Categories

The thermodynamics of Apple's share price

Andy Zaky at Bullish Cross wrote a great post on Apple’s valuation, showing the deep discount of Apple’s earnings vs. an average company. It essentially states that Apple’s money is not green.

Felix Salmon took it forward by enumerating a few explanations that might be used for the despondent valuation. None are successful arguments, but that should not be a surprise.

To understand the phenomenon a bit more precisely, I maintain and think about these charts:

This shows Apple’s share price (“P” in blue) and its earnings per share (“E” in green). In addition there are multiples of the earnings in “bands”. The first band is 35xE to 45xE which bounded the price during the period of 2006 through most of 2008. The second band is 15xE to 25xE which bounded the price since then. The data is updated weekly so it is current as of last Friday.

Illustrating it this way shows how the stock is seen as representing different companies at different times. The 2006 era (iPod) Apple was seen as a high growth, dynamic company with loads of headroom for growth. The current (iOS) Apple is seen as a slow growth, fairly static company with most forecasts showing 20% growth potential.

Note that the price has dropped outside the current band for the first time since the great recession. It is still below 15xE today. Perhaps a new band is forming.

 

The second chart shows the P/E on its own (in blue) but with a second measure where the P/E is divided further by the average trailing twelve months’ growth (P/E/tG). This is a variation on the P/E/G (aka PEG ratio) where instead of (mostly wrongly) estimated future growth I use actual growth history–hence the t for trailing. The P/E/tG is a way to normalize P/E as a function of growth and hence a more appropriate index of value potential.

I added a horizontal line to the chart to show the minimum value P/E/tG reached during the recession (0.17 in January 2009). As you can see, the P/E/tG is now lower than at that time (0.15). It implies a deeper discount for the company’s earnings growth than during the time when the world faced economic contraction.[1]

Note also the trend of that line as it shows a steady linear path toward zero.

Of course, it cannot reach zero unless Apple files for bankruptcy. But until it does file, the line can only reach zero asymptotically as E/tG increases. Which is a relief, I suppose, as it means the rate at which P/E/tG drops will decrease. This implies that as earnings growth persists, the drop in price will have to moderate.

The other threshold to keep an eye out for is when Apple’s share price will reach its cash per share. That’s the point when investors will consider the company to be a net value destroyer. If you performed that analysis in January 2009, and you were accurate about earnings forecasting, the answer would be well before today. See the following chart:

In other words, in January 2009 the stock was trading at a price (<$80/share) below the current cash per share (>$85/share). It took Apple 18 months to grow its cash to reflect the price set on the company. Had the stock not risen then the company would today be trading below book value.

The amazing thing is that today the valuation structure (P/E/tG) is even worse than in it was January 2009. An interesting exercise would be to project how long it would take for the cash to increase to the current share price.[2]

I imagine this time interval should have a name. How about the time to boil: the time for growth pressure to become sufficiently high to exceed disbelief that growth can happen.

Notes:

  1. Note that the low values were placed on the company after the crisis took hold, not as an anticipation of contraction. See the behavior of the index during the summer of 2008 as the credit crisis was unfolding.
  2. This analysis is consistent with the analysis that Apple is not valued on earnings or earnings growth but on its balance sheet. The ratio of Price/Cash has been fairly constant but if it breaks down (as it has been–see below) then we need to assume a new dynamic is in place. 
  • http://www.noisetech-software.com/Home.html Steven Noyes

    Horace,

    Question.  How much do institutional buyers, that may hold a billion or so dollars in AAPL, impact AAPL’s slower growth?

    My thought process is: As the value of Apple’s stock goes up, the position many of these institutions have in Apple increases.  Since, as I understand it, many of these institutional buyers have limits on how leveraged they are with a specific company.  As a result, when AAPL goes up, it forces them into actually rebalancing their portfolio buy eliminating Apple shares.  This effect actually holds the price down low since most shares are NOT held by small, individual investors.

    • Anonymous

      You have described exactly what goes on in my own managed account.  While I have no doubt that there are shenanigans afoot within the market in regards to Apple, a theory that I heartily subscribed to at one point, I know from my own comparisons over this year, that Apple sees much the same fluctuations as Google.  This would seem to provide evidence that your thoughts are at least explaining part of the equation, as Google shares a similar ownership profile.  You also have to figure in transitory price disruptions, such as the Q4 “miss,” and the expectation of a second recession, which would present a massive buying opportunity for the Permabear funds who sell and wait.

  • http://twitter.com/jdsweet J Sweet

    I suggest calling it the ‘Dediu interval’, or the alliterative ‘Dediu delay’. ;-)

  • iAppleTennisU

    ? Question to Horace:

    In a long term investment on AAPL, this stock fluctuates each year in a wide range yet goes up YoY, is this comparable to recent or past Great companies that survived growth after growth on new products introductions and acceptance through Sales/profits??

    Thanks for your analysis & work :-) 

    iAppleTennisU

    • Anonymous

      Maybe a comparable would actually be a Pharmaceutical company – one that has had a history of new “blockbuster” drugs every few years. Like Apple, for a pharaceutical company it would be difficult to value their future unreleased products, and also like Apple their current best-selling products have a limited life cycle before they are copied by generic drug manufacturers, so they are in need of constant new product lines from the result of R&D efforts.

      • Anonymous

        To follow up:
        As AAPL has grown its revenues & earnings dramatically over the last 5 years, its share price has been seemingly cursed by a ever decreasing earnings multiple.

        One explanation for this seemingly contradictory share price perfromance I havn’t seen proposed before is the following: Apples recent transformation from a traditional computer/software company into a consumer device company  means it no longer has a product portfolio that supports a high multiple valuation, even though the growth potential from the new product lines are very high.

        Most of apples earnings are now generated by product lines that did not exist 5 years ago, and are not guarenteed to still exist 5 years from now. Compare this to the rest of Apples history, where its revenue/earnings were generated relatively PREDICTABLY for over 2 decades from its traditional computing product lines.

        The original dramatic fall from 25+ PE occurred in 2008 during the financial crisis, and has never recovered back to pre-2008 levels.

