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Does Growth Matter?

In last week’s discussion of Apple’s (historically low) valuation, comments arose that perhaps the company’s discount is not unique. Can we look at comparable companies and determine whether the relationship between growth, size and valuation are consistent?

The challenge is in finding “comparable” companies. Apple is characterized by being large in terms of market capitalization, highly profitable, in the technology sector and growing relatively quickly. One can find a cohort of companies with each of these characteristics but not all.

Here is an attempt at looking at the largest companies by Market Capitalization (the so-called Mega-caps) to spot patterns of valuation. Some of the companies in the top 20 mega-caps were technology companies so I thought I’d highlight them. I then also added a few of the top 20 technology companies by capitalization to create a larger sample.

The group I settled on is shown in the list below ranked by market cap.

Companies below $130 Billion in market cap (i.e. below Novartis) are in the top 20 technology list but not in the top 20 overall list.

I then plotted the P/E rate vs. 5 year Growth Rate for these companies, separating the tech sector by color (Red):

The pattern is not encouraging. It appears that there is no correlation. Perhaps the technology companies are, as a group, further up and to the right, but overall they are equally unobservant of growth.

For example, SAP has grown less than 5% in five years and yet enjoys a P/E of 20 whereas Microsoft has grown 18% and has a P/E of less than 10. The non-technology sector companies are similarly broken. Berkshire Hathaway, a conglomerate, is rewarded for slow growth and China Mobile is punished for relative high growth.

But you’ll notice that some companies are not on this chart. That’s because they are outliers. Their growth or P/E are so far out of this cluster that the would make it impossible to discern individual performance. The complete “top 20″ picture is shown in the following chart which will require either a large display or a lot of scrolling (1300×1364 pixels):

With this level of detail, we can see how distinct some companies are. Not only from a correlation point of view but from a cluster of peers. The outliers are Amazon, Baidu, VMware, Google and Apple.

These outliers can be seen also in ranking of P/E and Growth:

Baidu has grown earnings by 132 percent while creating a market cap of $47 billion and has a P/E of 52. Amazon has grown by 26% while having a total value of $90 billion and a P/E of 104. VMware is “only” a $40 billion market cap company with a 5yr EPS growth of 33% and a P/E of 64. Finally, Google has returned a 39% growth rate, a market cap of about $200 billion and a P/E of 21 and Apple brings up the rear of P/E with 14 but with the second largest market cap of $360 billion and the second largest growth of 65%.

What this analysis shows is that the market does not have any “rule” of rewarding growth with a high P/E. If anything, the outlier analysis shows that there are significant anomalous valuations that cannot be explained by growth data.

Note: I’ve also tried to observe correlation between recent share price change and growth and recent price growth and long-term earnings growth.

Similar anomalies and lack of correlation can be observed.

  • Sgtshatta

    I don’t know anything about economy, but it always puzzled me how Google stock is over $500.00 while being far below AAPL market cap & annual revenue profits. Perhaps Googles bubble will pop someday.

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

      The price of a stock is dependent on the number of shares issued. It’s possible to have shares worth hundreds of thousands of dollars each or worth pennies each, both would be representing the same company value.
      Market capitalization does away with this by measuring company price/share * shares outstanding = company price.

    • Anonymous

      Google has 324M shares. Apple almost three times as many at 929M. 

  • Luis Berumen

    Sgtshatta makes a good point, can these be caused by a bubble?

  • http://twitter.com/designker designker

    Does this mean we can finally see an end to all these (tedious) posts trying to find something rational in a clearly irrational system? Nearly all the other types of analysis on this site are fascinating and thought provoking. But stock market ones, not so much.

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

      I’m not interested in finding a rational explanation for an irrational system, but rather trying to explain observations. Irrationality is in itself a topic for discussion.

  • Anonymous

    Nokia in its heyday had a market cap of over $200bn and now its about 1/10 of that. You have written quite a few articles about Apple and they stem around the market undervaluing Apple. Now the market can be wrong and it does over react but it seems in the case of Apple there has been a historic tendency to undervalue it.

    Are they mindful that the technology sector that Apple operates in is suscpetible to disruptions and so depress the stock in anticipation of that.

    Does Apple have no competing products? Ie the X Elasticty of Demand is zero.

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

      I think it’s too generous to assume that the market can price-in disruption. To the extent they are, then they are pricing in the downside of disruption and nut the upside. In other words they can sense the threat but not yet the opportunity.
      You can always read lists of things that can go wrong but the list of things that can go right ends at execution of current plans.
      One investment thesis might be that Apple is a “serial disruptor” that beat the Innovator’s Dilemma. You can be sure that the market cannot price this because there have been so few companies that achieved this and only for a limited time frame.

      • Anonymous

        What did Greenspan say “there was a flaw in his model”. Look at who drives the shar price. You think these investors will be switching in favour of Apple in their portfolios anytime soon?

        If Apple shares are traded amongst like minded instiutions with similar models and metrics unless you have a market maker or some large instiution that can be a Price Maker then I suspect the mismatch between Apples metrics and share price will remain.

