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Remembering January 14, 2008: The day the market lost faith in Apple

In a recent but recurring lament I asked why Apple shareholders are not being rewarded for the company’s growth. I pointed out that there is no fundamental reason why the company should receive such a low P/E multiple (about 18 ex-cash trailing and 10x forward while maintaining 70% earnings growth for over a year).

There were many objections in the comments. Most of them dealt with recent reasons why doubts might have arisen among investors: Android hegemony or some perceived lack of competitiveness leading to margin compression or some macro hangover from the recession.

In this article I argue that none of these objections hold water. My argument hinges on the fact that there is a precise date when Apple ceased being seen as an exceptionally valuable company and that date precedes any of the causes being suggested.

The day of disillusionment was almost exactly three years ago: January 14th, 2008.

How to pin down the date of disillusionment

Consider the following chart.

The blue area represents either a premium (above 0) or a deficit (below 0) of Apple’s P/E (ex-cash) relative to the S&P 500 P/E. This is a re-imaging of a chart, first introduced in June 2010 when I first pointed out that Apple was being discounted relative to the S&P 500.

By measuring P/E I am focusing not on the stock price, which has grown nicely, but the ratio of the price relative to earnings, which hasn’t (see the next chart below). P/E is a fundamental measure of potential (its reciprocal is the stock’s earnings yield.) It is usually highly correlated to the company’s growth. If that P/E is uncorrelated to past growth, there is some significant discounting of future growth. It’s the most significant (and simplest) measure of “faith” in a company.

By measuring the company’s P/E relative to an index of other large companies (S&P 500 P/E) we can assess whether the company’s potential is being valued as extraordinary or whether it’s being valued as ordinary. In other words we are measuring whether a company is “special”.

The chart shows that until January 14th, 2008 the company was valued at a significant earnings premium–a P/E consistently 50% higher than the norm.[1]

Following the collapse (about 40% drop in share price but 100% drop in P/E premium), there was a small recovery followed by a huge trough in valuation. During the recession quarters Q308 to Q309 S&P earnings fell to zero or below. As a result of S&P earnings collapse the S&P P/E shot up astronomically (as E approaches zero, P/E approaches infinity). Apple’s earnings dropped as well but remained positive throughout that period bottoming at 37% growth(!) in Q408. As a consequence Apple’s P/E fell as low as 11 while the market’s went well above 100 (122.41 peak). The P/E deficit for Apple went 80%: Apple was valued as basically worthless (3x cash).

After the earnings recession, the S&P P/E recovered close to historic levels but Apple’s P/E did not. It’s in-line with the S&P but does not obtain the 50% premium preceding the recession.

So we can establish that the day that Apple’s potential was discounted was nearly six months before the onset of recession.

What other discounting factors can we discard?

How about earnings growth itself? Did the collapse foretell an earnings collapse?

The chart above shows the P/E premium vs. earnings growth (in red). Although earnings growth began to slow soon after the 14th (earnings for CQ407 were not yet announced at that point), growth recovered six months later after the launch of the iPhone 3G[2]. Growth continued throughout 2009 and 2010 reaching new heights last year of 86%.

Still, the company received no premium to the S&P 500 P/E. Companies in the index averaged, at best, a quarter of Apple’s growth in earnings.

What about Android? The first Android device did not ship until October 2008 (HTC Dream or T-Mobile G1). There were no appreciable Android volumes until 2009, one year after the drop in relative value and no talk of a threat until 18 months later.

The last objection to be put aside is that of margin compression.

This last chart shows how margins (in brown) behaved during the same time period. They went up. The only slight decline took place during the last few quarters, after the launch of the iPad, long after the collapse.

Regardless of the adjustments with product launches, Apple’s GM is the envy of the world and is not at all correlated with the loss of faith in the company.

So What happened on January 14, 2008?

Having led you this far in the story, I’m afraid I’m going to let you down at the end: The cause for the loss of faith is a mystery to me.

There is only one noteworthy event that took place on that date: Macworld 2008 (January 14-18). During the keynote, Steve Jobs introduced the Macbook Air (and Time Capsule and Leopard and pre-announced the iPhone SDK which, six months later led to the app supernova). I remember that day and I remember that the stock began selling off exactly at the point when the Air was mentioned. It has never been the same since.

Obviously, correlation is not causation. The Macbook Air need not be the cause for the loss of faith in Apple as an investment. Or can it? I’m hoping someone can explain this because to me it makes no sense. The product was not a home run but it did not do badly either and its current incarnation seems to be a hit. Whatever sins the original Air may have had have surely been expurgated by now.

Regardless the cause, the bottom line is that, in the eyes of investors, Apple stopped being “special” that day. Its valuation dropped to in-line the S&P and, given its growth, well below what a large growth company should be worth. The company’s shares went into the bargain bin and are still there today.

[1] I should point out that the P/E ratio is based on post 2009 re-stated earnings. The restatement changed the P/E as the “E” changed. This was based on the abolition of subscription accounting for the iPhone. Although it may seem unfair to hold the market to this standard, restatement did not actually change cash flows which were transparent and visible to all, even to amateurs such as myself and the other unaffiliated analysts that published throughout this period. Earnings may be an opinion but cash flow is a fact. Valuation on the basis of cash flow should have yielded the same results as shown above.

[2] That quarter showed a y/y growth of 150% while the stock was in freefall. In fact, it was during that earnings day that Steve Jobs came on the conference call and pointed out the astronomic iPhone cash flow to an audience of analysts more concerned about their own jobs.

Comments

105 Comments so far. Leave a comment below.
  1. > As a consequence Apple’s P/E fell as low as 11 while the market’s went well above 150.

    Typo? Maybe should be 15?

  2. Eric D.,

    Steve Jobs looked thinner during that presentation than we'd seen him before. And over the next few months, he lost more weight. The market, rightly or wrongly, believes Apple's fortunes are tied to Jobs.

    You mean Android hegemony, right?

    • Steven Noyes,

      I think this is a huge aspect. If you look at photos and videos and demos of Steve J. as a younger man, thee is a stark difference. I think that presentation was the first honest realization that Apple's visionary was in poor health and that cast a cloud over long term earnings that persists to this day.

      So, while Apple's products have sold well, even in the "Great Recession", there is a level of uncertainty of Apple's future of being able to maintain their development of great gadgets that make life easier.

  3. Around that time netbooks were selling like gangbusters. The expectation was that Apple was going to release a netbook and participate in a potential growing important market.

    Instead Apple released a luxury sub-notebook at a comparatively high price. The stock market reacted accordingly – and perhaps accurately. The original Macbook Air did not sell very well and withered on the vine for quite a while.

    It took until 2010 when Apple released the iPad and a fundamental revision of the Macbook Air (at much lower price points) that they managed to decisively and effectively respond to the markets belief that Apple "must release a netbook". The irony is that by the time they did; the netbook market was effectively dead and most analysts realised that netbooks are really just cheap notebooks and yet another misguided race to the bottom by PC manufacturers.