        However something else also occurred during this period: The iphone started to become the dominant product line that apples growth originated from.

        Looking back to the begining of the decade, apple only sold traditional computing devices & software, and so had a steady non-explosive annual growth rate typical in the computing industry. Most importantly, the predictability of the company growth was rather easy to estimate, with neither dramatic rises or falls likely to occur.

        With the introduction of the ipod, apple dipped its toes into the consumer device market, and begun to sell a product line that had explosive growth potential (which it fullfilled), but which we now see (with negative growth rates) has a limited life cycle. Luckily, Apple had been able to release 2 more product lines (the iPhone & iPad), that have the same explosive growth potential as the ipod did, but also will eventually (in an undetermined amount of years) reach a growth plauteau and from then on may experience small/negative growth. At that point apple will again be reliant on new product lines in new markets to stimulate aggressive growth.

        What I described in the paragraph above is similar to how I perceive a big pharmaceutical drugs company generates growth. It has a portion of its income that comes from reliable products with low growth (like Apple does with the Mac) but the bulk of a pharmaceutical earnings growth comes from “Blockbuster” Drugs that can’t be predicted to be successful, and for the drugs that do appear they have a limited number of years where they experience explosive growth, but are then susceptable to losing marketshare & margins once rival/generic versions of the drug are sold by rivals (either from rival companies developing similar drugs or when the patent for the drug lapses and it is able to be legally copied).

        The industry P/E average multiple for pharceutical is about 13.

        Like a pharmaceutical company, Apple can’t guarentee that it will produce new blockbuster products once its consumer product lines start to slow in growth, even though it has done exactly that in the past.

        How does everyone else feel about this as an explanation for apples low PE?

      • Anonymous

        I’m pretty sure it’s just that Wall Street can’t fully comprehend what Apple is actually doing, earnings-wise.  There’s no other large cap company that’s close to it.  And Apple doesn’t have ‘explosive’ growth – they’ve been steadily growing EPS for quite some time.  But, again, Wall Street just can’t believe what they’re actually seeing.  They keep waiting for the train to come off the rails because ‘it always does’.  But then, there’s never been a better managed company than Apple, who keeps planning for a better future – not for sustaining future growth like most companies/mgmt.

        Here’s a stock screener for 5 yr EPS, PE, 52 wk price change, for large cap (200B+) stocks.  http://www.google.com/finance#stockscreener?c0=MarketCap&min0=200000000000&c1=PE&c2=Price52WeekPercChange&c3=EPS&min3=0&c4=EPSGrowthRate5Years&min4=0&max4=379&region=us&sector=AllSectors&sort=EPSGrowthRate5Years&sortOrder=1&

    • Anonymous

      The graph of price vs cash/share made me think of the channeling stocks ads on CNBC when looking at the 2009-current price range.  You can even draw nice straight lines on that graph to see the channel.

      Not that I believe in that, but if it’s remotely accurate, it looks like the stock will hit $450 after the next earnings.

  • Ron Mitchell

    Re Steven Noyes’ observation that the big institutions are holding AAPL back by having to sell to rebalance their portfolios, this could be managed by a 10-1 stock split, which would entice many smaller investors in who are now spooked by the high stock price.  And more small investors would make manipulation by fewer big holders less likely.  And how about a dividend to share that 81B, as you’re supposed to do?

    • Eric D.

      Do you think there’s enough smaller investors out there that could move the stock more than a few percentage points? Just wondering.

      • http://www.noisetech-software.com/Home.html Steven Noyes

        My thoughts as well.  I think I read that almost 80% of Apple’s outstanding stock was was held by various financial institutions holding 100,000’s to 10,000,000’s of shares each.  A 10:1 stock split would simply change this to 10,000,000’s to 100,000,000’s shares each.

        For example, Fidelity holds over 50,000,000 shares and JP Morgan (the #8 holder) holds just under 10,000,000.  At $300-$400/share, this is a serious amount of money.  The top 10 holders of Apple control 25% of the stock.  These are the people that move the stock one way or the other.

      • http://www.asymco.com Horace Dediu

        According to Yahoo’s finance pages, Institutions hold 70.8%.

        http://finance.yahoo.com/q/ks?s=AAPL+Key+Statistics

      • http://www.noisetech-software.com/Home.html Steven Noyes

        Google is at 80%.  Ahh.  Did not know that number was so easy to come by.

        So what is the impact to share price and growth to such a small number of organizations holding that much stock?

    • http://twitter.com/jdsweet J Sweet

      The set of investors who are substantially dissuaded from purchasing a great business because its per-share price is quoted with 3 digits instead of 2 aren’t likely to influence the market cap of that business much.

  • mysterio

    This is great analysis, Horace. As with all stock price data, we have to view this in some broader market context. Comparing Apple’s historical trends in various metrics doesn’t help us normalize these figures against other companies or trends, so all of the chart features you describe could simply be due to macro/financial events.  

    It would be great to see this paired with comparable metrics for some market benchmark (Nasdaq, S&P, etc.). Every “market representative” benchmark presents its own problems, but it’s helpful context nonetheless…

  • Markgoldmd

    Horace, you and Andy have done a great job in pointing out how irrational the stock market is. A stock is only worth what some one is willing to pay for it. No more and no less. You may compare the Apple to other stocks, historical valuations and versus the entire stock market. It does not matter, it is not a rational judgement but a beauty contest! The stock market is like a horse race. If you believe in the future value of your horse you buy and if you do not you sell. It is only over the long run will we know the truth.
    It is clear that Apple is under valued presently and that eventually it will reach a more rational valuation. When will that happen? Only the Gods, tea leaves or Mystics can say. For us mere mortals the real question is should we buy, sell or Hold? That off course is a personal question and depends on your

  • Anonymous

    Truly valuable insights into a very muddied and perplexing valuation pool – in Apple’s case at least.
    Thanks.

  • Ian Ollmann

    I see no analogy to heat, work, entropy, enthalpy, etc. Thermodynamics is probably not the word you want here.  I suppose you argue that AAPLs value is depressed because it is going through a phase change or somesuch, but what the finance analog of that would be I couldn’t guess.

