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The market values Apple's balance sheet, not its income statement

As I have tediously repeated in this blog, Apple’s share price has been de-coupled from its earnings for many years. Consistent earnings growth above 70% is not seen as valuable. As the chart below shows, there is no correlation between EPS growth and value growth.

With the outlying quarter when 154% growth was matched by a negative 50% price change, the correlation does not look much better:

If we cannot correlate share price with growth then what is being valued? This has been a vexing problem because growth is the traditional, and logical, metric of valuation. Share prices, by definition (net present value of future cash flows) reflect future potential. That potential is more sensitive to growth than to anything else.

But I’ve been leaving one factor out of the share price definition. Share price is NPV of future cash flows plus current assets.

Since future cash flows are being thrown out of the equation, the company must be valued as a multiple of its cash. Does this relationship hold true?

In the chart below I show the weekly closing price of the shares and the corresponding value of the interpolated cash (and marketable securities) per share over the last two and a half years.

A strong correlation can be observed. The R squared value is a healthy 0.94. Of course this is not to imply causation. Correlation is not causation, but it is a hint.

Can predicting the cash per share be a strong indicator of future stock price? Perhaps. As long as this relationship holds, then having a reliable earnings model would still give us a solid predictor for the share price. Not because we can use EPS forward estimates multiplied by P/E but because we can estimate cash flows and the increase in retained earnings.

Of course, the market “is being irrational” because it values on the basis of the present only (not its future.) But who are we to argue? This valuation has held since October 2008.

As far as the market is concerned Apple’s future is irrelevant. Its value is defined as a constant multiple of cash.

  • Iphoned

    Apple’s cash is just an acumulaton of earnings. So same.

    • Nicu (Paris, France)

      Not the same : cash is an accumulation of past earnings, while the stock price (in theory) reflects (mostly) future<i/i> earnings.

      • http://Notesark.com Iphoned

        Perhaps I should have made my point clearer. Because cash pile is a direct result of earnings, it only appears that stock is correlated to cash. In reality, of course it does trade on earnings that are clearly perceived ass having a high cyclical component. That perception could change on a dime…or prove to be correct. A truly insightful analysis would demonstrate which case is more likely…haven't seen it tackled yet on the blogosphere…

      • Ian Ollmann

        The interesting thing is if we multiply the stock price by number of shares, we get company valuation vs. cash on hand. Here we find two interesting things. Each dollar of cash on hand adds $7 to market cap. In addition, if AAPL had no cash, the Y intercept assigns a market value to the company of -$130B.

        So on the one hand, it appears that the market thinks that AAPL sans cash will lose money going forward. (I think if we assume a 15 P/E, that comes to $8.6B / yr). But, because it has cash, each $1 of cash appears to be priced in at $0.467 / year of return (again priced at 15 P/E). 50%/year ROI cash is pretty good!!

        It should be clear that the valuation is nonsense if viewed on these grounds. If however we just value the company about about 15 P/E since 2008, which the market has done, then it is more sensible. The market just doesn't believe the AAPL growth story. It is instead going to have to /prove/ every dollar gain upon the investors hide going forward.

      • iphoned

        >>It should be clear that the valuation is nonsense if viewed on these grounds

        Hardly nonsense. A drop in iPhone selling price due to competitive pressures could make a PE skyrocket on the same stock price. Just as with cyclicals, a very "low" PE could become a very high PE very quickly based on the E lone, as product pricing deteriorates.

        Now, I am not predicting this is what will happen to Apple; just pointing out why I think the market is valuing Apples "iPhone" earnings at a seemingly low multiple.

  • Tom

    So, then, if cash and stock price correlate, then price drops when cash drops? That would mean causation.

    • Thomas65807

      No, because cash could drop if the company declares a dividend or acquires another company. Or if it acquires cash by incurring debt or selling stock.

      Cash & equivalents is a poxy for earnings in the foregoing analysis; but if something impacts cash independently of earnings, then it's no longer a good proxy.

  • Chaz

    This is another excellent analysis Horace. I'm sure you've left out pre-2008 for obvious reasons, but *what about pre-crisis*? Does the correlation still hold?

    • asymco

      Prior to October 2008, the correlation does not hold. The stock had a high P/E then and there was a stronger correlation between P/E and growth.

  • Francisco Geraci

    Horace, I am no statistician, but those points look like a curve to me. The slope of the curve appears to be flatening out as the cash balance increases, which would seem to explain the P/E compression AAPL has exhibited. Maybe I am seeing things, but it looks like the market is not only ignoring growth, but has some bias against seeing Apple's market cap increase.

