In the looming global economic crisis, investors have begun panicking about their "golden investments". We've already seen Nasdaq dip 9.2% since early April and the Dow fall 6.6% just this month alone. What has happened though? We've seen record profits, strong balance sheets, and an overall strong outlook for U.S. companies, but something has to have occurred for investors to begin panicking in such an extreme. The answer? A shift in outlook from our positive growth over the past year to the looming European crisis that's on the verge of economic turmoil. The media is taking a heyday in creating panic and turmoil because it attracts viewers, but at the cost of their viewers' sanity. In the midst of all this fear and panic, I've increased my positions in Apple (AAPL) and Cheniere Energy (LNG) amid their sharp dips last week and I plan on holding onto my positions and ride the storm brewing in the media.
I take a very, very long-term perspective on my equity investments. Sure, Apple's stock can move down 2% tomorrow, leaving me wishing I had waited an extra day before investing, but I'm not dying over the most "optimal" entry point. It's impossible to predict when the best entry point lies so I don't lose my mind over trying to find it; instead, I wait for a market dip, like we experienced last week, and make my entry point then. I've held onto my Apple shares for months now and, though we've seen strong upward and downward movements, much hasn't changed rather than investor sentiment. I re-evaluated my current position in Apple through market research and analysis, only to re-conclude maintaining my current stake in Apple.
I've read ridiculous articles written about Apple's decision to issue dividends. Authors have argued that "it's not what Steve Jobs would have done" or "but Apple could invest it and grow at 25% a year". It's true that Steve Jobs condemned the dividend, but that's because Apple was on the brink of bankruptcy of 1997. The fear of being 90 days away from bankruptcy, as Jobs stated, created a very financial stringent perspective which was behind his repealing of dividends and donating to charity. Now, though, Apple is nowhere near Bankruptcy and is actually losing about $2 billion/year due to inflation outpacing the interest it receives on its cash. It's currently sitting on $110 billion spread amongst cash and short/long term investments. There is absolutely no way for Apple to reinvest the $110 billion back into itself to spit out 25% profit which is why their board decided on issuing a quarterly dividend payment of $2.65/share.
I find this to be a very strategic move for creating value and stability in Apple's stock. Although its 1.9% dividend yield seems low, it will help make a world of difference. The issuance of dividends unlocks Apple's gate to billions from funds restricted solely to investing in dividend paying stocks. The institutional ownership from these funds provides stability by restricting the day-traded shares which creates market volatility.
The issuance of a dividend also creates "stickiness" in investors. Currently, investors have very little reason to hold onto Apple's shares during a downward trend and are quick to sell their shares; further fueling the downward spiral. By becoming a dividend paying stock though, investors have to think twice before selling their shares, especially before the ex-dividend date. The investment perspective shifts from "well, the stock isn't performing well so let me sell it now and hope to buy it cheaper later" to "although the stock isn't doing well, at least I'll get a guaranteed dividend by holding onto it and hope the price lifts up soon". This shift provides at least some extra stickiness from investors to hold onto their shares, rather than dumping it on a whim as they have been doing.
I scratch my head at how overlooked the significance of retail stores are to Apple. On the second quarterly report, Apple stated having 361 stores open, a large increase from the 323 stores in the same period in 2011; also, they should be opening their 400thstore in this year. Why, though, are these stores so paramount to Apple's success?
Each store averaged generating $12.2 million in revenues just last quarter, meaning they averaged $4.067 million in revenues monthly. Accounting for about a 25% profit margin, each Apple store generates about $1 million profit per month, or $12 million annually. Apple opening about 40 new stores in 2012, adds about $480 million in additional profits just from the stores. However, the presence and success of these stores are far reaching beyond just in-store sales. Apple has been, by far, the most successful hardware company in creating its own retail stores. Others, like Dell, have tried to create a retail presence, but failed miserably and were forced to use intermediaries like Best Buys. Apple's physical store presence allows its brand image to be engraved in the minds of the consumers. I am a consumer and I've noticed the effects the Apple store has on me and my friends. There's a sort of excitement about entering the Apple store and playing with the iPad, iMac, and iPod; an excitement which follows you out of the store and associates itself to the Apple brand image. I've always been a windows fan and opposed people using Apple products, until I began visiting the store and quickly grew a liking to their products; essentially, they very quickly and easily converted a grinch to a fan simply because their products speak for themselves.