    • http://www.asymco.com Horace Dediu

      I will admit I chose the title whimsically. The title is the last thing I write and sometimes takes as long to come up with as writing the whole post. In this case I was in a hurry.

      • Viswakarma

        Shouldn’t the Financial Gambling Markets need to rethink the purpose of their existence and go into oblivion just as the dinosaurs did when the meteor (Apple) struck their Wall Street World?

      • http://www.asymco.com Horace Dediu

        Markets are a voting engine. They are no more interesting (or useful) to economies than democracy is to governance.

  • http://twitter.com/oelschs oelschs

    It is obvious to me that the financial world of markets, analysts, and media do not use conventional standards when judging Apple. Despite a consistent record of innovative products, growing world-wide market share, increasingly crowded Apple stores, and accelerating revenue and profits, the collective reaction is “yeah, but”. Historical performance is quickly brushed under the rug with the never ending questions, rumors, doubts, and lies. “Demand is too low, supply is constrained, products are inferior, flawed, and too pricey, and the latest iProduct killer is just around the corner.” It has been said that Apple used accounting gimmickry, broke options-pricing laws, and had an irreplaceable leader who was deathly sick, and yet operated without a succession plan.

    Over 10 years ago Michael Dell suggested the best future for Apple was liquidation. It would be interesting to see a timeline of all the reasons that have been trotted out since then as to why Apple is finished. As the gap closes between Apple’s market value and its cash-on-hand, it seems that the market has come to the same conclusion. It really is crazy, especially considering just how beloved Apple is by their customers.

    So, how can this be? I can think of a few reasons. One is that Apple has always had a demographic of haters and nay sayers. The people who were not “the rest of us” liked their PC world the way it was. Nobody needed Apple’s mouse-driven computers or keyless phones. It was obvious that Apple’s closed philosophy was wrong and had been defeated in the marketplace. I think those people are still out there and so is their attitude of “anything but Apple”. Maybe time has made them even a little more bitter as their bosses, spouses, sons and daughters express a preference for Apple products.

    I think another reason has to do with jealousy. Apple is “the man”, no longer the underdog, so Apple needs to be dragged down, criticized, and belittled. We all know that success is only obtained through less than honest methods. Apple the corporation is like the one percent that we publicly need to scold, even as we rely on their products. It is not about fairness, consistency, or logic.

    Ultimately though, I think the main reason Apple is not judged conventionally has to do with Steve Jobs himself. Jobs didn’t really seem to care so much about making money, and he surely didn’t care about Wall Street. Most CEOs actively cater to Wall Street, manage earnings, and aggressively pursue higher and higher stock prices. My take after reading Jobs’ biography is that those issues were not as important as making insanely great products. That is to say if you want to jerk Apple’s stock price around with incessant rumors, well Apple has more important things to do than to shoot down the misinformation. At most you might hear Tim Cook say in a quarterly earnings call not to believe everything you hear. In all the articles I have read about Apple and all the conference calls I have listened to, I can’t ever recall anyone from Apple talking about the stock price.

    Even though Jobs was not personally motivated by money, he did have an interest in retaining as much profit as possible at the corporate level, using the oft repeated line that they liked to have it for possible strategic reasons, even though they never had a history of making big acquisitions. The bottom line about the bottom line is that shareholders are not so important, and you never know how dark the future might be, so hoarding is a wise strategy.

    I think all of this can change for the better by Apple being more outspoken (something greater than zero) about having a fair stock price. Bob Iger’s purchase of $1 million in Apple shares for his personal account is a nice start. I think a stock split to position Apple to be added to the Dow Jones index could be marginally helpful. I think a $50-$100 billion stock buyback, funded half with debt would do the most to get people’s attention. Let’s face it. If Apple shares are really worth north of $500 a share and Apple believes that, then they are making a great investment to pull in those shares at current prices. Similarly, maybe a dividend helps marginally too, although I don’t like the double taxation of that strategy. 

    Apple could also do a better job of providing intra-quarter guidance, simple reassurances that the business is operating according to plan. They could do this directly, or by having designated back channels to get the word out. Right now there is way to much room for misinformation that I believe is intentionally done to manipulate the price.

    I’m not saying that Apple needs to create a bubble, and I’m not suggesting that Apple’s longer-term shareholders have not been rewarded, but right now it seems like the short-term manipulators and nay sayers are more highly and unfairly rewarded than the longer-term employees and shareholders. I’m hopeful that Tim Cook and the new board will bring some fresh air to this topic.

    • Ian Ollmann

      Nah. The problem is Apple makes its profits off of market disruption. Disruption is both extremely difficult to predict and in the absence of an oversized moat, the oversized profits are short lived due to rush to imitation. Since Apple doesn’t tell the markets what it is going to do next, the market only see what is in Apple’s rear view mirror, which is full of copycats and imitators doing everything they can to carve into Apple’s margins. Apple looks to be two steps ahead of mediocrity, and is priced accordingly. 

      • Space Gorilla

        That’s close, but a bit off the mark. Apple makes its profit by delivering a superior user experience in an existing market and dominating the high end of the market. That’s certainly disruptive in the specific market, but it is not short-lived and imitators tend to gather up what’s left of the market after Apple is secure at the top. This is how Apple makes so much money with such little market share. They don’t need to dominate market share overall to do well, which is why it won’t be short-lived and all the ‘Apple is doomed’ messaging is wrong.

      • http://www.asymco.com Horace Dediu

        Apple is a serial disruptor. I argued that this is not considered valuable here: http://www.asymco.com/2011/11/21/is-innovation-valuable/

        I guess what I’m asking now is whether an engine of innovation is actually considered a liability. 

      • Mark212

        I think it is, because when the risk-free rate of return is below 1% investors will happily buy stocks with a 3-4% dividend that are easy to understand.  Pharma, utilities, etc.  “Innovation” is a liability because it’s very difficult to understand.  