    • hoomie

      Also, I wonder what role risk has in the realm of bias. It seems that the value of risk in investing in the future growth of AAPL is increasingly deteriorating the more that AAPL's future exceptional growth and expansion become validated by each and every earnings report. I wonder whether heady growth is still the drug of choice on Wall Street or if the risk trade has acquired new sexiness now Wall Street has more cash to throw around again…

  • gerwitz

    Nice analysis. Anything noteworthy in moving averages, that might further imply (albeit not establish) causation?

    (Of course, if this view becomes commonplace, it could easily invalidate itself.)

  • Dave

    I think the bias against AAPLs market cap rising is that it unthinkable a tech company could be more valuable than Exxon.

    • KGB

      Yes. It seems to be a 'sentiment' issue.

    • Hamranhansenhansen

      But we have passed peak oil, and peak tech is still in the future. So we should expect to see Apple pass Exxon.

  • stsk

    Again, why? I think your analysis is correct, but what sense does it make to value Apple like a Savings & Loan? This is completely nuts.

  • Iphoned

    The compression correlates well with the rise of the iPhone and its growing contribution to earnings (70%+ likely by now).

    Pretty clear the market is voting that it does’t believe iPhone margins are sustainable going forward. This is quite similar to how the market assigns super-low pEs to cyclicals at just when earnings may look best.

    • Stefan

      Horace, I was skeptical of this statistical deduction, but then crunched the following:
      Based on eye-balling your graph, I get a slope of 6.3 and y-intercept of -70.
      Cash ending FY12 (Sept 2012) should be at least $110B.
      $110B x 6.3 – 70 = $623B
      Assume 950M shares outstanding, share price = 623B/950M = $655
      P/E = $655/$32 = 20.4 (assumed EPS of $32 for FY12).

      Assuming your theory is correct, I have not idea who in the market is looking at this stock this way, but the the forward math works and points to a stock which is about to pop. Hopefully the fall-off in the data points to a deep consolidation, and a mean reversion will occur.

      Thanks for article.

      • chandra

        I wish I had paid more attention during maths classes at school.
        This might as well be classical Greek to me!
        Oh well, never mind.
        I'm going to develop an emotion/sentiment index for mapping the true dynamics underlying AAPL's price lull.

    • Ted_T

      Every time I hear one of these sensible arguments about Apple's low P/E (and I have made the iPhone point myself in the past) I have to ask — how can the market then value Amazon at a 70+ P/E? Sure there are perfectly logical stories about why Apple's future growth is unsustainable. But I'd think they are way less likely to come to pass than Amazon's growth going down the tubes:

      Most of Amazon's income comes from 3 items — books, CDs and DVDs. All three are rapidly moving from physical goods where Amazon dominates, to virtual ones, where it doesn't. The CD market is the clearest illustration — Apple rules the digital music download market, Amazon hasn't broken 10%, in spite of underselling Apple consistently (and probably taking a loss in the process unless they are getting a radically better wholesale price). When CDs go away as a mainstream music medium, which they will, soon, Amazon loses that market. There is absolutely no indication that Amazon will do any better in the movie download market — so as DVDs die out, so will Amazon's share there.

      Their best chance is with books, but by hitching their wagon to eInk, non-touch screens/physical keyboards and a proprietary book format, there is a chance that B&N with it's much more versatile Nook (not to mention Apple's iPad) will keep them from major growth in that area as well.

      This leaves Amazon to have to sustain growth worthy of a 70 P/E with "other" physical goods like electronics, clothing, food. It just seems way more likely that Apple will keep growing than Amazon will. Is Apple's higher market cap that important?

      I think the fundamental difference between the two is that investors understand (or think they understands) Amazon's business, but they don't understand Apple. They can't explain to themselves Apple's torrid growth during the the past two years of "the Great Recession", never mind wrapping their heads around future growth.

      • Simon

        "there is a chance that B&N with it's much more versatile Nook (not to mention Apple's iPad) will keep them from major growth in that area as well. "

        I'm not so sure about the Nook. So far from what I've seen online, it seems the Nook's success seems to be driven largely by the same penny-pinching geek crowd who laugh at iOS users for "paying" for apps, the same group who made the Android Market such commercial success. They love to get good value from their purchase of hardware and love to get "free" content off the internet.

        On the other hand Amazon's tablet might be better positioned to attract the crowd who are willing to *gasp* pay for the stuff by leveraging the existing online consumer base and the name. And tablet market can prove to be a windfall for Amazon if things go their way.

  • Yev

    Seems Wall Street is better at “investing” into companies where management plays ball rather then companies that actually produce results. House can’t control the game hence no “faith” in the future growth.