Solely because of the stores located throughout malls in my city, I've come to admire and desire buying an iPad and upgrading from an Android to an iPhone 5 on its future release. Not only are the stores massive profit generators, but they also help create a loyal customer base. The instant they make a sale to a new consumer, they've likely guaranteed a string of future sales creating a user lock-in from their strong ecosystem. The very strong ecosystem, created through the integration of the iPad, iPhone, iPod, iBookstore, and iTunes, especially through cloud computing, helps generate very strong customer loyalty which generates continued success for Apple. Apple's current line of products are on the forefront of most consumers' minds, and are there for a reason. They were the first the revolutionize smartphones and tablets, quickly making them the most recognized and valued brand globally.
Apple's iPhone and iPad have been its golden eggs, launching it to become the world's most valuable company. iPhone and iPad sales, with related products and services, accounted for 74.7% of Apple's generated revenues. Even better though, the iPhone and iPad are also Apple's profit drivers with 75% and 44% gross margins. The iPhone's immense margins come from how heavily subsidized it is because mobile carriers value the utility the iPhone gives them: customer loyalty. The iPhone keeps customers from churning at the lowest rate to any other smartphone which, in an industry where the smallest churn can destroy bottom line profitability, makes subsidizing the iPhone a must for mobile carriers. During their earnings call, Sprint's (S) CEO, Dan Hesse, kept driving the point that Apple's iPhone is paramount to the survival of Sprint.
There have been issues regarding subsidy issues around the iPhone. Mobile carriers are trying to increase their margins, which has left some analysts pointing to large future iPhone subsidy cuts. I argue against large scale subsidy cuts because of Apple's immense values to large carriers like Verizon and AT&T. Also, subsidy cuts will be successful if, and only if, the entire market cuts subsidies simultaneously, but that involves market coordination which is barred by the Department of Justice. It's a game of who is willing to take the first step and hope, more like pray, that other carriers will follow their footsteps. I don't see others following the lead because they'll be benefiting largely by scooping up the lost consumers of the first-mover.
Immense global demand
To say the least, Apple products have experienced absolutely tremendous global demand. Sales in Asia grew 114% Q/Q, Japan sales grew 91% Q/Q, and European sales grew 46% Q/Q. I would also like to note that sales have grown tremendously in Europe and China despite the economic crisis and looming real estate bubble. Currently, Apple and Samsung are scrambling to tap into the relatively untouched markets of China. It's not yet a fight for each other's market share, but for growing their market size from a newly emerging middle class.
On May 16th, China Mobile said in its shareholder meeting that it's currently in talks with Apple to offer the iPhone on their network. Why is China Mobile such an unimaginably tremendous resource for Apple? Because it has a customer base of 665 million, dwarfing Verizon and AT&T's subscriber base by 6 times (Forbes), making them a key asset for Apple's rapid short-term and long-term growth.
The Apple Ecosystem has become its greatest asset in ensuring long-term growth. Essentially, the ecosystem is the seamless integration of Apple products together which creates a positive lasting impression on the customer.
By utilizing the Apple ecosystem, carriers use iPhone and iPad as staples in creating a strong customer base while reducing churn rates. This flows perfectly in line with an economic theory called utility which illustrates the reason why we purchase products at certain prices; the reason being that even though the product is priced at $100, we may actually see $120 of value in the product; the additional $20 being our additional utility (value).
Here's where it gets very interesting. In the Apple ecosystem, where you have multiple Apple products working seamlessly together, there's an unaccounted additional utility created from the combination of products. Let's say you pay $200 for an iPhone and see $600 of utility in it, then pay $600 for an iPad and see $800 of utility in it. From the iPhone, you receive an additional 400 utility and from the iPad, an additional 200 utility. You would assume that when using the iPad and iPhone together, you'll receive 400+200=600 additional utility (value); however, that is not the case.
In combining Apple products, the summed utility becomes greater than the sum of the individual utilities. Instead of receiving the expected 600 utility, you may actually receive 800 utility. This is why you hear Apple "fanboys" raving about the Apple ecosystem; because everything, from the iPhone, iPad, and iMac to the cables and earphones, creates additional utility (value).
Some argue although Apple is the king of today, it may be the prince of tomorrow. Overall, the technology world harbors unforgiving, relentless consumers who flock from company to company depending on which one is "in". We've seen the rise and fall of many and are analyzing, very carefully, Apple and its competition against Google (GOOG) and Microsoft (MSFT). Fortunately for Apple, it isn't only a hardware company, but also a software company.