        Far easier to think of Apple as a products company who just lost their biggest star innovator and has unknown products in the pipeline.  Sure, it’s got a big current hit (or three) but can’t count on any future successes, so let’s go buy more Johnson & Johnson.

      • Z Kariv

        So, why should hedge funds own any share at all? If it is a liability any other option is better–and yet they have probably 90% of these “liability”!
        I think that combination of many factors are in play:
        It is an unnknown animal, price of share, no dividend (many financial institues are requiring it), some hatraed/jeoulesy, current economic uncertanty and perhaps a host of others.
        Horace does a great job with the traditional analysis but it is obvious that the answer is somewhere else.

      • Anonymous

        Apple has made 2 major disruptions thus far.

        It was a maker of personal computers and entered the consumer gadgets market with the Ipod.
        Frome being a seller of computers and mp3 players it the entered the mobile phone market with the Iphone.
        From being a seller of computers, mp3 players and phones it will soon re-enter the digital TV market.

      • Kizedek

        The two three things you have listed are more like product areas divided along lines regarding their use or consumer market. These don’t necessarily equate to disruptions.

        Disruptions by Apple might be more along these lines:
        1) simple, affordable desktop PCs that enabled most schools to have large computer labs for kids to have hands-on experience. When I was young, in the mid seventies, I only ever saw classrooms full of Apple ][ computers.
        2) Apple’s graphical UI, LaserWriter and emphasis on typography, font rendering and antialiasing enabled the DeskTopPublishing revolution. Whether or not Apple had large market share of OS, whole creative industries, not to mention Adobe, we’re dependent on the Mac.
        3) Digital music
        4) Touch computing, which has ushered in the “postPC” error despite what anyone thinks. This has of to the idea that computing truly is personal and can be engaged in effectively by anyone, no matter what their age, abilities or previous experience. Computing is now for everyone.
        5) Software as innovation, differentiation and a value add to broaden a platform with developer appeal. Software as industry was pioneered by Gates, but due to monopoly and mismanagement and poor vision, it has been going down hill towards commoditisation ever since, with Google as the low point. With the App Stores, software is once again a fertile field for future growth.
        6) Tablets specifically — Apple’s effective approach and superior product at a competitive price point has truly disrupted low end PCs like netbooks.
        7) Manufacturing techniques and materials. By developing new methods and materials Apple has effectively raised its game and made it hard for competitors to offer products of similar quality. Apple is focused on iteration and not style over substance, as so many people accuse it. In fact, recent articles have shown how Sony an HP etc. may hit on superior designs and styles every once in a while, but then forget them, don’t know what was good about them and subsequently make worse products. Apple truly learns from its experience and puts the lessons into use. Apple aims to make insanely great products, and this is disruptive in and of itself.
        8) supply chain management and retail: Apple has made itself truly competitive with traditional low cost brands and has been shown to be extremely strategic… Why was no-one operating like this In the past?
        9) customer service. Lots of great stories about Apple replacing products, even out of warranty. Genius bar, etc. Apple must be doing something right and different (disruptive) in order to get the kind of customer satisfaction and brand loyalty that it receives.

        There are probably more…

      • http://www.asymco.com Horace Dediu

        The first disruption was the Apple II which introduced personal computing. The second was the Mac which changed many industries though itself was disrupted with a low-end product. Then I would add the two you listed and follow with the iPad which is a disruptor to the PC.

      • Anonymous

        I did say major. The Apple II did bring PC to the masses but it was beaten by the IBM PC as was the MAC. Apple may have had the headstart but in the end they ceded and lost the advantages of their disruption.

        As to the Ipad I would say give it another 18-24  months and see where we are. Currently it has set the cat amongst the pigeons and if it still disrupting in the timeframe above then I would say its impact would be as big as that of the Iphone.

      • Marcos El Malo

        Apple still disrupted the market, even if other companies eventually won the Lion’s share of the financial benefits. And I would argue that MS did its own bit of disrupting, changing the model for how OSes are sold, i.e., they licensed to the computer makers instead of selling.

      • Dan Andersen

        No, Apple makes its profits from best-in-class products and services. That many of those products and services are disruptive to the status quo is just the way it is. Apple’s goal is not to be disruptive; it is to be excellent and therein lies the moat to which you referred: Few corporations share that single-minded goal.

        So, not only are Apple’s products difficult to imitate convincingly, but Apple also has finally had enough of copycats and IP thieves and is taking appropriate steps to curtail such corporate misbehavior. Apple thus improves its “moat” continuously.

        Finally, your assertion regarding competitors eating into Apple’s profitability is not supported by many years of quarter after quarter increasing profitability.

    • $390AShareIsTrulyExciting!}:-D

      Does Apple really care about where its stock price is?  Doesn’t that only matter to shareholders.  Apple must be internally working like a well-oiled machine going about its business of selling consumer tech devices efficiently as possible.  Does it matter to Apple, the company, whether the share price is $400 or $500?  It really shouldn’t matter much to Apple’s daily operations.  Apple isn’t in the business to guarantee a certain share price to shareholders.  Isn’t the share price value pretty much out of Apple’s hands?  Can any company actually tailor their own share price to perfection?  Apple knows it is doing well by how many products it’s selling and how much cash it acquires every quarter.  Apple is basically doing what it has to do to keep consumers satisfied and coming back for more products.  I personally don’t think that Apple can stop media rumors since they crop up every day.  I’m only surprised that investors continue to fall for these vague rumors despite most of them being false.  I guess I’ll just have to face the fact that Wall Street is being run like a casino if strong fundamentals no longer matter to judge Apple’s value.

      • John

        Apple doesn’t need to raise money from the stock market but a rising stock price is valuable for compensating employees who get stock options. There may be some other problems with a low P/E I’m not aware of.

        I own some AAPL and would like to see a split. Perhaps 10 – 1 or 20 – 1 would be good.

      • jawbroken

        Why do you want to see a split?