  • HTG

    Horace, you comment in rely to Chaz above nails it…

    The reason for the strong correlation between cash and share price is due to the memories of the financial crisis. The market values certainty above all else and the cash in the bank is certain; and this change occurred right about the time of the GFC… so market sentiment has changed. The investors can see the cash and they are using that as a valuation metric, more or less…

    This is an entirely historical view and I wouldn't put much weight on it as a look forward measure – valuing companies and talking about it is a bit like quantum physics – once you observe the phenomena you change its outcome….

    • http://twitter.com/ShashNanda @ShashNanda

      i do not think "memories" of the financial crisis had anything to do with tis phenomena. we not be seeing p/e multiples of 100+ for companies then.

      this is an appl specific phenomena.

  • Rob Scott

    This would only work for me if you were to show other companies who exhibit similar behavior. Otherwise the whole thing look torched. As you said it doesn't hold for periods before 2008. Find other examples, I might be convinced.

    • asymco

      I claim nothing about other companies. I make a claim about Apple since 2008.

      • Rob scott

        I know. Which is why I am suggesting that more examples of this will strengthen your case. Are there any other examples of this besides Apple, that is all I'm asking. If there are, then great job, if not then I will remain skeptical until I see more data.

      • russell

        I believe Horace will be hardpressed to produce the examples you need as they relate to other companies. What you are asking for is another Apple-like company that is a mega-capitalized , but that's growing like a successful micro-cap in all its metrics.

      • Ian Ollmann

        What I'd like to see (pardon my ignorance) is that this sort of analysis actually yields expected results on other companies, e.g. XOM or IBM. Here is why the methodology is numerically suspect. You are measuring growth vs growth. Growth is a derivative measurement, not a real one:

        growth = (A' – A ) / A

        and as such becomes much more susceptible to measurement error. Lets say that the quantity A in question has a 2% error inherent to its measurement. If A' (the new A) is close to A, which it usually is, then we if we include measurement errors in the equation, we get

        measured growth = ( A' + Ea' – A + Ea ) / (A +- Ea)

        Now if we have low growth, such that A'-A = 0.05A, then our result is:

        measured growth = ( 0.05A + Ea' + Ea )/ (A +- Ea)

        thus if error is 2%, the error term is almost equal in magnitude to the growth term.

        Now, in this case, AAPL growth is so high, we might expect that a 2% measurement error would be swamped out. However, if we accrue into error market fluctuations that have nothing to do with AAPL, such as meteor strikes, Portuguese debt crises, US debt ceiling crisis, NASDAQ rebalances, short selling chicken littles, etc.) then a 2% measurement error is actually looking like a poor estimate and the real market uncertainty could be more like +- 20 or 50%, depending on investor mood.

        So, in my ignorance, I'd want to see that this methodology generally is empirically sound for other companies for making too many conclusions about AAPL.

      • asymco

        Ian, thanks for your comments. The post is a result of a simple empirical observation that the stock price as a multiple of cash seems to have remained fairly constant over a certain period of time. This caused a flag to go up in my mind as those values are almost never correlated and should not be causal.

        I only added the data about growth to emphasize that the correlation with cash is coupled with a lack of correlation with growth. The first two charts are "adding insult to injury".

        I am only making an observation over a limited time period and for a specific company only. I would not expect these relationships to exist for other companies (as I would not expect them to exist for AAPL).

  • Manny

    Horace – instead of an absolute share price on Y axis, why wouldn't you look at the change in price for a given quarter. This would make your analysis more accurate – i.e. stock price change in Quarter(N)/Earning Growth in Quarter (N). In fact even more interesting would be to match earnings growth in a preceding quarter vs. stock price in a current quarter. This way you could see how (if) investors reward AAPL stock for actual performance/growth delivered.

    Your current analysis simply does not work. For example, you could have a quarter where EPS increases at 100% while the price of share is $100. Your chart will show this quarter as undervalued from a stock price point of view. But let's say that same quarter the share price increased from $50 to $100 – i.e., an increase of 100%. So, really it's 100% EPS growth vs. 100% growth in share price.

    axis how the above chart would look
    Best not to look at absolute value of share

    A better analysis would be to look at correlation in

    • asymco

      You're right. I changed the first chart to show relation between change in share price and change in EPS. The relationship is weakly inverse.

  • Childermass

    Remarkable. Thank you.

    This immediately brings to mind your earlier piece exploring the reasons why the price had become decoupled from the usual metrics. Add to that the normalcy of their abnormal growth and the evidence is that Apple has simply outgrown the market.

    Too big, too fast a growth rate, too much innovation, too much domination, too much independence of thought, too little playing the game. If the normal metrics don't apply, and as you have painstakingly displayed, they don't, what is left?

    Cash.

