn't sweeping the nation, but it is breaking into Microsoft's market share, sitting comfortably now at 8%. As the de facto standard for graphic and video designers, web designers, programmers, etc., the Mac certainly has a future.

The Numbers Boost

What have these products done for Apple owners? In 2001 and 2002, Apple was running at negative cash flow, burning through some $500 million of excess cash in two years. Even 2003 was less than stellar, bringing in just $32 million of excess cash — a mere $0.02 for every dollar invested in the company.

As the IPOD took off (launched initially and slowly in 2001), so did Apple's owner earnings. Between 2005 and 2006, the company generated in excess of $3 billion of owner cash. In the last twelve months alone, the company has produced more than $3.6 billion of excess cash, generating nearly $0.50 for every dollar invested in the company.

Turnarounds seldom turn. But, they do turn from time to time.

Putting A Value On Apple

How do you value a company like this? Remember that the value lies entirely in the future, no matter what has happened in the past. Everything we do must be an educated guess, and that is where we will start.

Let's assume Apple can grow owner earnings at 25% for the next two years. Then, growth will slow to 20% for the following two, ultimately capping off at 15% for years 5-10. After that, growth will slow to 5%.

Using a 9% discount rate, the value of Apple's future cash would be $126.7 billion. Add in $13 billion, the last quarter's shareholder equity, and Apple's value comes in around $140 billion. With 880 million shares outstanding, Apple's intrinsic value lies in the $159 per share range.

A Fair Assumption?

No company, not even Apple, can grow rapidly forever. Now, I'm not a huge fan of Wall Street; still, it doesn't hurt to see what the analyst consensus is on Apple—just to see whether or not our 25% is hyper-aggressive or ultra-conservative (to the point of scared).

Yahoo! Finance reports that the average analyst estimate for Apple's earnings growth is about 26% for the next year. I wouldn't base my future on that, but it does provide a tinge of comfort that I'm not being scared with my numbers.

Is Apple Overpriced?

If you agree with the above assumptions, then yes. The stock price can do anything over the next few weeks and months. Still, price follows value. If Apple were fairly priced today (about $186 a share), it would have to grow at 21% for ten straight years, at which point it would be generating $24 billion of excess cash each year.

More importantly,the new Apple is currently converting roughly 15% of its revenue into owner earnings. Even if we assume that this pattern could continue (before the iRevolution, it was converting about 1.6%), Apple would have to be bringing in $161 billion of revenue ten years from now. If it only converted 10%, it would have to be generating revenues in excess of $240 billion a year. That's more than Motorola, Nokia, Microsoft, and Dell combined are generating!

A lofty goal to say the least.

Apple: Growth At A Reasonable Price

There is certainly some growth left in Apple. Unfortunately, that growth doesn't seem to be at a reasonable price, unless you think we'll live in an Apple-dominated world in ten years. Then again, many are clamoring for a Google-dominated earth and Google's phone could be devastating to the Iphone. Or, it could not materialize at all.

Sounds a bit like gambling to me.

Comments

[raylo]

Hey, in the world of stocks investing, everything's a gamble. Nothing's a sure bet, man.

[Oh Blah Dee Blah Dah]

RE: "Sounds a bit like gambling to me."

You want safety? Buy U.S. treasuries!

Growth at a reasonable price (GARP) works when a company is a steady supplier of a basic good (cereal, soap, beverages etc.). Then, the 10 years discounted cash flow model can be calculated according to the textbook theory.

Unfortunately, it's just a THEORY.

In the real world, a company with technological or market uniqueness, such as Apple, MUST be purchased early and ahead of its GARP period, if one is to reap the huge, early gains. Microsoft was always expensive in its early years. Read the early money managers' and analysts' interviews in the library newspapers. Many analysts and money managers said they wouldn't buy Microsoft because "it's too expensive." But, Microsoft created enormous wealth for investors in its early years of growth.

As of approximately the last 7 years, Microsoft has fluctuated between 25 and 30, essentially trading within a very narrow range. Its too late to buy it now for high growth.