  4. giromide,

    Great analysis as always! As someone who grabbed a few shares at the end of 2008, I’ve been happy with the stock’s performance, but now I see it in a whole new light. It makes me wonder what it’s stock price really should be in light of the fact that market right now is being manipulated to be the next bank-influenced bubble.

    Aside from marketwide collusion to keep its price lower than it should be to reap a windfall in the next year or so (think in-flight IPO), I have to fall back to your analysis. I recall the Air getting lukewarm reviews from Tech Media at large, and perhaps it was all the market needed to dismiss Apple’s success with iPod and iPhone to that point as brief and ended. The market is after all moved by big banks invested in Microsoft and their OEMs, and I think that bias still influences AAPL’s performance (even though MSFT has mostly moved sideways in the market for a long time, neither punished nor praised).

    Perhaps Lion and the Mac App Store can change all of this. What “Back to the Mac” is really about is getting those using iOS but holding onto Windows to finally let go. Perhaps once and for all Apple can lay to rest doubts that they can move lots of desktops and laptops running a full-blown OS. Time will tell.

  5. Les S,

    Steve Jobs health began to be an issue again after the introduction of the Air. Questions about his appearance began again in earnest after the developer conference.

  6. giromide,

    Oh! Eric D is onto something! It was the first time people were talking of Jobs’s mortality! Compound the confusion over the Air as the “One More Thing” with Jobs’s appearance, and you create some market doubt.

  7. Dan,

    Could it have anything to do with the actual price of the stock? This may be a reach, but even though it shouldn't, there are psychological barriers to buying a stock that has reached certain level, at least for the average-Joe investor. Perhaps a split here could invigorate the average Joe to invest, and ignore the concomitant rise in PE to levels more inline with its unprecedented growth.

    • JonathanU,

      It all depends on whether you think Joe public actually has enough influence over markets – pension funds, hedge funds and the like surely have far more influence over a stocks price than what the general public does, and they certainly don't care whether a stock is priced at $30 or $300…

    • Joe_Winfield_IL,

      Thanks for refreshing this post Horace! What really gets me is that Apple is trading at a much lower valuation than supposed derivative plays. Other businesses that are leveraged into the explosion of mobile computing have huge multiples. AMT (cell towers) 58 P/E, ARMH (processors) 92P/E, BRCM (cellular chips) 28 P/E, QCOM (cellular chips) 27 P/E, etc. Motorola is too new since it just split, but even Nokia with all its flaws gets a 14.5 P/E!

      And other widely held tech companies that don't depend on mobile are equally highly valued. NFLX has a P/E over 70, as does AMZN. Facebook just raised $500 Million on a valuation of $50 Billion, based on $200 Million in revenue! GOOG carries a 25 P/E, even as the stock is basically unchaged over the past year and well below the highs it set 3 years ago.

      I keep questioning myself as I place an increasing percentage of my IRA into AAPL, but the numbers are truly compelling.

      I do think that a major one-time dividend or stock buyback would do wonders, as either would instantly lower the market cap and give naysayers a chance to get on board. But the whole argument about market cap relative to companies in disparate industries is bizarre to me. Exxon is in an incredibly capital intense, highly regulated commodity business, with completely different threats than AAPL faces. Microsoft (3rd on the list) hasn't had a major new profit driver in 15 years, and has earned its disrespect on Wall St. I could go on down the list, but GE, Berkshire, Walmart, etc. simply don't have a better combination of current revenue, earnings, cash flow, and opportunity than Apple has today. They may be more significant, but significance does not equal value.

  8. RyanR,

    Apple does not pay a dividend, so, to invest into Apple is to invest into future years of earnings growth. But, to accept a higher than average P/E is to presume higher than average growth. I believe the market is hesitant to believe Apple can continue to grow with such stratospheric levels for much longer (and may have started to believe so around 1/14/08). Whether that is a reasonable hestiation is open to debate.

    I also cannot think of any other companies in recent times that went from barely surviving to one of the world's largest in such a short time. Without any other examples with which to compare, the market may be believe Apple's future to be even clouded than it otherwise would be.

  9. Xian,

    It's actually kind of simple, yet, of course, unprovable: Stock Manipulation.

    I remember those days very well— a bunch of hedge funds pushed Apple stock to $200 w/ a near 50 PE! during the final week of Dec/ first week of Jan. After MacWorld that year the fix was over and the vultures moved on to new conquests.

    I know I sound paranoid, but that's what happened.

    PS, probably has more to do with Apple bailing on Mac World than anyones cares to think about.

    • Deep Capture,

      Cool analysis, Horace.

      This was the 1st thing that crossed my mind, market manipulation. Any look into if there's any naked shorts or other hedge fund manipulation taking place post-Jan. 2008…?

      Recall the infamous spillage by ex-hedge fund mgr & CNBC blowhard, Jim Cramer, when he discussed on YT, how to manipulate a stock ("like Apple, really easy to do"). http://www.youtube.com/watch?v=HRa0B34jMOQ

      • Yes, the stock was being heavily manipulated. A competitor of APPL was behind at least some of what was going on. Then that threatened to become public knowledge.

  10. concerns about steve jobs' health is the kind of thing that doesn't go away with recovery. the market may continue to discount apple until there's a believable succession plan (and maybe that won't solve the "problem")

  11. Alan,

    Great job as always!

    Jan 14 seems to be a tough day for Apple. Jan 14 2009 was when Jobs leave of absence was announced. I'm keeping my fingers crossed that this Friday doesn't rain on the parade.

  12. Bob Monsour,

    If you look at the trading volume on Monday, Jan 21 and Tuesday, Jan 22, those days coincide with the unwinding of large trading positions due to the rogue trading incident at Societe General in France. See this Wikipedia entry: http://en.wikipedia.org/wiki/January_2008_Soci%C3

    That could have simply freaked everyone holding large positions of everything. And looking at the S&P 500, volume peaked on those same days.

    I think that it was simply a period of fear in the market. When you take into account Apple's run up to $200/share that preceded that, it's not unreasonable to assume that people wanted to take profits before all hell broke loose.

    Perhaps?

    • asymco,

      Perhaps indeed. Whatever the trigger, there followed a series of shocks which never allowed greed to overcome fear to this day.

      • Adam,

        The "day of disillusionment" is just a red herring. (perhaps intentionally so?)

        I agree with Bob here regarding what happened around the first half of 2008. These things are cyclical, and it was a down cycle for Apple due to a number of factors. Nothing incredibly unusual there in my view. Then what followed was the panic and recession, where you might as well throw any analysis out the window.

        So the real question you're driving at is why in the last year, since we've come out of the recession, hasn't Apple returned to pre-2008 valuation? Counterintuitively perhaps, I think the answer lies in the massive earnings growth that has occurred since then. It took place largely under the radar (due to a few minor distractions that were going on at the time), and by the time people woke up to it, the ground rules had changed due to the real earnings changes. Mr. Market no likey 50-100% premium for world's 2nd largest company. Simple as that. At the end of 2007 Apple was not in the top 20 even I don't think. Less than half the size of Microsoft at the time.