  • http://twitter.com/ShashNanda @ShashNanda

    Horace, I think your first chart – eps growth versus share price growth, is clearly being affected by outliers. I would look at those eps (0-50% growth) and stock price (100-150% growth) data points more closely to see if a pattern within them such as periods of time (early 2008/09) exist or not.

    apologies for a rushed reply, but overall, its an interesting blog post, but definitely needs another look / further statistical analysis imo.

    • asymco

      The first chart shows the same time frame as the second (October 2008 to present). I also took a look at a earlier times (back to Nov. 2007) and the correlation did not improve. The outliers are skewing the data (150% growth resulted in a 50% drop in the stock price) but if they are removed the correlation does not improve (R squared goes to to 0.005).

      The point is that the relationship with cash is exceptionally strong and the relationship with growth is exceptionally weak (I would argue completely unrelated).

      The thesis of the post stands: value responds to assets and not to opportunity.

      • Ian Ollmann

        Or maybe, assets are a directly measurable quantity, and growth is a derivative. Since the latter is more subject to error measurement, no correlation can be observed because the measurement error is too high.

        I think it is a mistake here to view market valuation of AAPL as infinitely precise at a given time. It is strongly affected by other factors that rock the markets in general and have very little to do with AAPL. For example, there is a pretty strong correlation between ^VIX valuation and the direction of AAPL share price growth.

  • chandra2

    Couple of points…

    1) If the growth in cash position mirrors the earnings growth, then nothing changes. We will be pointing out how the price is lagging the cash position growth. If the two growths are different, then some insight can be had as to why those two growth curves are diverging. ( remember, the decades old PV method was based on dividends, the cash is a close proxy for dividends, so I am perfectly fine using the cash position as long as the market rewards growth in cash position )

    2) 9 months or so after hitting the bottom post crisis, Apple changed the way it recognizes earnings. That distorts the picture quite a bit. If you somehow account for that, I have a feeling that the P/E compression would not look as sudden as it looks now.

    • asymco

      All my data accounts for restatements after the end of subscription accounting. In other words, the stock performance is shown relative to what the accounts would have shown without subscription accounting. I assume everyone was doing their homework back then by accounting for cash flow not earnings.

      • claimchowder

        That assumption more than flatters Wall Street ;)

      • addicted

        @Horace, claimchowder is absolutely right.

        Very FEW analysts were considering the subscription accounting. That was one of the reasons they are so surprised and shocked right now.

      • asymco

        When you predict an unlikely future you won't be believed. Your credibility won't improve when that future comes and nobody believes it came.

  • sam doji

    it,s amazing why we are talking about this mystical link between earninig and price movement for this exceptional stock. it,s a simple math: apple earning grouth acceleration is faster than it,s price acceleration. This gives a PE that is either declining or holding stagnant.

    apple should initiate a stock split to reconcile itself with mt Market.

  • http://aaplmodel.blogspot.com deagol

    Horace, for the first chart, when matching a particular time window of share price growth to a time window of EPS growth, try shifting the EPS growth forward a year, or maybe two. I remember the correlation was stronger when I tried that back in 2006 or so.

    But for the last couple of years this still might not show any correlation, due to growth expectations recently turning so radically conservative (coherent oxymorons rock!). I think the only reasonable causal correlation with share price growth one could seek is perhaps with consensus estimates of forward EPS growth. If estimates are good, then the correlation with actual reported EPS would follow. We have already determined consensus estimates for the immediately finished quarter are way off, now just imagine how bad it is for the one- or two-year forward-looking growth estimates. Thus, I'm not surprised you get even negative correlation.

  • http://twitter.com/mariomui @mariomui

    That's really strange. Doesn't that mean that the holders of apple stock are selling and holding at predictable levels determined regularly by quarterly earnings report? That the trading done is by big institutions and there's no real competitive pressure on the apple share price. I can't see how this model can exist for 2.5 years unless that was the case. Maybe the 800 million floating shares are just getting bounced back and forth between two institutions while waiting for the stock split.

  • KGB

    asymco…..so a share price of $400 would equate to cash/securities approximating $75b?

    Interestingly, your recent tweet ("Apple shares are trading at exactly five times its cash") match your February projection for the AFB group (Robert Paul Leitao) for May 2011. Wonder how your projections for August (370), November (443) and Feb 2012 (500) would look using the criterion of "cash" vs share price?

    Thanks for noting this correlation.

  • Thomas65807

    Apple pays no dividends, so its cash (and equivalents) obviously mirror after-tax earnings. Thus, the essential difference between the two charts reflects a debate on whether share price is more accurately predicted by Apple's a) Earnings or b) Annual Earnings GROWTH Rate.