They've created a marriage between developing both the hardware and software of a device, allowing them to create it in their exact image. The results of being successful at this have been absolutely amazing. The iPhone's physical feel was carefully developed with the consumer in mind; feeling how we want a phone to feel like. This has been so paramount to Apple's success that they've engaged in legal battles with Samsung, accusing them of copying the feel of their phones and tablets. Apple's iOS software is profoundly simple to use, aesthetically appealing, and highly intuitive. It's easy to learn and intuitive in its layout, serving a perfect complement to the hardware encasing it. The synergy created from hardware that complements the software has been apparent through the mass and rapid adoption of the iPhone product line.
Samsung and Google
The relationship between Apple and Samsung is truly an interesting one. Though many would assume Apple and Samsung are enemies because of the myriad of legal battles scoping over 10 countries, people sometimes overlook that Samsung is Apple's biggest supplier as well. I still scratch my head over why Apple is sleeping with its "enemy" when it clearly has the resources to shift its purchases away from Samsung. Recently, Apple finally began shifting more semiconductor orders to Elpida, which definitely reduces the conflict of interest between supplier and competitor. I believe we'll see a shift away from Samsung to other suppliers, like Elpida, over the next few years. Unfortunately for Samsung though, Apple is its largest purchaser and losing its patronage will dramatically affect Samsung's bottom line profitability.
Currently, Apple's iPhone and Samsung's Galaxy, running on Google's operating system, are controlling 90% of the high-end smartphone market share, which is projected to remain nearly the same at 88% by 2013. As we've seen with both Apple and Samsung's earnings reports, China has become the X-factor in driving up earnings to new records. The recent surprise in high demand has led analysts to predict smartphone sales increasing an additional 20-30% just this year.
Many analysts are viewing Samsung's increase in smartphone sales as a negative sign on Apple's sales, but we've actually just been seeing both companies doing tremendously well by tapping into open markets like China. Apple poses the same competitive risk to Samsung as Samsung poses to Apple; however, both Apple and Samsung pose an unimaginably high risk to other smartphone providers like Nokia (NOK) and Blackberry (RIMM), who have been experiencing consistently dwindling market shares. Currently, it's a race between Apple and Samsung to build a strong customer base as quickly as possible in China
Global economic conditions
There is a lot currently going on with Europe and China which will create market volatility, especially during the upcoming months. Europe is experiencing a myriad of issues ranging from a recessed economy to a drying banking sector. To complicate things further, Greece's upcoming elections will make a very huge difference on the behavior of the stock markets; on one side, is the extreme left party seeking to forego their responsibilities to their creditors and throw out austerity measures, while on the far right are conservatives who seek to implement austerity measures and cooperate more openly with the European union. The dynamic duality between the two parties will dramatically affect our stock market; regardless of how fundamentally well the companies are that we invested in.
Apple is still the same great company it was when its shares were $644, but now they're at $562. I still remember thinking back then "if only I could buy back more shares at $600" and I'm sure that was the same sentiment other investors had as well, but now that the shares have fluctuated around $560, at a trailing p/e of 13.62 and forward p/e of 10.42, investors have lost short-term confidence in the stock. As a long-term investor, I don't integrate too much investor sentiment into my buy-in point; in fact, I try looking over it because sentiment changes so quickly and often for no reason.
Apple is the leading company in an industry which is experiencing massive long-term growth. They have products that people demand, and supply them how people want. They've consistently shown innovative strides and will continue to do so in the future. A great leader, like Steve Jobs, doesn't create a great company that depends solely on him, but creates a self-automated machine that can exist without his presence. The same great minds are working at Apple and will continue creating the same great products we expect from them.
In my analysis, Apple's shares are fundamentally an undervalued investment. I invest in companies with low p/e and PEG, signifying undervaluation, with limited market risk and strong future market growth. Apple's Return-on-Assets of 31.42%, Return-on-Equity of 47.10%, and Return-on-Investments of 40.76% illustrate its current ability to generate vast profits on invested capital and, with tremendous global growth for Apple's products, their current ability to generate profits will fuel immense future profits. I also take into account analyst's projections, just as a way of double checking myself, and am re-assured by the average$708.09 1-year price estimate. Sure, maybe Apple may be down 5% next month from downward market pressures, but I'm not looking for a quick buy-and-drop investment. I see strong growth for Apple, which will trickle into realized stock price appreciation sooner or later. I won't allow myself to be wishing next year that I increased my position at Apple's currently attractive valuation.
Please read my standard disclaimer for my articles here