        We're pushing up against a glass ceiling here…

      • asymco,

        Your argument is based on psychology. There's nothing wrong with that, but you have to ask when that logic turns into an absurdity. If the company gets discounted enough it becomes a takeover target, no matter the size. I even entertained the notion during the depth of the recession that management could, with some leverage, take the company private. A hostile takeover was not an option because there was no liquidity from any other possible acquirer. But following this glass ceiling logic you get into a situation where the company is valued near book while it's throwing off cash that can be easily leveraged with debt. That makes it an easy grab out of the hands of shareholders who seem to be throwing it away.

      • Adam,

        If that is true, then I'm not sure I understand how Microsoft is not also an easy take-over target. It has a lower market cap, around the same amount of money in the bank, and is generating more cash than Apple. I'm no expert in this area, but the only difference seems to be the assumption that Apple is growing rapidly and will be much larger in the future. You and I and probably most anyone reading this blog would agree with that, but apparently the market does not. Future growth is a prediction, not an inexorable fact that must be fed into the equation. The market is essentially treating Apple as a slow-growing mega-cap stock along the lines of a Microsoft or Exxon, and that is not a totally absurd position to take in my opinion.

        Very interesting and though-provoking piece as usual Horace.

  13. Nobody, really,

    Agree with the Jobs mortality comments. The dude has pancreatic cancer (I think). What is the survival rate for that? If something were to happen to him, what would the price of aapl be then?

    • asymco,

      If his health is the issue, then if something happened to him then the stock would go up, of course. The uncertainty would be removed.

      • Nobody, Really,

        Please elaborate. Can't really make sense of your statement. I personally know quite a number of investors that equate (correctly or not) Apple with Steve Jobs. I might agree (not totally sure) with the belief that Apple would be in a strong position for many years after Jobs not being atop the company. But in the eyes of most of the world, Jobs = Apple.

        Isn't a big part of the "undervalueness" of aapl it's continual growth? Isn't that growth based on Apple's ability to come up with revolutionary products? How confident can anybody be that the next head of the accompany would be able to direct product development the way (I assume) Jobs had.

        I apologize in advance for my stupid questions.

    • chano,

      I think the price would dip 20% for about six months and then when the bozos realise that AAPL carries on smokin', the shares would rise as Horace, and there would be no human frailty component to hold it back. What the market does not know is that Apple has an ace team in place. Tim Cook is rapidly becoming a true all-rounder and not just a production logistics whiz. In Ive and others, he has the creative thread and the engineering excellence to keep Apple pushing forward. With a minority share in computing and smartphones, the market is there for the winning by Apple. They are in great shape as an operational entity and they are in a great space ripe and ready for plucking – the highest fruit first (with the premium products) and the low-hanging ones as they gain market share (by introducing the Nano equivalents).
      Be patient. The one thing we know is that the market corrects itself in the long term. January 18 is going to be bombshell among conference calls. 33 straight quarters of flummoxing the analysts.
      I, for one, cannot wait.

      Chandra Coomaraswamy

      • asymco,

        As per John Gruber: the greatest creation of Steve Jobs is not any single product. It is Apple itself. It is built in his image. It is Jobsian. If you believe that then you have nothing to worry about re. succession.

      • russell,

        Famous quote that fits rather nicely with this subject. "In the nearterm the market is more or less a popularity contest, but in the longterm its a weighing machine. Meaning, it often doesn't get it right initially, but it eventually comes around as long as the earnings keep adding up. It's just long over due for apple.

    • dubTX,

      My doctor grandfather died of pancreatic cancer. I believe that Steve's cancer was located in the Islet of Langerhans region of cells that comprise a paltry 1-2% of the pancreas. They are responsible for producing insulin. A quick Wikipedia check says they comprise 1-1.5 grams of total mass! (Gramps was the doctor not me.) If the cancer occurs elsewhere, you're doomed. If you watch Steve's excellent Stanford speech on YouTube, you'll see he mentioned his doctors tearing up when they found out the cancer was in this tiny treatable region. Steve indeed was incredibly lucky!

  14. Guiseppe,

    A big part of the Macworld 2008's disappointingness (or whatever) was that it followed such an enormous announcement (the iPhone) the year before. A lot of people expected something *more* important than the iPhone (especially financial experts, who are often naive in such matters), and in that light, Apple's jumble of releases, including the MacBook Air, must have seemed an incredible letdown. These people may have continued to hope for a huge iPhone-like announcement afterwards, contributing to the sustained loss of faith.

    • Agreed. I remember all the hype that led up to the announcement of the Macbook Air. Because of the success of the iPhone the previous year, there was an incredible amount of speculation and hope about a new product — probably a competitor to netbooks. The Macbook Air was met with huge disappointment, and I specifically remember the stock tanking and the sense that the new product was so expensive that it was irrelevant to most people.

      The spectacular change came from a shift in attitude from "Apple is a magical company that created the iPhone" to "Apple is a good company that got lucky with the iPhone and is now largely out of touch with the market".

      Apple was like a group that had a massive hit album, followed by a second album (Macbook Air) that was a dud. The third album (iPhone 3G) was good, but it was a rehashing of the first, and didn't prove that the company was still capable of dramatic innovation. The fourth album (iPad) has been a huge hit, but again it's an evolutionary development of the iPhone.

      However, it looks from charts like the P/E premium to SP 500 started going back up at about the same time that iPad rumors started coming out. Apple was starting to look like a magical company again.

      I think that the answer to the mystery is that Apple created something genuinely new and revolutionary with the iPhone, one time. That created the impression that the company existed in some kind of magic bubble. The following products have been consistently strong but have not been revolutionary like the iPhone was. The iPad is the closest thing to a magical product, and the P/E premium to SP 500 chart reflects that.

      It would be helpful to see the above charts with vertical lines denoting new product announcements and ship dates.

    • chano,

      But people expect too much, too soon and too often. No other company has matched Apple in terms of product strategy and innovation since 2001. Yet it is Apple that disappoints the bozos who demand more and more often too.
      Apple is a considered player. They release only when they are ready. As Jobs has said, he is as proud of the ideas they developed into prototypes, only to kill them, as he is of the products that shipped.
      I think Apple has it right in terms of timing. Why introduce new things before you've consolidated your position with recent introductions.
      There are a hundred spaces into which Apple could enter, disruptively and profitably. In some cases, hugely profitably. And from a cheeky point of view, if Apple could codify its world-beating MO into a business management methodology, they could elevate every poorly run business, large and small into undreamed-of realms of efficiency, quality and profitability. I'm a management consultant and so I make this last statement with my tongue only partially in my cheek.

      Chandra Coomarasway

  15. Danthemason,

    This will be the market's "dark matter" question for a long while. It's there, but we can't see it.

  16. hcabbos,

    What did Steve look like on stage? More fragile than usual? As an Apple fan but not an investor, I remember looking on at various Keynotes and paying more attention to his appearance than anything else.

  17. hcabbos,

    Oops, should have read the comments prior to posting. My observation had already been commented on.

