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I am a two-decade veteran of the investment business and am especially interested in technology investments.
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  • Apple And The Market Cap Argument

    Now that Apple has breached the threshold and become the most valuable company ever traded on a stock exchange, there surely will come a flood of articles decrying Apple's massive weighting relative to other companies that produce and sell goods and services that are perceived to be more vital to our wellbeing than phones, computers, and music players.

    At yesterday's close Apple's market capitalization stood at $614.48 billion dollars. Market capitalization is simply the price of the stock multiplied by the number of shares a company has outstanding. As such, price is a major determinant. Daily pricing results from many factors but the most important factor has to be earnings, both present and future. Since Apple does not carry a wildly inflated p/e, (meaning that investors are not paying a disproportionate price for every dollar of Apple' s earnings), the current price is supported by present earnings. Therefore, Apple's current market cap also is justified by the company's earnings.

    Apple is eating whole companies and industries alive and I think we can posit that much of Apple's market cap growth has come at the expense of the companies with which it competes: Dell, Research in Motion, Hewlett Packard, and Nokia. Each of these four companies achieved peak market cap in either late 2007 or in 2008, sometime after the introduction of the iPhone. Have a look at this chart:

     

    CURRENT MARKET

    CAPITALIZATION

    PEAK CAPDATEDIFFERENCE
         
    DELL19.70B69.51B

    10/2007

    -49.81B
    NOK11.65B151.14B12/2007-139.49B
    RIMM3.66B78.32B5/2008-74.66B
    HPQ34.70B133.23B10/2007-98.53B

    At the end of September 2007, Apple's market cap was $133.46 billion. The investment community has since added $481.02 billion to Apple's market capitalization. The four companies above have lost a combined $362.49 billion in market capitalization since the dates of their respective peak valuations, valuations achieved shortly after the iPhone made its debut.

    More proof that money goes where it is treated best, as they say on Wall Street.

    Disclosure: I am long AAPL.

    Aug 24 11:26 AM | Link | Comment!
  • Apple Dictates That Large Numbers Law Needs Revision
    Apple's trailing twelve-month earnings now stands at $35.12. The

    company has cash equal to about $103 per share. At $450 per share, Apple trades at 12.8X those trailing earnings, 9.8X if you subtract the cash. I believe the market's overall P/E is just above 12, so depending on how you want to look at it, Apple is either trading in line with the overall market or at a significant discount to it. If you choose to believe Cramer who said this morning that Apple could earn $50 per share this fiscal year, then those valuations drop to 11.11X with cash and 7X without it. No matter which way you choose to look at it, Apple's valuation is a complete joke. Why? The lazy person's rationale is something called the "Law of Large Numbers." This "law," as it were, posits that as Apple grows, it will take an ever-increasing amount of revenue to maintain its growth rate. As Apple grows, the amount of revenue required will become so large that the rate of growth will have to decline. The secret is in divining just when a company reaches its growth apex. For several years now Apple's growth story has been hurt by the invocation of this "law." As Apple grows quarter after quarter, analysts become ever-more certain that the "law" is about to come into play. However, as was pointed out in this excellent article, Apple's revenue growth is accelerating, not declining. http://www.readwriteweb.com/archives/apple_sales_growth_rate.php

    Even those whose analysis of the company is not clouded by whatever the current prejudice is are amazed by what Apple continues to do with its business. 2012 Q1 earnings surpassed even the most outrageously optimistic expectations of the amateur analyst community, a group whose whose predictions are not constrained by worries about job security. It is always dangerous to make the statement that "this time is different," but is this time really different? Can Apple overcome the prejudice directed at it by its position as the biggest company by market cap?

    I think the answer lies not in judging Apple's potential for growth by its current market capitalization but rather by the size of its addressable markets. Worldwide revenues for the global telecommunications market is expected to reach $2 trillion dollars this year, revenues for computing about half that. These are huge markets in which Apple has, by comparison, a miniscule presence. No one company is ever going to have a majority share in these industries but these industries' sheer size makes it possible for companies with small share to make enormous amounts of money. This is exactly what Apple is doing and what analysts and investors seem to ignore when they trot out the market cap argument.