    I have always learned that share prices reflect earnings, not the earnings growth rate. The company's earnings could double each year — from $1m to $2m to $4m — but the share price would be low; if its earnings are $10 billion, the share price would be far higher even if earnings were growing only by 2% annually.

    So … the findings of this article are not at all surprising. If the second chart had posted EPS on the horizontal axis, the slope of the regression line would have been the company's P/E multiple. That's how I would draw the chart, instead of putting cash on the horizontal axis.

    Speaking of the regression line, the pattern of errors (or residuals) in the second chart indicates the presence of 'serial correlation.' That is a signal that a key explanatory variable (other than cash) has been omitted from the analysis.

    • http://twitter.com/mariomui @mariomui

      Where was the pattern of errors in the second chart

    • Ian Ollmann

      > I have always learned that share prices reflect earnings, not the earnings growth rate.

      If that was true then all we'd need to do is collectively agree on the return for our money that we expect from stocks (e.g. 6.66%, and 1/0.06666 is 15 P/E) and we could price all stocks at a set value. There would be no need for a market. Earnings wound just set the price for the quarter and we could buy or sell based on that.

      The problem is that the market is not pricing stocks based on past returns, but based on expected future returns. If I buy shares today, I can't lay claim to past earnings, except when the company is lazy about regular dividend payments. I lay claim to my share of future earnings, either as dividends or higher company valuation. Here the valuation process becomes tricky because I don't know what AAPL will earning the future. I guess. This is why companies often trade significantly above or below past earnings. The market is expecting earnings to change. Thus, earnings growth becomes material. You should be able to calculate a fair price for your expected rate of return based on expectations of earnings over your investment time horizon. That would be the fair price for the stock today.

      Today, the market claims that the fair price premium for AAPL earnings growth is zero. In short, it doesn't expect AAPL to grow or at least not very much.

      • claimchowder

        …or that the mean investment time horizon is very short.

    • asymco

      Price can reflect anything. The value of a company however should be more sensitive to earnings growth as the growth is the indication of the shape of the future cash flows whereas current earnings is a single data point about the past.I can assure you that to most investors, and for most industries, the balance sheet is not a good indicator of the earnings potential of a company.

  • http://www.eliainsider.com Elia Freedman

    Interesting analysis, as always. No one has said it here so I thought I would throw it out. The Street correlates Apple with Steve Jobs. Since Steve Jobs' future is unclear, could this be why the Street is valuing Apple at present value?

  • http://www.apple.com Fake Tim Cook

    I think they are waiting to see what we do with that pile of cash.

  • Brian Gillespie

    Since the market "readjustment" I think a lot of investors just don't fully trust Apple's success. They think it is either luck or Steve Jobs' Midas Touch or some sort of combination of the two and can't believe it can or will continue. Hell, I think even the analysts are largely in the same boat, they're just waiting for something to happen to Jobs or the market circumstances and Apple to falter. So market value is based these concrete metrics. It's like the opposite of irrational exuberance.

    • Laughing_Boy48

      Then if what you say is the case, then throw away all the charts and spreadsheets, because Apple is being judged on emotions which means Apple's stock value can't be figured at all. I also think that average, individual investors no longer trust Apple. If I hadn't been holding the stock for many years, I probably wouldn't invest in a stock where its value isn't judged on normal metrics that most companies are judged by. I look at Apple and I see a lot of growth potential, a lot of revenue and a lot more cash for at least another year or so. If that doesn't mean anything to Apple's share price, then the stock is truly broken in some way and not worth the time of an average investor.

      On one hand, I hear that the company can do well for years without Jobs. On the other hand, I hear that if Jobs leaves the company will flounder. That's too risky to gamble on emotions. I don't know how this happened to Apple, but I'm concerned that Apple shares will never rise further than where they are now unless they acquire some large company and bring more individual investors in. Those large institutions holding Apple are frightening me because I'm thinking they must be manipulating the shares. I certainly have no proof, but nothing about Apple's share price movement really makes sense to me. For a company to be making huge amounts of money with plenty of growth while the share price is stagnant or falling just makes no sense at all if share value is supposedly based on fundamentals.

      • Brian Gillespie

        That's what I'm saying, it's a case of irrational caution.

  • mortjac

    Thanks for a great analysis Horace. It certainly enlighted me!

  • Pollak

    Horace
    If the price is no related to growth since 2008 we should have seen a dramaticall decrease of the P/E since then.

    But isn't P/E is being more or less constant?

    • asymco

      The P/E has been declining slightly. The ratio of P/E/G has been declining rapidly.

  • Hamourabi

    An other way to interpret data is that market expectation for future cash flows NPV is strongly correlated to cumulated past earnings a roughly equal to 4 times this cumulated earnings or that Apple market cap is 5 times its cumulated earnings.

