The Irrational Preoccupation with Apple's Guidance

Seriously now! What's with Wall Street's obvious narrow-mindedness when it comes to Apple's (AAPL) guidance? We all know that Apple guides conservatively every quarter, and every quarter we all know that Apple handedly beats its proffered estimates. Yet for some reason unbeknownst to anyone with at least a shred of intelligence, the media, Wall Street and the uninformed investor get completely caught up in the same old obtuse story: "Will Apple's conservative guidance disappoint investors?"

To that I answer: only if the investor is an idiot. Wall Street is like a child who hasn't realized that touching a hot stove burns until after the fifth attempt at doing so.

Every management team in the financial world has its own unique way of doing things. Apple just tends to be overly conservative in its projections. Investors should be lucky that Apple even offers guidance at all. Yet, instead of praising Apple's management for its outstanding job in managing expectations over the past few years, the media, Wall Street and its investors "sells apple short" (pardon the pun) by continuing to be transfixed on this inconsequential rubbish.

It's up to the investor to try and interpret how management really feels about the company's prospects by following trends in management's guidance. Just because Apple's management projects that Apple will earn $1.00 in EPS doesn't mean that's what management "really" believe Apple will actually earn. One should always take Apple's guidance with the biggest grain of salt.

Take OpEx for example. Apple has consistently reported operating expenses about $40 million above its estimates over the past year (give or take $1 million). Should one really have me believe this is a mere coincidence? I think not. Apple's management knows ahead of time how much it will likely expend in administrative and R&D expenses, and sets its guidance according to what it believes will be the best way to manage expectations. Likewise, Apple's management has a pretty darn good idea of how much it will earn in any given quarter, and guides with bias toward managing expectations.

Apple's management almost certainly had a meeting sometime last fall regarding how conservative or aggressive it plans to be in 2008 vis-à-vis its guidance. And based on what it concluded to be in the best interest of the company, management decided to be a little less conservative than it has in the past. This is evidenced by the obvious shift from the regular 50% beats Apple would report on its EPS guidance during 2007 to the mere 23% beat it reported in each of its first two fiscal quarters of 2008. Management likely correctly determined that expectations had gotten so out high that it had to be a little more aggressive in managing expectation – and I emphasis only a "little more" aggressive. The table below exhibits the obvious shift in Apple's guidance strategy with regard to EPS:

Fiscal Quarter	Apple's Guidance	Apple's Actual	Percentage Beat
FYQ2, 2008	$0.94	$1.16	23.4%
FYQ1, 2008	$1.42	$1.76	23.9%
FYQ4, 2007	$0.65	$1.01	55.4%
FYQ3, 2007	$0.66	$0.92	39.4%
FYQ2, 2007	$0.55	$0.87	58.0%
FYQ1, 2007	$0.73	$1.14	56.0%

As anyone can see, the table above implies that Apple has shifted its strategy from being ultra-conservative with its EPS guidance to being just conventionally conservative in the ordinary meaning of the term. Based on the trends above, Apple probably expects to report anywhere from a $1.20 to $1.24 in EPS; or at least that's what Apple's expectation were heading into the quarter. The investor shouldn't be so shocked to see about $1.24 in EPS this quarter. Yet, analysts will do what they do best—mess up an easy call and get it complete wrong; and investors will do what they do best—be as surprised as they are uninformed and act in a correspondingly irrational way.

Finally, if you're even wondering whether Apple will guide below consensus estimates this quarter, then you should probably rethink whether equity investments is the right thing for you. Don't hold your breath. Apple is probably going to guide well below consensus estimates. It has generally done so in the past and will probably do so in the future. The table below compares Apple's guidance with analyst consensus estimates at the time of Apple's earnings report.

Fiscal Quarter	Apple's Guidance	Consensus Est.	Difference	EPS Actual
FYQ3, 2008	$1.00	$1.10	10.0%	N/A
FYQ2, 2008	$0.94	$1.08	14.9%	$1.16
FYQ1, 2008	$1.42	$1.39	-2.2%	$1.76
FYQ4, 2007	$0.65	$0.82	26.2%	$1.01
FYQ3, 2007	$0.66	$0.72	9.1%	$0.92
FYQ2, 2007	$0.55	$0.64	18.2%	$0.87
FYQ1, 2007	$0.73	$0.78	6.8%	$1.14

Despite the fact that Apple consistently guides below expectations, it still easily beats the consensus. In Q4, Apple guided a full 26% lower than the street, and yet beat those estimates by 23.17%. So what's the point of being concerned with guidance that Apple always beats? Guidance should be used as a "guide" to help determine what Apple will report in any given quarter based on understanding the thoughts and predispositions of Apple's management. Not as an indication of whether Apple believes business has slowed.