  18. pk de cville,

    Horace,

    Take a look at QQQQs over the past 5 years. http://www.google.com/finance?chdnp=1&chdd=1&…

    Having held aapl LEAPS through Jan 14 (and having luckily sold 1/2 of them just in the new year) I remember a tremendous amount of fear in all the markets as the reports began about the mortgage mess.

    I believe Apple was tapped out by Wall St to make the margin calls. It had a tremendous value and the big guys made the big withdrawal during that week.

    • asymco,

      That makes sense, but why didn't Apple recover when The S&P recovered? I'm making several points I guess: 1. current valuation is not affected by fundamentals.
      2. fundamentals were thrown out the window three years ago
      3. value investing returned after the recession and the S&P reached a level proportionate to its earnings
      4. Apple is still however not considered a growth stock regardless of having huge earnings growth

  19. ChasMac77,

    So, commenters on here or Horace, please explain AMZN's P/E in light of what's been posted. It's a mystery to me when you compare it to AAPL and growth rates.

  20. pk de cville,

    BTW, Cramer has yet to reset his Apple target, currently at $325.

    I believe he'll announce a target of over $500 after the qtr's report next week.

    Thanks, it'll be easier for him to justify his $500 target because of your blog.

  21. poke,

    What about perception? When did the irrational anti-Apple hate really kick into overdrive? I seem to recall it being after the original iPhone proved a success. January 14th 2008 would be about 6 months after it was released so people would have had a good idea of the scale of how wrong they were about its perceived failings and would have reacted accordingly. Since then there's been a strong belief that Apple is always one step away from failing. This really peaked when the iPad was announced. The level of hatred exhibited was phenomenal and unprecedented. If the people investing follow technology at all they're likely to think Apple is incapable of innovation, hates its users, is destined to repeat the same mistakes it made with the Mac, that its products are fads that will implode the moment the competition merely announces a competing product and that anyone who tells you otherwise is a raving fanboy.

  22. Thomas65807,

    Way over 50% of Apple's sales and profits are currently derived from foreign markets. So perhaps analysts who recommend the stock and portfolio managers who purchase it are (incorrectly) focused on Apple's popularity and prospects in the US and fail to give appropriate weight to sales and earnings growth overseas.

    For example, suppose the iPhone's dominance has been eroded by Android among US carriers, so analysts project forward and expect the situation to worsen. That could make them reluctant to purchase AAPL. Meanwhile, iPhone sales are growing rapidly overseas and profits are rising rapidly … so AAPL's P/E multiple declines.

    Of course, I don't know why all of this would begin on 1/14/08. The possibility that Steve Jobs was ill sounds reasonable, but a Google search doesn't turn up stories about Jobs's illness until much later in the year …

  23. Thomas65807,

    A more careful analysis would show that AAPL's precipitous fall relative to the S&P didn't begin on 1/14/08. Though AAPL did decline by 3% relative to the S&P by Jan. 18, 2008, it fell by another 20% relative to the S&P from Jan. 19th until the 28th. By far the largest 1-day decline occurred Tuesday, January 23; AAPL fell by nearly 12% relative to the S&P that day.

    For those who wish to conduct their own research, check out Yahoo finance for historical prices for AAPL and the S&P500: http://finance.yahoo.com/q/hp?s=AAPL&a=08&amp

  24. bick,

    The day of disillusionment was almost exactly three (3) years ago: January 14th, 2008.

  25. Justin,

    II have a couple of thoughts on why the market isn't rewarding Apple for their continued financial success and growth in revenue and earnings. And maybe these are lame things that I've picked up, trying to understand this same question, but nonetheless:

    1) Every institutional investor who is interested in buying apple has bought it. While I don't have the data, the last time I was looking at Mutual Funds, Apple was listed at the top of most of these funds. They are limited in the % ownership in a mutual fund that one company can represent, which means they need to sell if that company's total value goes over some threshold. So, if most large cap value / growth funds already have a large Apple position, they might have restrictions on additional ownership.

    2) This one is purely psychological / emotional: I look at Apple, with it's 300B market cap during a time of relative un-frothiness in the markets, and I wonder how much more money I can make with the stock? One side of me sees that they don't really have a large % of the markets in which they can see a large amount of growth (iPhone & iPad (as a % of PC sales)), and thinks there's a lot of runway left there. The other part of me says, what risk do I take on as an investor in making a once-in-a-lifetime bet that a single technology company can have the large market cap ever in a non-frothy market.

    So, are investors at large willing to bet that Apple can become the world's first trillion dollar company, which is the valuation this risk will require.

  26. Thoms65807,

    This is from a NY Times item on January 22, 2008, discussing Apple's quarterly earnings report:
    "If there was one potential weak spot in the numbers it is with the iPod: Unit sales were flat in the United States, indicating that the market may have become saturated." http://bits.blogs.nytimes.com/2008/01/22/can-the-

    Clearly, investors began to worry that Apple's leading product was a 'fad' that couldn't continue generating outsized profits for the company. Wasn't that a valid concern? After all, over the preceding decade Apple's leading product (the Mac) persistently lost market share, and and analysts frequently predicted the company's demise. Now, with Android phones and a plethora (75?) of tablet computers introduced at this year's CES, such concerns persist.

    And those concerns are reasonable … if one does not believe that Steve Jobs and Apple can continue innovating faster than the competition. I, for one, believe they can.

    Which brings to mind this passage from Kipling's very long poem, "The Mary Gloster":
    They copied all they could follow, but they couldn't copy my mind,
    And I left 'em sweating and stealing a year and a half behind.

    But not everybody agrees. They think Apple is a fad, and its profits have no staying power. Here's the good news: The reluctance of 'the market' to believe in Apple's ability to stay ahead of the competition keeps AAPL's price at reasonable prices, so we can accumulate more at bargain prices. *When it's realized that Apple is hitting it out of the ballpark all around the world, the share price will skyrocket.*

    You don't think music players, phones and tablet computers are the only arrows that Steve has in his quiver, do you?!?!

    • asymco,

      The iPod slowdown was indeed a cause for anxiety, however anyone adding iPhone to the iPod totals should have seen how the business was going. It may be causal for the sell-off, but again one has to ask why a business which has shaped up to be much bigger than the iPod isn't getting iPod valuation?

  27. KenC,

    Two things that I recall: one, Apple was still deferring revenues and income from the iPhone back in 2008 and 2009. It was only in Sept of 09 that Apple announced that they were being allowed to change the way they recognize revenue and income on the iPhone, which would be reflected in Jan of 2010. Of course, starting in the Fall of 09 is when analysts really started projecting non-GAAP as the new GAAP numbers. That's precisely when the PE deficit seems to have rebounded.

    The second thing, related to the trigger, is that I vaguely recall in Sept 08, there was a week where Katy Huberty of Morgan Stanley downgraded Apple twice in one week. The second downgrade came based upon a Changewave Survey, indicating a drop in Mac sale buying intent. Of course, this never came true, and Katy nor Paul Carton of Changewave ever retracted their nonsense. Anyway, that big selloff in Sept 08 was when the PE premium went negative to the S&P.

    Anyhow, those are the two things that come to mind.