  • James Katt

    Since Apple's Stock Price highly depends on its Cash Holdings, Apple should NEVER give out dividends or buy back stock. These two actions – clamored for by some pundits – would kill the price of Apple's stock.

    • Pollak

      That's really stupid!!!

      Obviously giving dividends would make aapl to go back to a traditional valuation pattern

  • Iphoned

    Apple has cut the price of iPhone before. If ever they are forced to do it again sharply to keep up with Androids, the E could drop in half or more and the PE would rize sharply.

    The low PE signals clearly that the market assessing the risk of such an event as substantial. Perhaps the market is wrong. But there is no mystery to the low PE which has essentially been there sunce the iPhone.

  • KenC

    Interesting last chart.

    Can we be sure that the price is solely correlated to cash? Can it be correlated to anything else? Like time? Or revenues, or profit? I mean, the price rise has been quite steady during this time period from late 08/early 09.

    Is it possible that this is some sort of fallout of the whole deferred revenue period? What PE range was Apple trading in prior to restatement? Wasn't it still in the 25x to 40x range? Then after restatement the price drops into the 10x to 20x range, where it has stayed.

  • Ian Ollmann

    Does this surprise anyone? I'd even go so far as to say that the vast majority of the activity on the stock markets is parasitical rather than constructive. Set short term capital gains taxes to 75% and this will be reduced.

    > …or that the mean investment time horizon is very short.

    In principle, it should cancel out. If we are expecting a 6.6% return, it doesn't matter whether we've invested a day or a month or a year, we still on average expect to see a 6.6% annualized return over your investment time window. The only difference is that on the shorter investment periods, market volatility (noise) is dominant. Over the long term, the price should eventually revert to the mean. If you are a medium to long term investor and you believe this rate of growth will continue (even for just 1 year at current prices) then AAPL should look very attractive to you.

  • chandra2

    Brian, Nike can be quite illustrative. For the first 10 years, the stock price grew at around 35% compounded growth. The subsequent 15 years, the stock price grew at around 8%. During the first phase, the market seems to have overestimated the future growth ( irrational exuberance ) and in the second phase the market is underpaying for growth. I have not kept track of the recent growth numbers of Nike.

    Is it irrational caution or this kind of P/E compression for the same/similar growth rate expectations a common thing after a company reaches a certain size relative to their peers and competitors.

  • Niilolainen

    That is a pretty awesome piece of analysis. Bravo!

  • chandra

    What are you really illustrating here Horace?
    Are you trying to find a way to map underlying market behaviour since it isn't following any obvious traditional valuation bases?
    If you are, it's about time someone followed this line of thinking.
    I assume the idea is that, however perverse it may seem, there is some (sentiment/emotion) which guides the way the market values AAPL. Ummm that, unconsciously, the market thinks it has found a way to value AAPL that it feels comfortable with.
    By logging the market's valuations you then 'reverse-engineer' the workings to find possible patterns that match market valuation behaviour. And the correlation of market valuation with growth in liquid assets looks to be a strong match. It certainly seems to be. which is an astonishingly interesting insight imvho. Is that a fair explanation of your findings, or am I talking gibberish – an obscure language I learned on my extensive travels to the Far side.

  • Ziad

    Very good analysis, Horace, but I would advise against one technique you used: interpolating the cash between quarterly statements to reach a weekly number. I think this artificially increases the correlation coefficient.

    You would be better off using the share prices before and after the earnings statements. The general trend you found would still exist, but you would not be inflating the number of data points with processed data.

    In fact, I wonder what difference you would see between a graph of share prices before the earnings release, and another of share prices after. The trend may be the same, but I suspect pre- is bumpier than post- release. It would be interesting to see whether the pre-to-post adjustment is driven more by sales, earnings, cash or the alignment of Jupiter to Mercury when Mars is rising on the Capricorn phase.

    • asymco

      I believe it's safe to assume that the cash was growing linearly through the period however I did it both with and without interpolation. The R squared coefficient was still in the .9x range.

  • Kristian

    Next year AAPL is $1000. Take it or live it.

  • Hamranhansenhansen

    Competitors flummoxed … market flummoxed.

    I think the main problem is the iPad and iPhone *seem* so simple. They are so easy to use, it seems like they would be easy to copy by competitors. And of course, Apple 2.0 is still living down the fact that Apple 1.0 let Microsoft have 15 years to copy the Mac. Investors are looking at iPod as a fluke. Apple-is-doomed has returned full strength.