Thus, Wall Street, investors, and the media really need to stop focusing on Apple's guidance as if it were the boogie-man of the technology sector. It's not the end all and be all of anything. If you need a reason to sell Apple, then blame it on your fabricated recession. Blame it on Apple's write downs of its subprime loans. But blaming it on the guidance thing is really starting to get old.

 

Disclosure: I own long term 2009 and 2010 call options in Apple.

Comments

[Zach Bass:]

Excellent points Andy! Analysts will be staking too much on iPhone revenue in Q3. They're taking there eye off the Mac desktop, it's going to be the big surprise. I visit my local Apple Store about once a week. I've never been in there with less than 100 people. Often you have to wait to see product because every display has crowds. It's a big roomy store too!

On the iPhone front, anyone with any sensibility knows that Apple stopped selling the 2.5G iPhone 1 month before the intro of the new iPhone to clear a wide path, and to avoid the publicity snafus they experienced last year when they dropped the price $200. So, if the numbers for Q3 come in low, so what? It will have little meaning towards future revenues, because it's a whole new ball game now with the 3G and App Store and 22 countries, with another 50 coming on line this year.

Apple already sold 1 million iPhones in 3 days, and stores ran out of stock this past week, but they're being refreshed every day. How many more have been sold since the launch? You've got to figure that Apple had at least 3 million iPhones ready for the initial launch and another 5 to 7 million right behind that. Apple has demonstrated that their supply chain management has no equal.

The other thing is the reliability of analysts numbers as you so deftly pointed out. They're never right. Look at the recent huge miss by Piper Jaffray's Gene Munster and CNBC's Jim Goldman when they estimated less than 1/2 million 3G iPhones were sold the first weekend. Their models are obviously flawed. How could they be off by an order of magnitude? And these are the people investors are gauging their consensus numbers on? It's crazy!

2008 Jul 20 05:59 AM

[mrtaxx:]

The article states what actually transpires with Apple's guidance and backs it up with facts and data. Some of the articles I read on Seeking-Alpha are useless & worthless garbage. They indicate a writers opinion but many times the writer lists no facts or data to substantiate their opinion. Anyone can have an opinion but that opinion is worthless to investors if it doesn't include factual data. Such an article may lead the reader to think the writer is either writing for the longs or shorts he/she has relationships with.

This is an excellent factual article which I enjoyed reading.

2008 Jul 20 06:25 AM

[papita:]

I rarely pay any attention to what the analysts think when it comes to apple. I truly believe most people who talk negatively of apple are either short or are jealous of their success. apple is one stock I never have a problem holding into earnings. regardless of what it does after reporting, I have so much confidence in this company and management team.

2008 Jul 20 09:05 AM

[mollytjm:]

wonderful article and i also agree with Zach's comments. For me, Apple is an obvious choice to buy and hold. i was at the King of Prussia, PA apple store yesterday. They had just sold out the iPhone, again,but the store was packed with people buying all the OTHER stuff. and you only have to wait a few minutes to see someone coming out with a new computer. School starts again soon and i'm sure Mac sales will be through the roof. Will the market reflect the great profitability of this company? sigh. maybe not tomorrow, but eventually even a herd pauses to look around.

2008 Jul 20 10:53 AM

[piqqem sent...:]

Apple is notorious for low balling their estimates. They forecast a worse case scenario no doubt to make sure they can beat their own estimates. This probably helps to keep analyst estimates in check too.
The amazing thing is for a day or two after a earnings release the market doesn't seem to understand and selloffs commonly occur. For the long term, this can be ignored.

2008 Jul 20 12:13 PM

[marcos:]

Go on vacation for about 6 months, but pack in some stock now.

2008 Jul 20 02:38 PM

[texasgolfer:]

investment information from a so cal lawyer is not usually at the top of my things to read list.

2008 Jul 20 03:37 PM

[Camden:]

Nice commentary, Andy. The stats make it a great article.
Thanks.