    What is even more frustrating is that Apple's current valuation seems already to have factored in declining growth. How else to explain Apple currently trading at a cashless p/e of 9.8 and at a 20+% discount to the overall market? Look at this chart from the above-mentioned article:


    In every instance but one, Apple carries a lower trailing p/e despite posting rates of growth that are orders of magnitude greater. The one exception is Nokia and even there investors currently are willing to pay 5.2X for negative growth.

    My point is that, according to analysts who say that the large number law is what eventually will do Apple in, Apple will at some point suffer additional p/e contraction. Really? Investors now are only willing to pay 10X for Apple's 50+% annual revenue and earnings growth and analysts with the market cap argument are trying to make you believe that at some point investors will pay something less than that. Buyers right now are paying 10X for Microsoft's 5% earnings growth, so why should the Law of Large Numbers even be discussed as a future concern for Apple when it is apparent that investors already have priced the shares as though growth has ceased?

    The market cap argument against owning Apple shares is a specious one, conveniently trotted out by analysts who either are too lazy or too timid to make the bold call that the Apple story demands.

    Disclosure: I am long AAPL.

    Mar 09 10:11 AM | Link | 2 Comments
  • Everyone Knows Apple is Cheap, So Why is It?
    If I could collect a penny for every word that has been written about the disconnect between Apple's business execution and its stock price, I would be so rich that I could quit pondering this question. Since I am not entitled to such royalties however, I must seek answers that go beyond the more easily-offered explanations. It may be impossible to reach a consensus opinion here, but this site is the perfect forum for such an inquiry.

    There is no doubt that Apple investors are frustrated by the failure of the market to reward what Apple owners feel has been exceptional business execution by the company.  As Apple's product successes have piled up, its p/e has come down, an indication that investors are becoming less and less willing to pay for each dollar of Apple's sharply rising earnings.  Why is that?  Why are investors so unwilling to accept the proof that has been put before them every three months for the better part of the past decade?  I daresay that a better macroeconomic environment would have made investors less circumspect, but Apple, despite its execution, has not escaped the investor anxiety brought on by a decade of financial and economic turmoil. 

    Many of the reasons have been discussed at length.  For several years, the issue of Steve Jobs' health was the accepted reason that Wall Street would not accord Apple a price commensurate with its performance.  Well, we are in the process now of jury deliberation and an initial verdict on that issue should be returned in February with the release of Q1 earnings.  Despite the fact that these three months really will tell us almost nothing about Apple's ability to execute without Jobs at the helm, the scrutiny on the company is intense.

    Another popular theory is that Apple is viewed as a "trendy retailer."  When the fickle consumer finds something that it thinks is cooler than whatever it is that Apple sells, Apple will be left with no end market for its products.  Personally, I think this is ridiculous, as Apple has proved quarter after quarter that its products continue to be in high demand.  Furthermore, Apple's progress with its enterprise initiatives indicate that those who once derided the iPhone as a toy and the Blackberry as a tool for business now are rethinking that bias.  Corporate IT executives who misunderstood Apple's simplistic design ethic are realizing that simple is better and that a simple design is infinitely harder to achieve than a complicated one.

    The refusal of Apple to pay a dividend is a popular theory. I spoke last summer with a hedge fund manager who had a substantial Apple position and he was apoplectic about Apple's refusal to share its cash with shareholders.  He has since trimmed his Apple position substantially. Apple has about $81 billion in cash + long- and short-term marketable securities, more than enough to pay a decent dividend that would–as the theory goes–bring in those investors who invest only in dividend-paying stocks and bring back those who sold because of Apple's cash management policy.  The problem is that Apple really does not have $81 billion lying around.  I read last night that more than $50 billion is "trapped" overseas in the form on unrepatriated earnings, earnings that would be subject to as much as 35% corporate taxation were it to be brought home.  Without going into the ridiculous tax policies that have allowed this, the fact is that Apple is sitting on a big unpaid tax bill.  There is a movement afoot to grant tax amnesty to these earnings so that this money can be brought home and put to work, but until this issue is resolved one way or another, don't expect Apple to announce a dividend. I will concede that Apple seems to have little in the way of a reasonable defense regarding its cash hoarding.  The company earned less than 1% on its cash last year. Certainly there are better uses for that cash but whether Apple's cash management policies are responsible for a lagging share price is debatable.