    • KenC,

      To be fair to Katy, Mike Abramsky of RBC also downgraded Apple late in Sept 08 based upon the Changewave Survey which predicted slowing Mac sales, which didn't come true.

      • KenC,

        And here's a link to Philip Elmer-DeWitt's Fortune blog which has the details of that lame Changewave Survey that triggered downgrades by Katy Huberty of Morgan Stanley and Mike Abramsky of RBC. Interestingly, the very next survey done in November, none of Changewave's predictions came true, "These are the weakest numbers we've seen all year for Apple in terms of future buying," writes Paul Carton, ChangeWave VP for research. "And the biggest drop in 2 ½ years." Of course, no retraction from Carton for making such a bad call, and no reversal of Huberty or Abramsky's downgrades. The downgrades were self-fulfilling driving scared investors to the sidelines.
        http://tech.fortune.cnn.com/2008/10/02/the-survey

      • asymco,

        I became suspicious of ChangeWave surveys some time ago. The biggest problem is with the notion of measuring purchase intent. People say all sorts of things in surveys. If I look at my own decision process for purchasing computers or consumer hardware, I know that I cannot predict my own behavior. I doubt most people can.

    • asymco,

      I'm sure some investment decisions were based on poor analysis of accounts, however there were so many eyes on this ball (40+ analysts) and so much discussion, I find it hard to believe that the "consensus" could not be persuaded by transparent facts.

      Put another way, if the market can be so incapable of measuring visible cash flow, what hope is there that it can see through fraud. (Maybe I've answered my own question…)

    • Ziad Fazel,

      Thank you Ken. I saw large swings in Oct 08 and Oct 09 also, and am glad you suggested some reasons for those also.

      I would appreciate the input from other commenters whether those swings look equally significant, and what their reasons would be.

  28. KVL,

    That was the day we all saw on stage how emaciated Steve Jobs was. He was clearly unwell, and it looked like Apple was hiding some bad news. I think that was the shock for people, and it still is. Where will Apple go without Jobs?

  29. johnnyzee,

    Without any smoking gun, the most probable explanation for the AAPL undervaluation is a combination of the factors discussed here as well as the fact that the investing masses are failing to see how differently the sides are equipped in the current battles of the Apple-v-the-Option war. It's obvious that those (a lot are out there) who think that history will repeat the Apple loss to Wintel are failing to consider that the economies of scale now favor Apple, that it owns first-mover status and that it's platform is simultaneously sticky and more appealing to the younger generations. Nor Enterprise Adoption.

    But, at this point in time, it's more profitable to consider, "When will the market resume valuing AAPL more favorably?"

    I am guessing we will be seeing improvements to AAPL's P/E Premium (nice chart, Horace) in the very near future and, perhaps, revisiting this chart years hence will show that date as the earnings call on Jan. 18, 2011.

    Horace, are you expecting to update your earnings forecast? I can't discount that it's largely emotional, but I am intuiting a strong upside surprise from what's currently being forecast … possibly due to iAd revenue as well as an underestimation of Apple's synergistic multipliers, i.e: hardware x software x media content x ads.

    Lucrative speculation #2; Like last quarter, will there be a big stock run up to the earnings call (I say yes) and a corresponding nonsensical sell off as soon as the first bits of the report are release? (I'd like to know).

  30. Davel,

    As you mention this has been discussed b4.

    I have no answer.

    Apple is held by a huge swath of institutions. Many individuals own it in one form or another. Perhaps it is in part that it is already owned. It's price is also an issue. 300 is hard to buy in standard lots.

    I think it is deeper than that. Apple has always been undervalued. In part I believe analysts just don't get it. Half the analysts have given up bad mouthing the company after yrs of doing so. Anthony Sarcossi is one who threw in the towel. The subtle interconnects of Apple's products do not compute with the bean counters. Someone always comes up with a negative; Jobs's health, new competition, high price, lack of differentiation, whatever.

    Apple has been on a role for 10 years now and yet many want to kill the stock after the company has shown continued resilience even in the face of the great recession.

    I don't know the answer and defy anyone to give a conherant reason for this situation.

  31. Macorange,

    Horace, the answer is clearer if you just go back a few more years. In 2005 and 2006 AAPL's priced dipped in the first months of the year. As a consumer product company, the big gains happened in the last quarter with the excitement of holiday sales. Once the earnings came in January of each year, there'd wasn't much to look forward to, so there would be a selloff. Jan 2007 didn't sell off as much, probably due to the announcement of the iPhone, but even that year the price slowed until later that quarter.

    So January 2008 was part of a pattern that had been going on for all the growth years of 2005-8. What made 2008 drop off more pronounced was how pronounced the dec 2007 runup was. AAPL became overheated, and Dec 2007 was the only time that my favorite analyst, Charlie Wolf, opined that the market had gotten ahead of itself with AAPL. A larger selloff than usual was almost guaranteed for Jan 2007 absent a big new product, and nobody thought that the high priced Air was a big product, and few people realized the potential of the iPhone SDK at that point.

    The usual pattern continued into March of 2008 when the stock price recovered quickly, and I believe that the stock was heading to new highs in the second quarter of 2008, when the economy started to take a dive and investors started to flee from high flyers like AAPL. Ever since then AAPL has been undervalued due to market fear. At some point greed will return, and when it does AAPL's PE will rise again.

  32. kyler,

    We only know now in hind sight that iPhone didn't destroy iPods, and iPad didn't cannibalize Macs. However, at the time of the launch of these products, you didn't necessarily know how things would turn out. Those analysts had to wait until such possibilities were ruled out before going for it. The case in point is Gene Munster, who's saying Verizon iPhone will cannibalize 6.5M sales from AT&T. So I'm guessing the the AAPL stock price is lagging behind due to the very nature of Apple's disruptive and potentially destructive innovations.

    • asymco,

      This is a very good point that I was hoping someone would make. One of the indicators of a disruptive company is that it's chronically under-valued. In a strange way, once it's fully valued, it becomes "understood" and its asymmetry disappears. That would be a good time to sell.

      So we are making a call on Apple being on the trajectory to surprising a lot of people. Seeing the Unforeseeable is the only way to create wealth through investment.

      • TomCF,

        Instead of "unforseeable", maybe "underestimated"? "Actively ignored"?

      • JonathanU,

        Awesome comment – I couldn't agree more with you Horace.

        Let's hope we see far more to the Apple story than the market does – I for one am betting the farm on it!!!

    • Joe_Winfield_IL,

      Great point. Along the same line of thought, iPhone was not yet an unqualified success on 1/14/08. In fact Apple had recently dropped the price of the orignal iPhone to broaden its audience. The analysts probably had taken this as a sign of weakness rather than a catalyst for exponential growth. With this in the back of their minds, the MacBook Air probably seemed like a terrible product. It was (accurately) seen a niche device aimed at high income shoppers, and Wall St. probably saw this as a strategic move toward the ultra high end rather than an expansion of the MacBook lineup. In light of the perceived weakness of iPhone, the MBA was the worst product launch conceivable to investors on 1/14/08.