Apple is at its first early stage of hyper-growth. Apple has approximately 3% of the world computer market. The other 97% is THE market for Apple to grow INTO. Apple is only now just starting to hit its stride. In my opinion, Apple can be a $300 million market cap company with a few years, based upon a growing world middle class and its line of computers, iPods, and, eventual, line of iPhones.

NOW is the time to buy Apple. It was much riskier to buy years ago. Now it has its best product line-up, the safest and fastest operating system, Windows capability, fully integrated personal and business software, and mobile and cellular extensions of its operating system with the iPod and iPhone!

[Stustanton]

Geeze! You are pulling numbers our of the air. Do your estimates have any basis at all? I don't think so. Run the numbers on their business model and the possibility of it filling, not your numerical fantasias.

What happens in the numbers if Apple establishes a real presence in the cell phone industry? Use your calculator. Suppose they get a 10% market share in the billion-cell-a-year world business? Click, click, click – two year business cycle, click, click, revenues of... etc., on 200 million cellular contracts, that’s _____ dollars/yr. What happens if 40% of laptops and desktops sold worldwide are Macs that simul-boot Windows and Mac OS? Click, click, … that’s ______ dollars per year. Reasonable? No PC can follow where the Mac PC is headed, so yes. And I don’t suppose you believe that Apple will bring out other new toys, do you. Guess not, but they will. Convergence is where the world is headed, and few contenders can follow Apple. The iPod is not an mp3 player, it’s a node, a new-world remote in your pocket for converging your digital multifunction lifestyle. It's a pocket super-computer. Estimate the revenue. Then, Apple’s price is earnings-per-share times price-earnings-ratio. THAT is how you sketch the potential future, not grabbing your unattached percentages out of the air.

At a 6% PC market share and 1.2 million iPhones, Apple is has just begun to emerge. Sketch THAT future for us please?

[sane_man]

Henry Blodget set the valuation of Amazon at $400 and sent personal mails to friends calling internet stocks as "piece of trash". That is what is happening with Apple. Analysts are pumping the price to 200, 210, 230 and even 250. Now itself the P/E is 53. How can one raise the price estimate further with nominal increase in earnings? Sky is the limit for these analysts. A lot of innocent investors are going to get hurt eventually.

[Tom B]

"That's more than Motorola, Nokia, Microsoft, and Dell combined are generating!" MOT: used to be a chip company; focussed on cell phones; getting its clocks cleaned. Nokia: soon to be defunct phone company. MSFT: all its markets exist ONLY because of ignorance and resiatnce to modernization. Dell: used to be a PC giant. Before China got in the business. 'CHEAP" only goes so far; sometimes you need more in your playbook.

"Then again, many are clamoring for a Google-dominated earth and Google's phone could be devastating to the Iphone. Or, it could not materialize at all." Google has no experience in consumer electronics. As a holder of BOTH GOOG and AAPL, I'd advice Google to sit tight.

The future:
Apple; hardware
ATT: Network (including 700 Mhz)
Google; search, ads, services, CONTENT (buy Universal maybe?)
Plenty of room in the pool for everybody.

[rd4sndk]

Apples currently growing earnings above 65%annully. Gross Margins are expanding, the leading product line is gaining market share and they just release two hardware products that will require paid software upgrades inwhich margins are typically 90%+. So how do you justify a 25% earnings growth in the face of these numbers. Think of Apple as a combination of several companies:

Microsoft - for its operating system SW apps (90% GM)
RIMM - for its smart phone (60% GM)
Dell - for its computer equipment (45% GM)
Apple - for its mobile media devices-ipods (55% GM)
Best Buy - Services and Electronic retailing (40% GM)
Amazon - Content distribution (50% GM)
AT&T - for its mobile subscription revenue (100% GM)

Now in 2 years from now, make an estimate as to how much market share Apple will have of each of these markets and you'll see what the rest of us Apple investers are betting on. Apple could become the largest company in the world bar none. Can't happen? Google is only 5 years old and has a market cap greater than MS, IBM, Nokia, Intel and others. In 2 years Apple could have a market cap of $500B if it continues to grow at the pass its growing today--doubling every year. The odds are greater for my valuation than yours. 25% a year!!! What a laugh; you must have been drinking when you wrote that. You were just kidding right? come on just kidding right?