    Competition.  Since monopolies are illegal in this country, all companies face competition.  Apple is such a company.  It defends its intellectual property viciously, knowing that its ideas and designs are its best weapons in the competitive markets in which it participates.  Every company with an interest in telecom and computing is attempting to one-up Apple's success with products of their own.  Sales data offers conflicting evidence as to whether these companies are making meaningful progress.  After years of effort, other companies eventually conceded the mp3 market to Apple.  iPods continue to make money for Apple and serve as an important entry point to the "Apple experience" to the youthful consumer, but Apple's future is tied to the iPhone, the iPad, and perhaps Apple TV and the various products that spring from Apple's efforts in that segment.  The various smartphones that use Google's Android software do offer plenty of competition for Apple.  Apple currently owns the tablet computing market, but not because of a lack of effort from competitors.  The iPad has the very important "first-mover" advantage and is the tablet by which all other tablets are measured.  Whether or not tablets are the future of computing is still a point of debate but for the moment Apple is defending its tablet dominance against all comers. 


    Apple currently is in the uncomfortable position of having minority market share and a huge market cap, a dichotomy that investors find troubling.  Apple proponents point to the minority market share in computing and telecom as evidence of the potential for continued growth while Apple doubters point to the market cap and say that Apple's ability to grow is just about over. The market cap argument has been bandied about for a few years now but, as with the "trendy retailer" argument, I find that this one lacks credibility.  Apple already is priced as a slow-growth or no growth company.  Apple has a trailing p/e of 13.90 including cash (10 ex-cash) but last year delivered earnings growth of 83%!  As hard as this may be to believe, Apple has delivered 65% annual earnings growth over the past five years.  Apple investors will tell you that they have not been suitably rewarded for this growth, as the market has only been willing to pay as much as 20 X for that growth.  The geniuses who follow Apple for Wall Street currently are expecting Apple to earn $34.65 in this fiscal year, growth of 25% over last year's $27.68.  Apple's p/e based on these estimated earnings of $34.65 is 10.6 (including cash) and is 8 if you subtract $90 in cash from the current price of $368.  That is absurd.

    Apple is known as a source of funds because of its huge capitalization. Mutual funds and hedge funds own large quantities of the stock. These funds can sell large blocks of the stock without causing too much downward pressure on the stock price. When funds are chasing performance and want to try to milk a few percentage points from an up market, they buy Apple. Likewise, when the storm clouds gather, they sell Apple, buffeting the poor individual investor who is trying to maintain a long-term perspective. If hedge funds really can manipulate the stock in the hope of driving down the price, how much more downside can they want from here?

    So, the question remains.  If Apple is unversally acknowledged to offer the best growth and the cheapest price in the mega-cap universe, why then is every investor not loading up on the stock?  The downside risk at these levels seems to be miniscule, but if investors are willing to let Apple trade at a 10 p/e, is there any reason to believe that it cannot get cheaper?  Fundamentals apparently don't matter here.  Technicals also seem not to matter, as Apple currently is at least two standard deviations down, a level that suggests an extremely oversold condition.

    No, there is something else going on.  Is it the stock price itself?  Is the fad of the high-dollar stock price losing its cache?  Despite price targets several hundred dollars higher than the current stock price, Google has been trying to get past the $650 level for two years now.  Same with Apple.  $400 seems to be a level above which investors have a hard time buying the stock.  Eventually, earnings growth will push us past this level, but Apple currently is worth much more than $400 per share in my opinion.  All analysts agree, yet investors refuse to participate.

    Apple currently sits on its 150 moving average, an indicator known as the "smoothing mechanism" by renowned technical analyst Carter Worth of Oppenheimer.  This smoothing mechanism often acts as support for stock prices and it would appear that this $360-370 range is what the "professional" investors have been targeting.  Now that we are here, will these pros step in or are events in Europe overtaking any desire to buy Apple at this level?  At some point fundamentals will matter.  I believe that we are at that level now.  RIGHT NOW.

    My perspective comes from having closely followed this stock for almost a decade.  I read Seeking Alpha for the chance to gain perspectives that I may not have considered.  Apple's price action has confounded me.  Stock usually climb a wall of worry. Not Apple.  In Apple's case, the worries seem to trump any of the positive expectations for the stock.  I have never seen anything like it. 
    Nov 21 11:15 AM | Link | Comment!
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