  33. chano,

    Horace, you outdid yourself, Sir.
    Thank you. I learned a lot from this article in terms of new ways to visualise market realities

    Chandra C

  34. Jon T,

    That was the date the NY taxi drivers started to talk about APPL…!

  35. Charlie,

    Obviously the answer is concerns over Steve Job's health. I'm very surprised you didn't mention it. It remains an undercurrent of concern to this day – if not his current health per se his future role at Apple. This by itself raises the discount rate of the future earnings stream.

    (By the way, using PE as a measure of financial performance is like using a carnival funhouse mirror to check your appearance.)

    • asymco,

      I did not use it because it was not an issue in early 2008. Lots of issues were raised after that event and perhaps they, in aggregate, are keeping the stock down.

      P/E is certainly problematic. Earnings are but a matter of opinion. Cash flow analysis would have been better but I don't know how one could get comparable index metrics (as an individual investor).

      • newtonrj,

        Horace,

        Actually, his health was (and is) the issue of the time and fully explains what is going on with P/E. check out the Wiki page on SJ. http://en.wikipedia.org/wiki/Steve_jobs. Follow the rest of the P/E drop and recovery, of sorts in '08-'09.

        August’06
        – We see a thin SJ giving us a WWDC address.

        14Jan'08
        – We see SJ, thin and looking bad. Forget the fantastic iPhone for now, this is the end of Apple's run, not the beginning

        July’08
        – SJ is seen at WWDC and looks thinner. People are worried but the market is given a rare glimpse by a NYT piece saying he doesn’t have cancer but it is not a “common bug”

        September’08
        – SJ is now seen at the Lets Rock iPod announcement and the P/E falls off. Still, SJ is thin.

        14Jan09
        – SJ says to us all that he’s out and Tim Cook is in for the next 6 months for a hormone imbalance.

        Sep’09
        – Nothing to report until SJ is seen on the job at the “Its only Rock and Roll” iPod event

  36. Mark Hernandez,

    As someone who doesn't know anything about the stock market, observing from the outside looking in, I can't help but notice that while Horace is Mr. Factual Due-Diligence, the numbers cannot also quantify the fact that everyone participating is a human being – an emotional / psychological creature – who is always overloaded and can't spend the time to do the numbers, the critical thinking, the careful analysis, and can sometimes take the easy route and be a lemming.

    In my field, Information Interface, one cannot ever escape the fact that the deterministic nature of the world will always be at odds with the often irrational nature of the human being.

    One thing that's missing from this analysis is what investors were actually saying (and gossiping) to each other when they talked on the phone before they made their moves. Has anyone got that essential data?

    • TomCF,

      I would guess that most of the volume is mutual funds and investment firms, who don't tend to get overly emotional about their investment decisions. I don't think individual investors have a lot of sway in the stock price. (I could be wrong…)

  37. Fred,

    Let's examine P/E relative to PEG.

    forward P/E …. 5 Yr PEG

    RIM 9……0.45
    Apple15…..0.87
    Nokia12…2.12
    Mot Mobility28…?

    Qualcomm17…1.12
    ARM49…2.75
    Google18…1.17

    (source data: Yahoo Finance, January 10, 2011)

    Apple’s forward P/E of 15 is reasonable, relative to peers. It’s five-year PEG (P/E to five-year growth rate) of .87 is approaching equilibrium of 1.

    Qualitatively as mentioned by previous contributors, constraints of Apple’s P/E include the psychology of its large market cap, institutional holding limits, and the uncertainty about Android’s impact and Steve’s health.

    Nokia's P/E of 12 appears overvalued with PEG of 2.18.

    Motorola Mobility P/E of 28 is highly speculative relative to peers and uncertain growth, especially with its Android tactical positioning.

    RIM may be somewhat undervalued, if you believe analyst’s consensus five-year growth rates.

    • asymco,

      The Yahoo data is based on forward earnings which is an average of the fantasies of a set of provably inaccurate analysts. The average error of the average analyst in predicting Apple 3 months ahead is 20%.

      But there's a better test: If you went back in time five years ago to 2006 do you think any analyst put forward a figure of 70% growth for 2011? Do you think any even envisioned an iPhone? An iPad? No analyst financial model includes lines in the income statement with a blank heading for "future product x".

      • Fred,

        The sell-side analysts may be inaccurate, but they influence the share price.

        It is near impossible to estimate earnings three, four, and five years out in a dynamic technology sector. Who outside of Apple can guess what new products are coming out of Apple and their impact on earnings a couple years from now? No one.

        But on Wall Street, the sell-side analysts, accurate or not, still exert enormous influence investment managers and traders. Sell-side analyst inaccuracy partially explains why Apple's P/E is undervalued.

      • Joe_Winfield_IL,

        "No analyst financial model includes lines in the income statement with a blank heading for "future product x"." This will always hold back AAPL shares, despite the proven track record of innovation. And not innovation for innovation's sake, but the kind that drives massive unforeseen growth.

        Companies like 3M and DuPont are seen as serial innovators, and Apple belongs in this camp. Instead it is seen as a gadget maker and priced accordingly.

  38. Sam Penrose,

    See also: http://blogs.reuters.com/felix-salmon/2011/01/10/… :

    "there are millions of individual investors doing diligent homework on companies and trying to invest intelligently in the stock market. When they finally arrive at a conclusion and the time comes to buy or sell, their collective decisions are known politely as “retail order flow,” and less politely as “dumb money”; high-frequency trading shops make lots of money by paying for the privilege of filling those orders and taking the opposite side of those trades."

    • gctwnl,

      It's products are crap? The money in the bank is fake? The effective user-experience driven innovation does not exist? Microsoft Windows based tablets are a runaway success?

      The most often heard naive understanding of what Apple is is "Apple is just image". There is a bit of image, but that image could not exist unless they did not also have top notch user experience.

      • davel,

        I hear this every day at work. Mostly by Microsoft lovers who religiously hate Apple.

        The comments are it is all image, fluff, bling, pick your synonym.

        They point out that individual features are not new. This is always true. Apple almost never brings out something completely new. They cannot. They bring out singularly simple, elegant, minimalistic devices that work and work intuitively. New technology by definition is unstable. Apple is loath to produce something unstable.

    • asymco,

      And your comment isn't?

  39. Adam,

    I think it's worth pointing out that this is all great news for investors looking to get into AAPL. There is an asymmetry here between what the market thinks and what likely will transpire. I think this kind of asymmetry is what you named this blog after, no? Even if we continue along this path of no P/E premium for Apple, if we assume say a 60% growth rate for real earnings in 2011, should we not be at around $500/share by the end of 2011?

  40. Kizedek,

    You've contrasted Apple with lower profile companies, but the implication with "volatile" is that the market contrasts Apple with more "steady" companies. Boring and predictable ones?

    The stock price has certainly been volatile, so maybe there is a bit of a self-fulfilling prophecy at play here. But I am with Horace, here: how can any other company be considered as "steady" as Apple which has shown consistent growth for some 30-odd quarters?