[briangee]

I don't know..i like my iMac a lot..and i like my iPhone a lot...and i like my shuffle a lot..I take near high def videos of the grandkids and put them on my apple tv without ever looking at a manual or taking a class. This is some great stuff. I don't think it hurts to own some of the stock too. They are really on to something. If you use their products then you will understand.

[beech_35]

People have been digging Apple's grave for decades. OS X is a flop, the iPod was flawed, Apple stores will fail just like Gateway's and the iPhone was an iPOS. Remember what was said about the iMac? Critics labeled it a failure - for lack of a floppy disk! Not to mention anything John Dvorak has written. All the while Apple kept innovating and growing, stubbornly making fantastic products, adding to a large cash cushion, and growing shareholder value. Not even I would have guessed AAPL could ever exceed IBM in market cap.

Apple is now ideally positioned to capitalize on a sea change in the computing status quo. It's about time people are waking up the fact that Apple reliably delivers quality while Microsoft's offerings have failed to deliver the user experience so often promised. Vista is a disappointment at best. MSFT's enormous success also presents a huge obstacle to any meaningful change to its basic interface, and any box maker reliant on MSFT is going to see their futures tied to an aging interface. Dell and HPQ computers are already considered throwaway junk, how are they going to look in the future, when all they can run is Windows?

As a long term investment, AAPL has a long way to go before any sane person would put it in the same league as a bank or GE or KO. That's why Warren Buffet doesn't buy tech, no tech stock in the world has been around for a century like them. BRKA might buy tech around the year 2080.

Several reasons I think the outlook is decidedly positive for AAPL over the next five to ten years: The iPhone is likely to be a franchise, and a high margin one at that. Its worldwide market is virtually limitless. iTMS and iPods already are. The biggest potential for huge success is computers - a much higher margin product for them. Having languished for too long, market share is finally accelerating. Some accounts put laptop market share already at 20%.

If there is speculative value in APPL right now, it's on their computers, but given recent trends I think it's worth the risk. Ten or more years from now? That's an eternity in tech. In 2017, AAPL might be the next MSFT - and you can interpret that any way you like!

[drianross]

I am from Germany and started value investing with rule number one. Now I read a much about value investing - Graham, Buffet, Lynch, Greenblatt and others. I calculated Apple and studied the annual reports. Over the last 9 years equity-, EPS-, sales growth have been far above 10 %. ROIC has been the last 5 years 12,3% on average and last year 25,3%. Only cash flow was last year negative. The 2 years before far above 10%. It is true Apple is starting and that is why you have not all numbers great. The equity growth low-rated would be 25%-30% the next years. The margin of safety would be therefore between 250-300 USD. So my conclusion is that Apple is not overpriced and you have to start with Apple before it is too expensive (value investing!!!).

[Kontra]

Yesterday, a Motorola executive said he was skeptical Apple would ever fully open up the iPhone. Here I examine how Apple has flourished without having to open up:

Motorola: Apple won’t open the iPhone
counternotions.com/200.../

[FreeRange]

If you look at the online readers' survey in today's online WSJ you'll see the results on the survey of purchase intentions for "your next home computer", an unbelievable 75% of almost 4,000 respondents say they will be buying a Mac - "are certain" (53%) or "very likely" (22%) to buy a Mac, with another 16% saying "somewhat likely" for a total of 91%!!!!! Go Apple!!!!

[Tom B]

Super-encouraging, but self-selection in on-line surveys can be a problem. If I were a masochist contemplating purchasing a Vista PC, I suspect I would feel pretty disinclined to own up to that.