Daniel Agramonte

Daniel Agramonte
Contributor since: 2008
Actually, there are many companies that don't fully book revenue when they sell their products. In fact, many of them ALSO have order backlogs as well.
For example, GE doesn't book all of its revenue on many of its products (e.g., locomotives, aircraft engines, etc.), but keeps some of it for actuarially determined product issues. In fact, they do the same with the long term service agreements (some going out all the way to 24 years) and they level-load the revenue vs. required maintenance expenses (they use sophisticated algorithms such as cumulative catch-up, etc.).
Looking at Apple objectively, spreading out revenue over the product lifecycle is actually a reasonable way to do it and not really that remarkable. Consider this: how do you think they paid for the $100/phone 'rebate' they gave early iPhone adopters or the iBook battery replacement programs?
Also, beware how you define 'product'. If you get very granular (e.g., iBook G4, 14" with 1.42Ghz processor), your product cycle is only a few months (I have 4 Macs, none of them was sold for more than 6-7 months). While they may roll-over some of this revenue into a new quarter or a new year, it's nothing more than a short-term, self-insurance policy. Besides, much of this HAS to get plowed back into new product development anyway, so it's unlikely they'll pass it back directly to shareholders. Personally, I'm not that awed by deferred revenue or how it may or may not impact valuation on Apple.
Many companies use 8-10% as an internal hurdle rate--I was generous in discounting at 5% for years 1-10, as this is typically a risk-free rate. As such, discounting at 9.5% in the first 10 years, still assuming 20% earnings growth gives an Intrinsic Value of about $80/share (about 50% below current prices).
After that, I guess it's fair to grow earnings at 5% (who knows, we might have a depression at that point?). I really struggle after year 15--in practical terms, where was AAPL 15 years ago, and where will they be 15 years from now? Who knows? Regardless, growing revenue at 5% during years 10-15 gives us a valuation of about $117/share. While fraught with execution risk, this may be achievable. I haven't screened it lately, but I suspect VERY FEW companies have had 20% earnings growth for 10 years. Think about it--with compounding, etc., it would only take one flat year to mess things up.
That's where it starts to get inplausible. How many companies can keep from having a bad year or two during a 10 year stretch? As I recall, AAPL was losing money in 1999. Their phenomenal growth in 2005, 2006 and 2007 enabled them to overcome the drag at the beginning of the decade. Bottom line: while the constant growth model is good from a theoretical standpoint, and my mathematical brain wants to add something to cover earnings in perpetuity, I struggle to comprehend what might be going on beyond year 10, let alone year 15. The changes in the technology alone due to Moore's Law would be enough to boggle the mind after year 10. Lots of food for thought and even more risk and uncertainty. In short, plenty of moving parts for a company that, despite a good four year run, hasn't yet proven its ability to grow consistently for a decade. In fact, I can only think of a handful of companies that have shown an ability to grow a large enterprise for a decade, and many of them are already held by Berkshire Hathaway: GE, P&G, American Express and perhaps a couple of oil companies.
There's more analysis, this time more qualitative, on tap for Monday. Thanks for the comments and feedback. Your unique perspectives are appreciated.
You are exactly right. Taking EPS growth at 20% annually out to 20 years gives about $590/share. I used 10 years for a very practical reason: I suspect Steve Jobs will be sipping Mai Tais in Miami in less than 20 years (Bill Gates is already bowing out and Andy Grove is long gone, but John Chambers is still going strong at 58). In other words, 20 years is a long time and Apple may not even exist as we know it today. It was certainly a mess before Jobs came back--who knows what'll happen after he leaves. Then again, maybe in 20 years Warren Buffett will still be around (at 97) and Berkshire Hathaway's A shares could be trading at $1 million? Thanks for the comment.
Chad interesting analysis. If you're interested in a different perspective, feel free to check my recent posting on seekingalpha.com. While it's definitely drawn the ire of Apple fanatics, my analysis leads me to believe AAPL is priced at or somewhat above its intrinsic value (focused strictly at earnings). I'm basing this on: (1) it will be extremely for AAPL to grow earnings at 20% annually for the next 10 years, and (2) AAPL's on a major product development treadmill.
To elaborate on the first point, all one has to do is look at AAPL's financials for the last 10 years. Revenue is up at about 20% annually ($5.9B in 1998, $24B in 2007). Earnings, however, have increased by 30% annually. This is phenomenal. The difference? Growing margins. In 1998, margins were about 5%. In 2007? 15%. Again, this is phenomenal. AAPL is focusing on high-margin businesses (iTunes, videos, etc.) by reinventing themselves (they even changed their name last year) and 'value pricing' their products. Can it go on? Well, that gets me to the 2nd point.
AAPL is on an innovation treadmill. The cash it's sitting on is actually an insurance policy (a hedge of sorts, if you will) in case they make a bad bet. An analogy? MSFT and the XBox. How much have they plowed into the XBox? Has it paid off? The jury is still out. The interesting part is that AAPL has to plow the earth to retain their prime mover status which is why they enjoy the fat margins. This means they will have to continue to push the envelope, which inevitably means they will roll the dice. Eventually, they'll come up snake eyes (are you old enough to remember Betamax?).
For AAPL, my sense is 20% earnings growth for 10 years--which is still great. At that rate, intrinsic value is about $90/share. You pile on the cash and deferred revenues (which I would still argue is nothing more than an insurance policy against taking on long term debt), and you might get to close to what the stock is trading for. Is it a bargain? At best it's priced at fair value with a ton of execution risk.
Supplemental Disclosure: The author is long 6 iPods and 4 Macs
Good article; similar to one I published recently (albeit with criteria somewhat modified for microcaps). I've looked at many of these before. One stock on the list is very interesting: Temple-Inland. Suffice it to say they've done a lot of good stuff recently (I dealt with them professionally for several years), but they have the same problem as most of the others in the forest products group: too much debt (a paper machine costs about $900 million).
By the way, I've always loved the irony about dividends: a sign of overall health, but Brk.A and Brk.B have never paid one (go figure). All in all a good read.
I found this stock the other day, Monarch Cement Co (MCEM); not sure how badly hit they've been by the housing issues, but their balance sheet was decent (except for about 16% LTD/Cap which is borderline for me). They're in Kansas and Iowa and I know these areas haven't been as hard hit by the housing woes.
Walmart has about 1 million employees, largest private employer in the world. At least that's what Marketwatch.com says on WMT's profile at:
Please see my latest article, comparing SJM to TR. Before looking at it, I wasn't sure how it was going to turn out--the result was actually pretty clear. Cheers.
Thanks for the feedback. As always with investment advice, caveat emptor (buyer beware). The approach here was designed to focus on companies showing strong value despite their modest size (since value investors typically restrict their focus to companies with more than $500 million in sales). There are many aspects of the company that you should look at and it goes without saying that microcap investors (as opposed to speculators) should perform a deep due diligence before deciding to own a specific comany. The guidelines here are simply starting points in the analysis and don't purport to be the definitive answer. Thanks again for your feedback.