    Yeah, the growth rate for iPod sales was perhaps not sustainable forever. But it doesn't stop it from being a solid earner for Apple going forward, forever. So, the "MP3 player market" has "matured". Apple is still the major player and always will be since they have not failed to bring advancements to their products every year.

    Compare this with a steady company like Sony: Sony completely lost its Walkman and DiscMan and Beta VCR and now VHS markets. Is the MP3 player market going the same way? Maybe eventually, but not anytime soon; and if it does evolve into something else, it will be Apple at the forefront making the changes.

    So, Sony plods along, continues to make staple consumer electronics devices like DVD players and TVs and Stereos (the latter two of which also are are not going anywhere anytime soon), and Wall Street is completely happy with them? Sony is expected to churn out DVD players and TVs and HiFi's year after year with minimal innovations and continue to get its 30 percent or so of the these markets. Wow, how lovely and steady.

    So, why won't Apple continue to sell 75 percent of the MP3 players year in, year out? And 30 percent of the smart phones? And 65 percent of the tablets? And continue to make more profits than the next six companies combined in each category?

    Horace, is it really a case that the stock price/value assigned by Wall Street is all to do with Apple's growth alone (with how fast an investor can make a buck off them), but has nothing to do with the solid and sustainable markets that Apple has entered and in which it has won a solid user base (more solid than most companies can boast by all accounts)? I just don't get that.

  41. John,

    One other idea may be Apple’s penchant for for secrecy. Apple doesn’t promote its stock. It doesn’t offer a road map. It doesn’t speak about future products. Without this investors are left to their own imaginations as to what might develop.

    By way of contrast most other companies talk up their plans for the future. I once asked an investment banker why Amazon had such a high PE. He told me the story about the Kindle and digital books and how this was the next great thing. Put aside the validity if that story and just recognize that he had a story. Amazon was promoting this story. To my knowledge Apple does not promote itself this way.

  42. dotdash,

    "So we can establish that the day that Apple’s potential was discounted was nearly six months before the onset of recession."

    I'm assuming you are referring to S&P earnings recession. In any case, the actual economic recession began December 2007. The markets have an amazing ability of predicting events at least 6 months out. In Q4C07 recession was just starting to be debated. The term "sub-prime" was at full shrill.

    I submit nearly everyone (myself included) was waiting for earnings to then exit the market. And what a mass exit it was. Pain begot more pain. And the pain still lingers.

    As to why the P/E is still depressed relative to others that have recovered, it is likely a combination of factors. Most of the reasons given here in the comments in aggregate is the reason. Everyone has their reason and they are all not the same.

    BTW: The AAPL P/E given is ex-cash. Is the S&P P/E quoted ex-cash as well (or more appropriately cash – debt(?)

  43. Horace the Grump,

    At a $300b+ mkt cap the direction of AAPL is driven by the insto investors… these guys all have large holdings in APPL and their natural appetite has been sated. Of all the reasons noted above only one has noted the supply/demand balance for holding AAPL stock; this is what drives the share price in the end.

    One thing insto investors are noted for is the blind conservatism. When you are holding a large slice (relative to your fund size) if the #2 stock there are large risks of pushing to a larger holding; you sure ain't selling, but buying loads more? Unlikely. They like AAPL, they may even love AAPL, but given its current position in a lot of portfolios they aren't big buyers any more… Everyone is long AAPL…

    Another factor that hasn't been mentioned is the ever increasing pile of cash AAPL holds, which is earning, say 2% max at the moment? AAPL has great operational management, but in the eyes of insto investors crap financial management.. AAPL had $50b+ in cash at the end of September and will likely have more than $55b at the end of December… 2/3 of the balance sheet is cash.. this is very weak financial management.

    To excite the insto investors AAPL should consider a share buyback program. It could easily buy back 10% of its stock and still have c$20b left in the bank, no small number!

    This would reduce the supply of AAPL shares in the market and demonstrate better financial management and signal to investors generally that there is no better place for the company to invest its cash but in its own shares… That would change the supply/demand balance which would positively impact on the share price…

    • azazello,

      … and APPL doom-sayers would immediately jump on the buy-back as 'proof' that management (i.e. The Board) must be alarmed by market forces/projected declining margins/Steve's health, therefore they have changed their traditional untraditional stance regarding cash and so this is the beginning of the end.

  44. Joe_Winfield_IL,

    Do you question 3M's ability to constantly innovate? How about DuPont? Or the pharmaceutical industry? McDonalds is still smashing its own record sales quarter after quarter, and one would be hard pressed to say that the market is not saturated for fast food. How do they do it? Innovation. All of these companies establish massive markets for products, then constantly invests in incremental improvements to drive repeat purchases and replacements. HP still makes all its money on printer ink by tweaking formulas and cartridges. Apple is doing the same thing, but from a much smaller base.

    Other than mp3 players, Apple has a minority position in every category in which it competes. And the categories themselves are expanding at huge rates. Even with nothing beyond incremental innovation, Apple will grow handsomely for 3-5 years. And do you believe that they will be unable to identify another growth driver during that time period? Maybe I'm naive, but I bet they will find the next thing. If not, they will eventually start to use their cash to purchase technology and intellectual capital. This strategy has worked well for MS, Oracle, Intel, etc. While acquisition is not the core strategy at Apple, it is always on the table as an option for the day when growth begins to taper. But keep in mind even the lowly PC is growing at 26% annually for Apple, and this is before they reintroduced the MacBook Air.

  45. Hamranhansenhansen,

    The way I remember January 2008, a lot of investors who were new to Apple were expecting another iPhone-level product, and instead a very gaunt Steve Jobs introduced a new kind of Mac notebook that they didn’t understand. Then it was like the other shoe dropped on Steve Jobs’ previous health care issues.

    > 2/3 of the balance sheet is cash.. this
    > is very weak financial management.

    Apple is saving up for something big, like a carrier, or new production methods. They have said they have a 20 year plan. They know what they are going to do with that money.

    > Other than mp3 players, Apple has
    > a minority position in every category
    > in which it competes.

    This is a common myth. It’s only in phones that they have a minority, with about 4% of the market. The rest are majorities:

    • music players: 75% (iPod)
    • mobile PC’s: 95% (iPad)
    • high-end PC’s: 90% (Mac)
    • online music sales: 70% (iTunes Store)
    • online application sales: 75% (App Store)

    And they take the majority of the profits in all those markets also, including phones.

    • Tony,

      Maybe you're forgetting about Apple's other Macs since Apple's share of the overall PC market is so tiny. Apple also makes servers and desktop computers (mac mini, iMac, Mac Pro) all of which combined have a tiny market share. Also I doubt that the high-end PC is its own separate market category but nevertheless, Apple's Macs compete with not just high end PCs but all PCs (other than netbooks – which are really a recent category). Also doubtful that the iPad is considered a mobile PC, it may compete with netbooks but it certainly isn't taking much share away from traditional laptops.

      Apple was late to the music player market but has a majority position because it offered a better product/system than the established players. Same with online music sales and tablets. In every market Apple is in it came in against established players who controlled the market. You can easily find the many online stories predicting massive failure and disgrace for Apple's due to its efforts related to: music players, online music sales, Apple retail stores, mobile phones, and tablets. The predictions of failure have been following Apple since 2001 when the original iPod was introduced.