    • berult

      Innovation is an admirable business proposition. Most certainly worthy of imitation, …witness the practice’s many adepts. But once you’re making it your core product, and acknowledged as such through repeated successes in an unforgiving market place, you’re bound thereby by its unwritten statute of limitation; products are judged on their innovative merit for they couldn’t possibly be ‘ordinary’  in as much as they’ve sprung out of an innovation process. As Coke’s taste only has to to be perceived as being consistent to sell formulaically well, Apple’s innovative mantle has to be worn in all weather for the signal to remain credible as a message ‘vendor’.

      Apple sells metaphysics, a structured way to subconsciously apprehend and deal with a complicated world, with minimal residual prejudices to one’s own core values. For Apple to be successful, it has to cast an unbreakable spell over its business transactions. Faith, …good faith to and fro. Devices are simple props in a seance of conjuring the ever so easily hijacked spirit of human enablement.

      Coca-Cola sells a secular cola. The recipe hums along the market’s alleys, through ways, highways and byways… And so do Investors’ expectations. Not so for Innovation as a product defined essentially along its axis of disruption. It sort of stands there in clear defiance to rules of medium and long term investment engagement. 

      A sure fire ‘Siri-like’ disruption walks the beaten path of congenial Apple Innovation, …beaten …for lack of ‘innovative’ alternative to serial disruption. A gordian knot tying the Investor to an admiration dilemma; a simmering  apprehension towards the transient nature of journeys into infallibility. Apple has …by well diffused spirit of intent, created a world of its own which, for it to have come alive, tethered ploughing duress to outward pulling cluster of stars. 

      Immediacy pulls its weight in gold and dreams beyond any call of duty, past the ‘now’ resides the ‘then’ of silver linings,  calming …tangible rhapsody. Apple intertwines while investors do …or do not invest…

  • http://wmilliken.livejournal.com/ Walter Milliken

    I’ve been having similar thoughts to Steven Noyes; I wonder if there’s some kind of asymptote related to Apple’s market cap relative to the total value of the whole US stock market, for example, or of the NASDAQ.

    Also, it seems to me that the point where the P/E track curved off from the middle of the 15x-25x band was around the time the NASDAQ rebalanced APPL’s contribution to the NASDAQ index, which may give some weight to the thesis.

    • http://www.asymco.com Horace Dediu

      The Nasdaq re-balancing took place much later, in April 2011.

  • Pingback: Thursday links: rubber meets the road | Abnormal Returns()

  • Anonymous

    I’d like to see a macro comparison. How has the S&P PE ratio changed over the same time period? It seems to me that it has also compressed, particularly amongst Big Tech. Of course, we have a few outliers which boggle the mind like Amazon, and previously, Netflix.

    Speaking of Amazon, their yearly sales seem to be lagging Apple’s sales by 2 years, but their profits are nowhere near. Maybe, Amazon’s investors have convinced themselves to use the bubble metric of pricing Amazon on the top line and not the bottom line. I just don’t see how Amazon can ever cross the Rubicon and eventually grow their profits to match expectations. They either have to grow sales to over $1T in order to make Apple-size profits, given their current margins, or they have to grow margins, but those are constrained by discount retailers like Walmart. I just don’t know how Amazon investors can justify their positions.

  • WFA

    1. I was told by a mutual fund manager that no matter how highly a fund manager may think of Apple, when customers want to sell their shares — as many are wont to do in this economy — he has to sell shares to cash them out. Down goes the price.

    2. A triple-digit price is understandably off-putting to an individual investor.

    3. I wonder about the effect high-frequency trading is on the stock prices. Is AAPL an especially rich opportunity for HFT? In a market dominated by trading, not investing, who cares about a company’s business, much less its fundamentals? Heck, all a company needs now is a ticker symbol! Then the algos go to work. Maybe when enough mathematicians have a go at pattern recognition the whole thing will blow up. Then, maybe, we’ll abandon what John Bogle calls a renter’s mentality in favor of an owner’s mentality. (Not holding my breath on this one.)

    • Anonymous

      I think item 1 is worth bolding. 

      Managed (discretionary) accounts create another barrier, and one that is likely to grow as more and more Boomers move into their retirements.  Because my funds are so invested I had to be really proactive in getting the bank to purchase my Apple shares, because their value totally throws off the Balance in the Balanced account.  In my little iPiggy way, I did not understand that much of what my bank trust “adviser” does is simply to keep rebalancing the account, rather than trying to increase the net value of the account.  (When I added Google to the holdings, it got even worse from their perspective.)  Neither a dividend nor a stock split will address this basic problem.  I expect these same kinds of restraints would apply to mutual funds, as well.

  • Guest

    Horace: According to deagol’s estimates, we are about 5 years out from Apple’s cash reaching today’s PPS.

    • http://www.asymco.com Horace Dediu

      That’s a good estimate.

  • Guest

    It also appears you are using the deferred earnings-adjusted PE, unlike Zacky. The picture is worse using the PE that was available at the time (where the low in 2009 was around 14). That data is available at bigcharts.com if you apply P/E to their interactive chart, or Zacky’s data.

    http://tinyurl.com/7phvmzo

    His reasoning is that the data that counts is the data that was available at the time people make decisions, not adjusted later in the rear view mirror, and I agree. Therefore, we are now lower than we have ever been, including the low of the great recession.

    • http://www.asymco.com Horace Dediu

      During the time when the company was deferring a large portion of revenue, valuation should have been computed differently, in terms of cash flow (EV/FCF). I’m using the restated earnings as they are the best information we have today. We can argue about the *perception* of value at any point in time, but I’d rather just put out the data as it stands.

    • Anonymous

      I suppose it depends upon whether you think investors understood or didn’t understand Apple’s deferred revenues and earnings.

  • Viswakarma

    Isn’t trading in shares more like trading base-ball cards? All the financial markets do is to move funds from rabbits to wolves! The financial markets don’t create any tangible real wealth!

    • Guest

      All baseball cards cost the same when they are new, but some become worth more over time than others.

      • http://www.asymco.com Horace Dediu

        All markets do is tell you the price of things. It may sound frivolous but prices are signals that tell you where value is and isn’t. Knowing that information means resources get allocated efficiently. If markets are avoided, economies become subject to decisions of very few people.