    What is required to alleviate those fears is a steady succession of piss-poor iPad clones. I'm pretty sure we will get them. At some point either an Apple release or competitor release will tip the balance and make it clear that iPhone/iPad is iPods all over again. Could be the first crappy NT/ARM tablet that does it, or could be an iPad with Retina display and 4 cores. Or could be iPad passing all notebook PC sales, which is not that far off if trends hold. There needs to be an iPod nano -type moment, where Apple is clearly and obviously way ahead of everyone else. Whatever it is, there will be a major correction.

    It is amazing that after all of this, Jobs is still living down Scully.

  • chandra2

    claimchowder mentioned above "the mean investment time horizon is very short"

    Here is a quick PV model for that premise which seems to fit the data.

    Discount rate is a conservative 8%

    Current E = $21.00 Zero growth ever. P is 262.50 ( This is a theoretically correct number and this is how typically a AAA quality/Treasury bond will be priced. )

    Current E= $21.00, First year growth 40%, zero growth assumed after that. P = $358 .

    That is right about where we are now. So this thesis of really short term focus and not trusting any long term
    growth numbers has some merit. We will have to see how much this holds.

    In this view, 2011 growth is already priced in to the current stock pirce. As we move forward, the growth during 2012 will start getting priced in.. The price should march towards $500 with a E of $29.4 around this time in 2012. That march to $500 is really based on an expectation that the E will hit $41 around this time in 2013 .

    It looks to me that the above model fits Horace's thesis as well. The reason why it looks like the price is a linear function of accumulated cash is because of the simple relationship of next year's price = this year's price * ( 1 this year's expected growth in accumulated cash. ) ( approximately, with one year discounting thrown in ).

    In theory this should also align with growth in earnings since growth in earnings should closely mirror growth in accumulated cash. As deagol suggests above, it may just require some shifting of the horizontal axis.

    Complex systems like this, when disturbed with the powerful force of the financial crisis, take a while to settle down in a new stable pattern..

  • andrew

    maybe its cause its viewed as having run its course, as far as can be seen now. its simply a product maker (at this point) after all. of a few distinct highly succesful products. what is next? can iphone really be expected to continue to be nearly the big part of dataphone sales, 5 years from now, as it is today? its pretty uncertain really. will the pads really continue to expand into the everyday world of computing, and will ipad be also the big player it is now in that area, 5 years from now? tablets before didn't really cut it. this is different but still… these are somewhat vexing questions. apple has in a way created markets now. can these markets really continue to just grow and grow AND with apple getting major market share as it does now. in the immediate future (next year or so) it looks like it, but beyond that (say after Jobs is gone) it doesn't 'feel' so clear (as opposed to say Baidu where its hard to imagine it not cotinuing to have a major presence in china for five years and more ahead).

    if apple can hit it with some kind of exciting cloud thing, perhaps that takes Netflix at its game, as a component of what its about…. If apple can deliver a kind of nano iphone (lower cost) and hit the new middle class urban Chinese market with a super hit… IF….. then I think it starts to look like something wider and deeper in the immediate and in a way in the long run.

    The other thing with apple is that they are so tight-lipped about any new directions that in this moment it leaves something to be desired. It leaves a lot of people in the dark just as to what things might look like a year from now… So then what are you investing in? continued super sales of iphone, possible transformation of everyday computing with wide use of ipads in every home? where is the growth going to come from beyond the hits of the last year? and will this Next Level in how Apple is perceived, etc. come before Jobs is gone… All elements in thinking about Apple that I think keep the stock kinda locked in a limbo point. Looking for a sign, of something more then last quarters earnings.

  • chandra

    There's a lot of informed, intelligent discussion here about the numbers. But this failure of AAPL's price to rise to match its performance is more about psychology than rational market behaviour, surely? Where are the equations for analysing doubt or disbelief as a market influence? What are the relative weightings for the influence of greed …. or fear? Why do some still worry that Apple cannot possibly sustain its levels of sales and profitability. Why should there be a hiccup in the rise and rise of its solvency?

    Nothing lasts forever. But this horse still has a long way to run. How do you project forwards from such a position of franchise strength? Do the bean counters at HP and RIMM still produce upward trending five year forecasts for shareholders? How do they do that? Where are their assumptions stated? Does Apple do medium-term forecasts? I doubt it. They do it a quarter at a time. But they think long term on market trends for products and strategies to play in those futures. That much seems clear.

    The iPod was a simple, limited, one-trick pony – two-tricks briefly but back to one really now.

    The iPad embodies all that the iPod is and opens the horizon to being a do-everything device – as the PC was, and remains, even as it slowly declines. And yet the iPad costs so very little.

    Unlike the iPod then, there is every reason for the iPad to flourish as it evolves over the next 20 years. It is the first truly personal computer for everyperson, from infants to centenarians, as we have seen. This means the iPad has the broadest and deepest constituency it is possible for a device to have. The only threat is that, eventually, a competitor will do better still and topple the iPad. But there is an Everest-sized mountain for any competitor to climb to become a contender with Apple. And that is the moat-of-moats that makes the iPad and every major Apple offering so difficult to challenge right now.