      I think Apple has hit upon the Big Three strategy for computers. Detroit moved into selling SUVs because the margins were very high and the customers were often quite insensitive to price. Apple doesn't want to compete in the general PC market because the margins are slim and the competition (which is all about price) is fierce. Better to cater to folks who have fat wallets. I hope it doesn't end like it did for the Detroit carmakers.

  46. azazello,

    Economics and market analysis have been struggling to accurately describe and model human behavior (with the tacit goal to prognosticate) and had always failed to account fully what we consensually label 'the irrational.' I was often struck by 'gut responses' that can be only understood as driven by unconscious envy–in part, seen as hatred. Success, innovation, perfection (and I do not mean perfectionism but brilliance), and creativity predictably elicit philistine criticism and dismissal. This form of irrational scepticism is not the exception, it is the rule.

  47. Lee Penick,

    Using Round Numbers in an example:

    Apple has roughly 1 billions shares.

    If Apple had used just $1 billion to buy back shares recently when shares dropped below $90, they would have bught back 11,111,111 shares.

    $15 billion for yearly earnings:
    – with 1 billion shares, that's $15 eps
    – with the buy back, there would only be 988,888,888 shares, that's $15.17 eps

    use a P/E of 23 and you get:
    – $345.00 for a share price
    – $348.88 for a share price with the buy back.

    That may not sound like too much difference, but that one dollar per share that was used to buy back shares, would now be nearly a $4 increase in share price.

    i.e. spend $1, make $4.

    We missed that opportunity, but we don't need to miss the next.
    Apple can afford a much larger share buy back now. Initially it has a nuetral effect unless there is a boost to emotions and the PE ratio. Over time as earnings increase, the multiplication begins and again each doller per share converts to several dollars in increased share price.

    If Apple can't reinvest the retained earnings in equally fast growing business prospects that equal it's core growth rate, then a share buy back program should be instituted.

    As owners of the business, we are watching our business grow at 50-60% a year, and then the cash sits there at 1-2%.

    Where is Warren Buffett when you need him on the board of directors?

    Come on Steve, are you really going to spend anywhere close to $50 billion on acquisitions, new facilities, equipment, etc? Not to mention the new cash generated every quarter.

    I see this as one large reason the PE ratio is well below the growth rate. Great product development, product design, positioning, marketing, foresight into consumer taste and needs, but they don't know what to do with retained earnings at the rate they are generating them.

    Lee Penick

    • davel,

      Thank you for the numbers.

      But why should Apple or any company for that matter spend energy manipulating the stock price. For the example you give is exactly that.

      This would mean that Apple is spending energy manipulating the stock price rather than growing its business or looking to innovate which adds real value to the company.

      I understand mkt analysts may like this approach but that is their business. That is what they do.

      Apple is a consumer electronics company and I hope they stick to their knitting rather than expand into financials.

    • TomCF,

      What if Apple suddenly decided they wanted to buy AT&T, because they got tired of the stupid carrier games? $50 billion is a lot of leverage when dealing with Verizon, Orange, Docomo, etc. even if they do nothing with it.

  48. I remember being in my office and gasping at the sight of Steve Jobs. Stupidly for me, I did nothing although my first reaction was to think that Steve was not well. Why I didn't think that this was a tradeable development haunts me still, but that is the answer to your question. It has nothing to do with MacBook Air, which, by the way, although early, is a look into the future. The advent of the cloud kills the need for super capacity hard drives. Flash storage will be more than adequate. The elimination of the hard drive makes notebooks, lighter, faster, and way more durable.

  49. Chandra,

    apple has been selling at a premium to S&P on a trailing P/E basis for quite a while ( at least 6 months ), is it not? ( do not do ex-cash since the cash position is reflected in the price and taking it out of the calculation skews the matter.

    The tipping point is not because they lost faith in Apple, but because the investors did not lose faith in the overall market even as the earnings tended to zero. That is the power of a diversified set of stocks as compared to a single or a single sector. As S&P earnings tended to zero, the stock price did not tend to zero and so the P/E went up a lot. That is what causes Apple P/E to lag S&P P/E/ But as Apple price recovered from that low of 80 in late 2008/early 2009, two things happened. Apple price and earnings went up and so did the S&P price and earnings. This made their P/E come back together again… Apple's P/E increasing and S&P P/E coming back down to historical levels.

    One quick way to look at this is. Yes, the market did lose faith in Apple for a while which caused the price to come down to around $80 but it recovered fairly quickly.

    But now what.. as Apple earnings grows, the price will not go up in proportion but it will lag. This happens with any big company. Over the years, there will be a gradual P/E shrinkage and it will stabilize around 12.
    Let us say that happens in 5 years. By that time, apple's earnings would be at around $50-60. So the price will stabilize at a low of 600 and a high of 720 in the next 5 years. A five year double is not bad…

  50. Luis Ahumada,

    In my opinion it is just the law of large numbers. Stock markets are forward looking and though AAPL may have experienced strong growth in recent years, it is unreasonable to extrapolate even a small fraction of that growth into the future – hence a forward multiple that is more in line with a company reaching peak margins & sales volumes that will possibly normalize sometime in the future. Companies that hoard cash, with limited track records of successful capital allocation, also deserve a discount on an ex-cash basis. The truth of the matter is the market has been right all along – Apple sported an extremely high valuation 4 years ago on ttm and 1-year forward looking metrics, but was correctly anticipating revolutionary innovation… unfortunately it is now saying it will probably continue to do well, but won't "blow the world away" again anytime soon (at least not financially … primarily due to the huge base in terms of sales, earnings & market cap). Thoughts?

    • asymco,

      Apple's growth has been 70% this year. Ex-cash P/E of 14 and forward P/E of 10. The market did not anticipate 70% growth this year with a high P/E last year. The P/E was even lower. There is no right or wrong price but it's worth noting that there is no correlation between price and performance.

  51. nagha,

    People were expecting a Jan '07 announcement that didn't come. It was unrealistic to assume that Apple would have something as earthshaking as the iPhone. The iPad was announced in Jan '10 and I think it takes that long to come up with a new product that will radically change conventional thinking.

  52. Ziad Fazel,

    Horace, another article in this vein of low P/E relative to Apple's growth.
    http://www.calgaryherald.com/technology/funds+sel

    Despite Jobs appearing in person, and introducing iPad2 which offers better value than this year's long-awaited competitors, not to mention ecosystem, some institutional investors are still selling off.

    Maybe they are selling at the perceived peak. There may be something to their argument that Apple's growth should slow in about 2 years as their devices saturate the market, but I think they are looking only at developed markets in N America and W Europe. Not to mention large loyal chunks of the installed base buying the latest model 2 – 4 years after their prior purchase.

  53. Allen,

    Any previous cases with a similar P/E pattern?

    Also might you say the situation is mysterious enough to merit a legal investigation, as it appears academic research has no answers for this?

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