  • Anonymous

    You’re touching on something I’ve been thinking about the past 90 days or so, when the edge seemed to come off Apple’s valuation.  I think the market is being asked to evaluate something it’s not really seen before, and that’s never easy.

    I think the problem is that Apple is still thought of as a tech company, and it’s morphing into something altogether different.  In some ways (hold the giggles), Apple is becoming the GM of the 21st century, and I mean that (sincerely) as a compliment.  If you take a long term perspective, from the Sloan era on, GM was like no other company in the world:  it was a leader in innovation in design, manufacturing and sourcing, leveraged success in North America into a global footprint, renewed its products in a regular and predictable rhythm, added features and technologies across its product line continuously, used comfortable and convenient outlets to sell products that brought tremendous utility and reliability to its customers, commanded extensive brand loyalty and moved consumers up through a product line over a lifetime, but in a way that presented a profitable plateau wherever they settled.  What about that summary does not apply to Apple?

    And please remember that I said “long term” – I’m not talking about the GM of the last 20 years, but of the 80 years before that.  

    Steve Jobs was nothing if not deliberate in every thing that he did, and dropping “computer” from the shingle over the front door was no small step – the ramifications of that change are just beginning to surface, and that’s what the market can’t yet figure out.

    • http://pulse.yahoo.com/_RKS56BXI5SF2II2YTQD6MBE54A Hosni

      Steve Jobs did drop “computer” from the company’s name, but he also boasted in recent years that Apple is a MOBILE computing company. Its main function (and source of profit) is to produce computers that accompany their owners, and make computing power available when and where their owners need it. 

      I mention this because it draws attention to the company’s long-term game plan. Whereas most of its competitors focus on improving existing computing technologies (such as adding a larger screen or faster processor to their mobile phone), Apple’s strategy is to identify aspects of the human experience that could — if done correctly — be enhanced by the application of computing power, then providing software & hardware solutions for those situations. 

      The iPhone is really a hand-held computer, and making phone calls is only one function it performs. It also plays music, helps one manage his/her investments, provides amusement (games, videos), serves as a camera, and so forth. The iPad serves many of the same functions, but with its large screen is somewhat less mobile but more useful in activities where visual images are needed — both by consumers and by business users.

      Apple’s future is bright because it knows where it’s going; it has a strategy. Its employees identify human endeavors that would be enhanced by computing power and serve it up in easy-to-consume packages. One example is AppleTV, but so is the widely rumored iTV. The iPod has morphed over the years from music player to a multi-purpose computer. 

      What this forecloses is such schemes as Apple buying AMD for its processors or Netflix for its video streaming business or Sprint for its wireless network. The services from these companies are used by Apple and its customers, but are peripheral to the company’s strategy: providing computing solutions to empower its customers. 

      If it could, I have no doubt that Apple would design a computer that interacts with the user’s brain. Its impact would be analogous to adding IQ points, boosting memory, facilitating communication, improving physical coordination, providing entertainment. 

      This is the future I see for Apple.  And though it will take decades to implement, the direction is (I believe) clear and provides enormous profit opportunities. The company has a long-term strategy, whereas nearly all of its competitors are focused on short-term tactics. 

      As others have said, investors don’t know how to value Apple because they have nothing to compare it to. 

      Jim Cramer (‘Mad Money’) says that it is fruitless to value companies using the usual metrics when its technologies are disruptive. (He’s used this in discussing the value of ARM, for example.)  Their value shouldn’t be based on what they’ve achieved to date, but on the size of the market(s) they could move into and dominate. If Apple continues down the path it’s on, its value is incalculable … which in this instance means virtually unlimited.  

      TLW

  • Anthony Finta

    Yes to most of these comments – and I will reiterate – it is just psychology here. We are in a near global recession and Apple has grown earnings like this year over year. If it was 1996 Henry Blodget would be calling it a $1,000 stock and people would be buying it hand over fist. Hey – I had shares at $16.00 once. I am not complaining – but the “market” is making no sense on this. 

    And think about this – do you think people who went iPod, iPhone, iPad, Air – are going back? Do you think any parent with an Apple goes out and buys their kid a PC? Forget the stock price – it is the future of computing, technology, and communication. That’s exciting.

  • Mpkalman

    Everyday, one can find at least a half dozen articles on the web that bemoan the low market value of Apple, Inc. stock. The reason for this is simple, and has nothing to do with the profitability of Apple’s business.

    It has to do with the structure of our corporate system. Apple, along with numerous other corporations does not currently pay a dividend. If and when I purchase some Apple stock, I am not guaranteed any real financial gain. Buying the stock is merely the entrance fee to the casino.

    Imagine a world where in order to issue an IPO, a company would have to show a record of some minimum profitability. Furthermore, a profitable corporation would have to distribute a portion of its yearly profits to shareholders and maybe even employees.  This distribution of profits would vary directly as profits varied.

    There, we would have a situation where the incentive to buy Apple stock would be enormous and the price of the Apple stock would better represent the real value of the corporation.

    Absent this scenario, the price of Apple stock is weighted down, unfairly in my opinion, by all the past baggage of Steve Jobs and the company he co-founded. Profits are ultimately meaningless unless they find a way into your pocket. It will be interesting to see how the market responds, if and when Apple’s profits follow their exponential trajectory. 

    I predict the price will lag even more until Apple splits, re-buys shares or declares a significant dividend.

    • Anthony Finta

      Its so funny how opinions like this shift and change in a few years time. In 1995 a company that paid a dividend or bought back shares was considered a dead one. You don’t buy a growth stock for dividends –  you buy it for growth. I mean look at a 5 year chart of MSFT vs APPL – you want a 5 year down trend and a dividend, or do you want a stock that went up 300%? 

      Times have changed – there is no  “world where in order to issue an IPO , a company would have to show a record of some minimum profitability” – you just have to show a business plan you believe in and be willing to work. VCs invest in ideas. You should read the “The New New Thing” by Michael Lewis to get a taste of this.