2008 Jul 20 04:13 PM

[BurkPhoto:]

I just love to read comments about Apple from folks who have no real understanding of the IT industry or the consumer electronics industry, or computing in general. Thanks, Andy, for NOT being one of those people. I've seen enough of their crap elsewhere this past week.

Apple is the real deal, folks. They are on a serious roll that started in 1998 when Steve Jobs came back to the company, kicked the Mac clone makers in their collective crotches, released OS 8, 8.1, 8.5, 8.6, and 9.x, while launching the iMac, the iPod, OS X, and the iTunes store. Add the iPhone and Intel-based computer systems, pro audio and video and photography apps, and consumer iApps (iMovie, iDVD, Garage Band, iWeb, iPhoto...) and you have the core of a healthy computer and telecommunications revolution.

The key/core feature of all of these things is INNOVATION. Apple puts their magic user-friendliness spin on everything they touch. For the most part, it works better than other solutions on the market, and those who try their wares become ardent evangelists if not happy users.

We haven't seen anything yet. OS X is about to get much faster, slicker, and more capable. The App Store for the phone is a huge and potentially game-changing development. MobileMe got a rocky start, but will recover (You would have supply chain and infrastructure issues, too, if you sold a million of anything in three days!)

I could go on, but you get the picture. There is serious cultural good and game-changing innovation to be had from this company. That can, will, and does translate into long-term profit potential. The stock will go up and down, but I can't see many reasons for it to go low in the near future, other than FUD generated from bozos who want it to dip so they can ride it up again.

2008 Jul 20 05:25 PM

[Robcal1:]

Andy, excellent article! I agree with a previous post about you listing actual facts. Apple has become less conservative with their guidance and they continually beat the analyst's estimates. But it's just not good enough. Apple managment is failing us shareholders. I agree that Wall Street is a HUGE crybaby when it comes to getting what they want. But the fact is that Wall Street has figured out Apple's business and they've got a pretty good beat on where Apple should guide. Now I absolutely hate to say this, but Wall Street is right for KILLING the stock every single time Apple management screws up the guidance! Doesn't Apple management get it by now? The big boys on Wall Street control most of the money that's traded. You can't pull the wool over their eyes. Yet Apple continues to fail at getting it right. If Apple cares anything about it's stock price going higher and the investors that have helped make Apple what it is today; then they're going to have to get even less conservative.

2008 Jul 20 08:35 PM

[terder:]

Why should Apple care about it's stock price ? They can make cash and put it in the bank the same whether it's $5 or $500 per share. What we as investors buy and sell Apple stock for I contend has NO bearing on their performance and their capability to make good stuff or crap. Their only connection to stock price I would assume would be when it comes to employee stock options -- but with billions of dollars on hand I don't think they're looking for stock appreciation as their primary compensation mechanism. Back to my point, someone tell me what Apple does differently with their stock price at $100? at $250? at $165? What does it matter to them ?

2008 Jul 20 10:35 PM

[jmmx:]

Andy-

You say:
"Apple's management knows ahead of time how much it will likely expend in administrative and R&D expenses, and sets its guidance according to what it believes will be the best way to manage expectations. Likewise, Apple's management has a pretty darn good idea of how much it will earn in any given quarter, and guides with bias toward managing expectations."

I am sure they pretty well know ahead of time the Operating Expenses. But the earnings? I think they have been surprised as hell at the growth, AND working their asses off to keep up with it!

What was it 50% growth in MAc sales? These figures are blowing their minds. They never even dreamed of these numbers. Same with iPhone sales.

I imagine they are working through the weekend to figure out what to put out tomorrow in light of the iPhone sales. (I predict 7 M units in this quarter calendar Q3).

2008 Jul 21 06:14 AM

[jmmx:]

BTW-

(Up on a soapbox again) Apple never gets the credit it deserves for pulling off 3 of the most extraordinary technical feats in computer history:
1- Switch from Mot 68000 series chips to the PowerPC chips (completely new architecture)
2- Switch to OS-X (completely new OS structure)
3- Switch to Intel chips (completely new chip - again)

It did all these while maintaining backwards compatibility that went on more or less without a hitch (OK there were a few hitches - but none were major)

These were absolutely incredible accomplishments.

IMHO

2008 Jul 21 06:31 AM