Thursday, September 15, 2011

Why Value Investors Like Apple

OK, this is supposed to be a value investing blog and my first three posts are about tech stocks.  Hard to believe.  I don't like technology, but if that's where the cheap things are, that's where I'll look.

This is just a quick note on how cheap the stock is.  A quick look at Apple, currently trading at around $393/share shows it to be trading at around 14.3x the current year eps estimate, and 12.1x next year's eps estimate (for the year ending in September 2012).

That's pretty darn cheap for a company growing so fast with such great products like the iPhone and the iPad, not to mention the great eco-system that makes those products so attractive. 

The company as an operating margin of 30.4% and return on equity of 42% despite having so much cash and securities (presumably earning low returns) sitting on the balance sheet.

Anyway, here is where things get very exciting. 

Apple is generating so much cash that they now have $76.1 billion of cash, long term marketable securities and short term marketable securities sitting on the balance sheet.  It breaks down into:

Cash:                                              $12 billion
Long term marketable securities:  $47.8 billion
Short term marketable securities:  $16.3 billion
Total:                                             $ 76.1 billion

Since Apple has 927 million shares outstanding, these cash and securities account for $82/share in value.

Deducting this $82/share in cash from the current Apple stock price gives a value of $311/share for the Apple operating business.  In other words, $311/ share is what you are paying for the business of Apple.

Using this $311 against the eps estimates shown above gives the following p/e valuations:
                                     eps               p/e 
year ended 9/2011:  $ 27.53           11.3x
year ended 9/2012:  $ 32.37            9.6x

These are pretty cheap numbers no matter how you slice it.  If you asked anyone what a company that has 30% operating margins and 40%+ returns on equity with tons of cash/securities on the balance sheet and growth in revenues of +82% in the most recent quarter (ended June 2011) and +78% for the first nine months of the fiscal year, and operating earnings for the same periods respectively of +121% and +94% should be trading, I don't think anyone would say 9-10x p/e.

That only makes sense if it is a fad stock.  Is Apple a fad?   Does Apple have a competitor about to really crush them?  Actually, I don't know.

But at this price, you are not paying up and not taking a whole lot of risk, I don't think.  The iPad and iPhone continue to sell well.  The iPad does seem like it will continue to take share from laptops, notebooks/netbooks etc...

Is this a stock to own for the long haul?
I am not too sure about this for the longer term.  Companies like Berkshire Hathway, Coca-Cola, General Electric, Proctor and Gamble and many others have been around for a very, very long time and have long established businesses so I would tend to agree that they are good holdings for conservative long term investors; they are safe to buy and hold for a long time as long as you pay a reasonable price.  You don't have to worry too much about new products and technological change/obsolescence.

Apple, to me, is a little different.  It doens't really pass the ten year test:  What will the competitive environment/industry look like in ten years?  It's easy to assume that Coca Cola will still be the dominant soft drink company selling more drink servings ten years from now. 

But in the world of technology, you can't do that.  I really don't know how long Apple will remain dominant.  Product cycles are short so Apple will have to keep reinventing the wheel to remain dominant.  (I say 'dominant', but they have nowhere near the market share that, say, Microsoft has).  Motorola was dominant for a while.  And then Nokia, for example, in cell phones.

The moat to their business is the great eco-system that the products live in and is really hassle free.  I think this is the part that many conventional analysts miss.  They assume that an iPad is just another tablet computer that anyone can make and sell cheap (HP tried and gave up recently.  The iPod also was a market that the big firms failed to penetrate.  I think the Android is a serious competitor, but there is room for more than one in such a fast growing segment; iPhones have been selling very well despite the rise of the Android).

However, there is risk here to this eco-system too as I just read an article about software firms who have to write code twice for everything; once for the iPad/iPhone, and then again for the Android.  This means that in the future, more things available on the iPad/iPhone will be available on other devices.

So How Long Should One Own It?
For me, the interesting thing about Apple is how cheap the stock price is.  Therefore, I would not be interested in it at all at higher prices. 

For example, if 20x p/e for a high growth business is 'fair', then Apple can trade up to:  $630/share or if it trades at 20x September 2012 estimated earnings of $32.37/share, it can take the stock price up to $730  ((20 x 32.37) = $647.40 + $82/share in cash and securities = $730/share.

This is a far cry from the three to four times higher that Julian Robertson thinks this stock can trade at (if it was the 1980s), but that's quite a bit higher than the current price of $393/share. 20x p/e is not so demanding when you look at where other companies trade or have traded at.

Will Apple get up to $600-700+?

I actually have no idea.  If the iPad/iPhone momentum tapers off and the current year and next year earnings turn out to be the peak, then the stock price may have trouble going up much higher or may even go down alot.

There is also the risk of what Apple will do with so much cash on the balance sheet.  Companies do tend to do destructive things with their cash, like make poor aquisitions.  This is certainly a big risk.

Steve Jobs is also a big issue.  It is highly doubtful that Apple can continue being as amazing as it is without Steve Jobs.  This is not to say that they can't do well for a little while.  Part of the cheapness in the stock may be due to the fact that investors have known that Jobs is not healthy, and if he goes, then Apple will just become another gadget company with nothing special.  

This is certainly a possibility. 

There are no certainties in the stock market and Apple stock is a stock.  So it may go down, it may go nowhere or it may go down a bunch.

But as a value investor, when something trades at an attractive price, I have to at least take a look!


  1. I've had the stock for a year, bought it at $250 in July 2010. I'm sorry I sold some before the debt ceiling drama, but I didn't want to be heavy in one stock in August. (And a good thing it was, to be almost all in cash... almost time to start buying again. You can blog about that next.) Back to AAPL, even in a long term portfolio, you would rebalance, exchange stocks in the same sector, so you wouldn't keep AAPL for much longer than it keeps to perform, would you? You'd keep it if it went to $730, but not if a competitor became more attractive. My feeling is I'll keep AAPL for a few years, as long as it keeps doing so well. But I wouldn't want more than 20% of my portfolio to be in it.

  2. With Apple shares acquisition by Warren Buffett, I think Apple stock is still worthwhile to consider investing in the long run. Why? Ask Warren and his team. Something might be coming out.


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