  • Anonymous

    Love PE/ttm Growth (P/E/TG) It is the ultimate metric to show how cheap AAPL is. On another note. Wall St is forgetting one thing about P/E compression, cash. Once that cash builds the E will become irrelevant. Meaning at $300B cash AAPL earnings could be negative and the stock would still be $300B plus mkt cap.  

  • Aformalevent

    the first graph should really be in log scale

    • jawbroken

      Why? How would that help better demonstrate the point made in the surrounding text?

  • RobDK

    All this discussion on Apple’s share price seems to be oblivious to the simple fact that Apple’s Senior Management and Board have shown no interest over the last 10 years in doing anything to ‘pump’ the share price up. 

    Apple is not interested in Wall Street! Apple is interested in making the best stuff there is on the market. If they sell a lot and earn a lot so that the next great thing can be developed, then I am sure they are glad. But, they do not do these things to get a higher spare price per se. That is not the driving force, unlike the rest of Corporate America and Wall St.

    • Mbeauch1963

      Apple wishes it were private. I have been talking about this for several years. Don’t think for a second that they they do not think about money, all the executives are awarded options worth hundreds of millions of dollars. When you have the option to buy at $100 your focus is not on the share price when it trades at $300+. Another thing, Apple sells its products at a very high margin, saying that they don’t care about money is just irrational. I am heavily invested in AAPL, Apple could care less about me and I am suppose to have a stake in the company. The money Apple has is being used against shareholders, it is not a plus. When SJ says he would use $40 bil to fight in court that should have opened everyone’s eyes, apple has no idea what to do with the money, they feel it is theirs and screw the shareholders.

      • davel

        A shareholder is not the owner of a company. This may be true in some twisted theory, but I have never seen a case where the shareholder is treated as such by any company.

        Companies cater to the bondholders ( lenders ) or the finance guys that directly talk to the board. Why is it so hard for a shareholder to get an item on the ballot for everyone to ‘vote’ on? Why do they always fail?

        As RobDK above says, Apple does not cater to the Street. I think this has at least some effect on the price of the stock as the Street is the major buyer of the stock.

        As a shareholder in a high growth company, why do you care what they do with the cash on the books unless they squander it? The stock has increased $100 over the past year. This is your return.

        Apple should care about its products and its customers, not its shareholders.

      • Secular Investor

        @2c1a20f9b4e54377620b8642355999d7:disqus 
        You say: “Apple should care about its products and its customers, not its shareholders”

         That is a false dichotomy. 

        Apple is perfectly capable of caring for its products, its customers, its employees and its shareholders.

        As a matter of law the Board of Directors owe a fiduciary duty of care to shareholders, who are legally and in fact the owners and are entitled to enjoy the benefit of their company’s success, as indeed are employees.

        SJ hoarded cash, probably because Apple once came close to bankruptcy, which may have left him deeply scarred. Cash seems to have been like a comfort blanket for him.

        Cook has said he is not religious about cash. Apple is generating so much cash that there appears to be an obvious surplus to any working capital requirements. 

        There are two things he could do to boost the share price, which would benefit the owners.

        1) Distribute a dividend – which would attract a large number of new investors – many funds are only permitted to invest in dividend bearing shares.

        2) Carry out a 10:1 split. Although this does not add any intrinsic value, (and does not cost the company anything other than the legal and admin costs) but it does have a significant psychological effect and there is a lot of evidence that splits enhance share prices.

        Using cash to buy back shares is a waste of money – there are many studies which show that buy backs have, at best, a temporary short term beneficial effect, but an indiscernible medium to long term positive effect on share price.

      • jawbroken

        Why not make it a 100:1 split? 1000:1? What does your evidence tell you about the optimal split ratio? Where can I read this evidence?

      • http://www.asymco.com Horace Dediu

        How about pi to 1?

      • genkihito

        Anything other than 2 for 1 is rare and pi would create a mess for options holders. The options clearing corporation determines the effect of splits on options, so you could browse there website for more info presumably.

      • Anonymous

        Bidu – 2010 had a 10/1 split. Has a 52 week high of $165. You think it would have reached $1,650 with no split?

      • jawbroken

        I have no idea. That seems like incredibly weak proof of anything. What would Berkshire Hathaway’s cap be if they split 10,000:1? Should Baidu split 10:1 again? Will that help their price soar?

      • Anonymous

        If BRK-A split 10,000/1 I’d say it would probably be valued with AMZN. So it’s market cap would be ~$750B. 

        All you need is one example to make, well, one example. Yes, Bidu should split again, their P/E would then go from 50 to 100. 

        Hey, it cost just about $0 to find out. Why not?

      • jawbroken

        I don’t understand how you’ve done these calculations. Would you mind posting your working?

        What about companies that split their stock and then lost market cap in the following year? What was the difference between them and Baidu?

      • Guest

        There is a theory that splits invite weak hands. Anyone who can’t afford to invest in AAPL simply because its $400/share and not $50/share are usually mom and pops. With weak hands comes volatility as they buy and sell on every emotion. Volatility means that Apple has a harder time predicting their income and cash flow and therefore harder to invest long term. Apple ends up catering to the quarterly whims of main street and wall street and not their 2-5 year roadmap. This is the same reason they guide low each earnings. If they keep surprising people, they keep the monkeys off their back while funneling cash into possible abandoned and experimental products and acquisitions. For the opposite scenario, observe RIMM.

        Apple cannot survive in their industry (unlike birkshire) bouncing new products quarter-to-quarter (like RIMM or HPQ). They build shareholder value only over the long term, as Steve Jobs once said to an employee who wanted a raise, as the story goes.

      • jawbroken

        I doubt there are enough people with only $50 to invest, waiting to snatch up a single Apple share, for this to matter at all. There are nearly 1 billion Apple shares.

      • http://twitter.com/lemieuxd David Lemieux

        You hit the nail on the head. They are a forward looking business that plans years or even decades ahead. This does not work in the modern public space where 90 days is the maximum horizon.

    • Anonymous

      For the most part I would agree, Apple shows obvious disdain for Wall Street analysts, though Steve did marry a former Merrill Lynch and Goldman Sachs analyst. 