    Apple's business franchise is the broadest and deepest that there is right now. Can any of you suggest one that's better? To compete with Apple, or the iPad, is not as simple as Tim Bajarin's point about competitors having to make both the hardware and the software. that's only a starting point to raise a credible player. Success against Apple means going much further than that. It means creating an interlocking set of related, inter-operable devices with airtight seals between them in terms of compatibility. Then there is the rest of the famed ecosystem componentry to begin and develop to the same high standard.

    iPad will change computing and it will endure I believe. What will really set the cat among the pigeons will be the arrival of Mac OSX Lion, which should hint to the world, the advantages of a hybridised OS that allows you to use your Mac like an iPad, when you want, or as a Mac (with keyboard and mouse), when you want. The process begins with 10.7 but it will hit people's buying behaviour pretty quickly.

    After all, as new as the iPad was last year, everyone understood it immediately because they knew about iPhones and iPod Touches. When Lion springs into the market, people will realise that, if they know their iDevices well, then a Lion Mac will seem like a familiar friend. And adoption of Macs will reflect the result of the end of many prevalent uncertainties, out there amongst the great unwashed, about embracing a new and alien OS.

    imo, for these reasons and more, Apple has plenty of room for continued growth. Its share price has grown 90 plus times (9,000 %), since its lows around 4th July 1997 levels (e.g. $ 3.42 pre- the two splits). 90+ times growth in share price in 14 years (even after dilution) and we are worried about anticipating another tripling within the next 5 years? Even for a fan and investor like me, it takes a few moments (or a few months) of pause for reflection, to take in the magnitude of the journey this company has made from near-death to becoming the Ace of Tech. Why should the market take a little time to find some religion? It's a story of recent history that borders on the unbelievable, if you think about it.

    Finally, if you go back through these last 14 years, there have been many times when AAPL was spinning its wheels and going nowhere on price for long periods. This is the time the market needs to take to renew its belief in the franchise or throw in its cards. Clearly, as in casino plays, the higher the stakes on the table, the entry price to play as it were, the longer people need to decide whether to jump into the game, to stay on the sidelines or to cash in their chips and bail out.

    To me this isn't like a visit to the Casino. It's much more like going to the racetrack knowing that there is a runner in the big race whose form is well known to you but to few others – all of whom expect it fall one day, and probably rsn. That isn't gambling. Chance hardly comes into it and nor will it for at least five years.

    Just my usual 20p's worth….

    I am into AAPL for the long haul. I can do patient.

  • %K %D

    If you borrowed cash from the bank, would that increase the stock price? According to your theory it would.

    Regarding stock price to growth, clearly the market sentiment discards the PEG ratio for Apple. At a PEG of one, 92% earnings growth rate would imply a 92 PE ratio. The average analysts' 2011 AAPL earnings estimate of $24.54 earnings multiplied by a PE of 92 (PEG = one) suggests a valuation of $2.26 billion. Market psychology is not prepared to accept this, especially since a large portion of AAPL's intrinsic value is tied to a couple of products. Cutting the PE in half to 46x suggests a valuation $1.13 billion. The most aggressive bulls have trouble with this value. Size matters.

    As an investor, I would not bet on PE expansion. I also do not bemoan the fact that Apple's PE appears low. I simply trade the price action in the context of market structure, support and resistance levels, and changes in expectations of free cash flow.

    Free cash flow (earnings from operations adjusted for changes in the current assets and liabilities minus non-cash charges minus capital expenditures) is closely correlated to stock price action over the long term. Free cash flow is true generator of value.

    • John

      "If you borrowed cash from the bank, would that increase the stock price? According to your theory it would. "

      Only if investors are too stupid to subtract debt from cash when evaluating Apple.

      Which, admittedly, is not beyond the realm of possibility.

  • %K %D

    correction: above billion should read trillion: $2.26 trillion and $1.13 trillion

  • chandra2

    Horace: Your post seem to have triggered some reporting at CNBC TV. Their web post refers to you but on TV they did not give any credit to you. :(

    Web: "Apple—the Real King of Cash Published:"

    http://www.cnbc.com/id/42879245

    TV: "Apple In the "Green"

    http://video.cnbc.com/gallery/?video=3000019870

  • Ziad Fazel

    Two recent articles from Andy Zaky at Seeking Alpha on the mismatch between earnings and price:

    http://seekingalpha.com/article/269751-zaky-apple
    http://seekingalpha.com/article/271199-apple-s-st

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