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.