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Dr. Jacques Saint-Pierre
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Dr. Jacques Saint-Pierre was full professor of finance at Laval University (founded in 1852) until his retirement in 2010, where he has taught finance at the bachelor, MBA and Ph.D. levels during 40 years. He is now adjunct professor at the same university and board adviser. He has been during... More
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  • Apple Inc.: Is The Future Bright ?

    Apple Inc (AAPL) is a remarkable value creator and enjoys a sustainable competitive advantage. Its growth prospects are still considerable. In this article we present revealing data that have not been presented elsewhere.

    Performance Spreads Over Time

    How do you know that Apple will continue to add market value in the future? Simply by looking at the performance spreads over time.

    One of the keys to finding superior long-term investments is to buy companies that will be able to stay one step ahead of their competitors. Companies that have generated returns on their capital higher than their cost of capital for many years of operation usually have a competitive advantage, especially if their returns on capital have also increased over time. This line of reasoning is fundamental. In other words, having an unexpected or a temporary competitive advantage is not enough for a business to be able to declare that it has a competitive advantage. Simply put, you cannot expect to obtain abnormal return (alpha) as an investor if the business you invest in does not have a sustainable competitive advantage. We define sustainable competitive advantage as the difference (the performance spread) between the return on capital and the cost of capital (correctly measured, that is after transforming GAAP numbers into a rigorous computation of economic profit, after deducting the full cost of capital, and eliminating the accounting distortions). The higher the performance spread, the bigger the competitive advantage. In the table that follows we present the performance spreads over time of Apple.

    PERFORMANCE SPREAD (Trailing 36 months)

     20082009201020112012
    APPLE6.7%11.1%15.8%23.8%24.7%

    It is impressive to see that the positive performance spreads are increasing over time. A performance spread greater than 20 percentage points is remarkable. The most prominent and stupendous fact in the above table is that with its substantial size, Apple is able to increase year over year its performance spread. It has gained 17 percentage points since 2008. Why the Apple case is outstanding?

    As a long term value investor, you know that, over time, market value and intrinsic value converge. A company with a positive performance spread, that is a return on its capital greater than its cost of capital, a necessary condition for market value creation, will see it decreases to zero, if the company is not able to embark on a new strategic value increasing trajectory. That is not the case for Apple. It means that Apple has a rock-solid position in integrating hardware, software, services, and third-party applications into differentiated, premium devices that provide superior functionality and ease of use for the end customer.

    Apple has a robust product pipeline and ample opportunity to gain share in its various end markets. Even in a world of short product life cycles and intense competition, Apple is able to maintain, even to increase, its performance spread.

    Intrinsic Values Simulations

    Equipped with the above information on performance spreads and the fact that we are in the presence of an outstanding value creator, it follows that a breakthrough in value creation is not expected. Indeed, powerful competition typically leads to new, innovative products that have historically prevented any single firm from dominating the marketplace.

    In this competitive landscape, we have estimated the intrinsic value under two scenarios. They are presented in the following table. In a scenario called "convergence toward competitive equilibrium" we suppose that the performance spread will decline gradually over the next five years from 25% to 10% and stay at this level afterward. This scenario gives an intrinsic value of 478$. This price is not too far from the current market price.

    In another scenario, a very optimistic one, we suppose that Apple will maintain the present performance spread of 24.7% forever. The intrinsic value for this scenario is 810$. It gives an upper price that Apple has never attained in the past.

    A superficial knowledge of how prices are established in the capital markets and an over confidence on a point estimate of the intrinsic values would cause some analysts to declare that Apple is undervalued under this second scenario. We are not going that far and take these results as simply supporting our overall analysis that Apple is a very incredible value creator. What confidence do we have in our estimations presented so far?

    Intrinsic or Fundamental Risk

    To answer the question we need to recall that the value of any company (i.e., the market value of total capital) is composed of two parts: the value of assets in place, [Va] or, the value of the current operations (i.e. the discounted value of the current net operating profits), plus the value of the future growth opportunities [Vg]. In the simplify approach that we use here, this second part is just the result of subtracting the first part, (i.e. the value of assets in place) from the market value of total capital [VT]. As you can see in the last three columns in the table below, [Va] plus [Vg] is equal to [VT] or 100%. The calculations are based on the recent market price of Apple.

    The greater the market value of the total capital of the corporation is composed of the value of the current operations [Va], the less significant is the value of the most uncertain part of the total value, i.e. the future growth opportunities [Vg]. For Apple, most of the market value, 93.2%, comes from current operations, the most confident part of its value.

    APPLE

    Intrinsic Value

    Recent PriceTotalVaVg
    Convergence toward equilibrium478$461.91$100%93.2%6.8%
    Optimistic810$461.91$   

    Actionable advices: First and foremost, invest or stay invested in Apple. This stock is a rock-solid choice for the very risk averse investor. Apple's growth prospects are still considerable.

    Second, why not take the opportunity to diversify the IT part of your portfolio in investing in the above value creator and the other value creators that we have analyzed recently on Seeking Alpha. The IT part of your global portfolio will leave you sleep at night.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: AAPL, long-ideas
    Mar 26 11:02 AM | Link | 2 Comments
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