      However, Apple has shown some small interest in the last 10 years; one) obviously the whole backdating of options indicates some interest in the share price, two) Steve answered a Jim Goldman question back in October of 2008, about Apple’s low share price being due to shorting hedge funds, which also indicated some interest in the share price and combined with Apple releasing non-GAAP data in that quarter’s conference call, seemed to me to be a clarion call not to pump up the share price, but to get a fair valuation based upon its real performance. So no, Apple does not cater to Wall Street, but they do seem to care about the share price, a little.

  • Pingback: OnlineMagazine » Blog Archive » About Apple’s incredible shrinking P/E ratio()

  • Chandra2

    Horace admitted the title of the article is a bit whimsical, but the title triggered a thought in me. The market price is about the future alright, but there seems to be a hysteresis, a memory of the past. That is why stock prices do not adjust quickly to fundamentals. The reason is, there is no one market for apple, for example, there are million markets. There is a market in each person’s mind. For example, if I had bought Apple at $387 and the stock went down to, say, $365, the memory of that purchase is so strong within me. But to the overall market, the price of $387 has no meaning but to me personally it does. Same way, but with a different outlook when the stock price is above the price I bought it. There are million such memories. All those memories together creates a hysteresis of the past. Second law of thermodynamics is about one way flow of time, from present to the future. Stock market, as a reflection of the memories of the millions of participants, seems to set that starting point to the past. How far past is the complex system effect of a non-linear combination of all the memories of the participants.

    Now, how does that affect the future in non-fundamental ways. If I bought it at $387, and it goes down to $365, I may swear and then pray to the Almight ‘Lord, save me one time, let the stock come back to my price and I will sell, I will never make that mistake’. Technical analysts have various terms for this type of stuff: Resistance etc. which we fundamental folks may scoff at. But it is all that non-fundamental past hysteresis problem. Or, a few other investors who bought at $387 may be emboldened to buy more,now that they are no longer suffering from the loss. Which one wins out among the zillion thoughts out there is no one’s guess, but once the sufferers all sell at $387, the price will break that and go higher.

    Apple has a long hysteresis going back 30 years. First ten years mostly good, next ten years abysmally bad and the last ten years great. But the way old people do not forget depression years, the middle period sufferers do not easily forget and do not jump in the bandwagon of Apple and make it a 30 P/E stock.

    There is a good chance it will happen in the future. That is the time to sell and not now.

    • Anonymous

      Some great ideas …

  • Pete Kelly

    Guest from Texas
    I think this a wait and see game. Jobs is dead and gone the game is in the first quarter and there has been no score… So what? O the next Ipad and I phone will be commanded by voice and interact with your car and your TV and even your thermostat… and The Mac will be the business machine that out sells the competition … OR it company is a tome stone over Job’s grave but loaded with cash… So it is a solid low-priced stock with a potential 1000 a share near term price!!! I think it deserves to be part of my portfolio…

  • davel

    Thanks for this post. Felix Solomon gives the definitive laundry list of reasons for the depression of the stock price. I guess we just need to submit to the inevitable that the PE ratio is falling and no satisfactory explanation will be had as to why.

  • Guest

    very good article. 

    However it only points to a probability of the stock moving up it doesn’t explain what event can cause it to move up.For me the key question is this one: what is the data that will make the market revise its price expectation with respect to Apple. I don’t mean just sales figure but data that will lead the market toward understanding that the type of growth apple is on is durable and sustainable and that as a result the stock price should go substantially north.

    If this data comes then all bet are off as to how it will skyrocket, until it comes up I believe that  the post that said “”I was told by a mutual fund manager that no matter how highly a fund manager may think of Apple, when customers want to sell their shares — as many are
    wont to do in this economy — he has to sell shares to cash them out. Down goes the price” is likely to be true. 

  • MOD

    In a situation where the super-committee failed to balance the US budget, and where the Euro may split up taking several European economies down is not the time for exuberance and investment in a bright future. On the contrary, institutions will sell and go to cash and other safe investments (Treasuries).

    Their primary responsibility is to preserve capital, not to make money…

    This does not bode well for stocks, even blue chips like Apple.

    Microsoft is also widely considered to be undervalued:
    http://www.crossingwallstreet.com/archives/2011/11/is-microsoft-a-value-stock.html

    This is for the same reasons. And this happened before. During the liquidity crash of 2009 institutions sold stocks simply because they needed the cash. Ie, an internal reason, nothing to do with the value of the stock.

    Then again many institutions simply follow the trend. If the stock market declines, they sell everything and wait until the stock market increases, then they buy.

    To attribute some kind of intelligence to this, like “voting” or democracy is a mistake.

    • Guest

      Actually, your mistake is that you attribute intelligence to the concept of voting or democracy. On the contrary, democratic systems themselves are a mechanism – not necessarily intelligence which is a subjective virtue.

      • MOD

        People vote for a candidate because they think he would be the best leader or their best representative. It is a personal decision.

        People should choose stocks based on this criteria, but they often don’t. They use other criteria, sometimes bordering on absurdities like technical trends, etc. Sometimes there is no valuation reason to a buy or sell decision.

        People might invest in Apple because they came into an inheritance and now they have money to invest. You would not vote for someone because you came into an inheritance.

        Or they would sell Apple stock to buy a house. You would not vote for someone because you want to buy a house.

        And these are good reasons. Hedge funds trading in and out of Apple stock every day are just following a computer program based upon mostly nonsense.

        Intelligence is not subjective. I don’t mean intelligence vs stupidity. Even stupidity is good enough for me. I am saying there is not even stupidity to the move of Apple stock (or most stocks).

        This is why even the biggest idiot can make money off of it. :-)

  • Pingback: Does Growth Matter? | asymco()

  • http://www.jerseyfamilylawblog.com/what-do-structured-settlement-funding-companies-do cash out structured settlement

    There are many investor which is interested to invest his money for the share market. That always show the different company share price. Here give a good advice to invest your money in share market. That’s give a price list of the Apple share.