        The investors perhaps find it easier to value negative impact on sales than trying to make calls on future projections based on opporunities.

        The problem with the thesis as Apple being a serial disruptor is that it assumes past performance is indicative of future performance. Could you say Apple will remain a disruptor for 5,10, 15 years?

      • http://www.facebook.com/people/Shameer-Mulji/1685212657 Shameer Mulji

        “Could you say Apple will remain a disruptor for 5,10, 15 years?”

        There are no guarantees in life except death.  That’s what makes it fun & interesting.

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

        The theory of disruption holds dearest precisely the notion that disruption is repeatable. I cannot say that Apple will remain a disruptor for n years, but I can say, without a shadow of a doubt, that it’s possible.

      • Anonymous

        In 1984, Apple disrupted the computer industry with the Mac, so much so that after Windows we used to say that IBM stood for “I Became Macintosh”. Yes, one could argue that the original impetus for the disruption was based in Xerox, but there’s no argument about Apple spearheading that disruption.

        I mention this because that disruption continued to echo for at least two decades. Indeed, the only reason Apple survived was because it was so integral to the disruption.

        A few years back, Apple created another disruption, not with a mouse but with a touchscreen. And then just a few months ago, it dropped another disruption bomb in the form of Siri.

        It doesn’t take a genius to figure out that these two latest disruptions are only just beginning to have an impact, or to figure out that Apple has put itself firmly in the catbird seat for years, perhaps decades, to come.

      • gbonzo

        How many markets does Apple have left to disrupt that would be meaningful to their size? Once you rule some very big market, you are less a potential disruptor and more a target for disruption.

        The mobile phone market is quite a big one by annual sales. Do you have some specific markets that you think that Apple might disrupt in the future? Maybe the TV and movie businesses? Maybe something else? Please share with us if you have an opinion on this.

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

        I don’t know if they will succeed, but there are more industries that they could disrupt than I can count. But this is true of any company.

      • Anonymous

        I would like to see the Apple electric car which you can only charge at Apple Stations.

        Or the Apple iWallet where you can only use with other iWallets.

      • Anonymous

        You would charge an Apple car overnight at home, but get it serviced at Apple. Plenty of people would be happy with that.

      • Ian Ollmann

        I’d buy that.

      • Anonymous

        You prove the point that even when there is no disruption you will still buy the brand “Apple”. The argument re disruption is overplayed – Apple is best seen as a strong brand with crazy loyal fans.

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

        I see no such connection. The idea of automobile transportation as a service (not a product) makes a lot of sense to many people. The “job to be done” is not to own a car but to ensure a hassle-free transportation option. There are many experiments in this area like ZipCar and even the popularity of leasing and company cars in many countries.

      • Anonymous

        In that case why own an Iphone just lease it. Leasing has tax benefits. You forget the status symbol cars are. This leads onto the issue of ownership and control. People like to own than rent their properties. 

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

        Some do. Vanity is a big job to be done, but not everyone has it.

      • Anonymous

        Then theres not disruption there most people get their car services by their dealer.

      • http://twitter.com/disc1979 Dirk Schmidt

        Disrupters do not look at the size of a market as a measure of “meaningful”.

      • gbonzo

        But investors do.

      • Anonymous

        That’s why investors fail to price disruption.

      • gbonzo

        No. If Apple disrupts and starts to control the market of premium cigarette lighters, the stock market can ignore that for the right reason, the market is too small to matter for Apple earnings.

        The size of the market may not matter to “disrupters” or to Dirk Schmidt, but it does matter to investors.

      • http://twitter.com/disc1979 Dirk Schmidt

        gbonzo, did you notice that you agreed to 100% with Nicolae_M?

      • Anonymous

        They don’t agree.  The use of the word ‘fail’ implies that the investors are making a mistake.  gbonzo is saying that they they may be making a valid approximation.  

      • Anonymous

        “How many markets does Apple have left to disrupt that would be meaningful to their size? ”

        Here are some obvious ones:
        - health. Basically better versions of a collection of devices we have seen already — devices that monitor your activity level, exercise, sleep patterns. Add to this decent sensors — detect glucose levels in the blood via ram scattering, check the breath once a day, monitor blood pressure, etc — and you have something. 

        This market looks a lot like the pre-digital consumer “electronics” market — there are walkmans and cameras and VCRs and TVs. they all suck, they all work badly, none of them work well together. 
        Yes it’s a hard problem. There’s the UI part —make it easy to configure the device and see its results (using your iPhone of course); but there’s also getting the sensors right — which mostly exist in theory and at the lab level, but not yet in mass manufactured quantities; and getting the package right — all wireless, waterproof and rugged, easy to wear ideally 24hrs a day, doesn’t need recharging, etc.

        - home security and automation. We’ve all seen the rapturous applause that has attended a thermostat that doesn’t suck. Now add to that thermostat a security system that’s easily controlled (and either easily installed, or Apple get’s into the service business and does the installation), easily accessible via internet, etc. Once again, pieces of this exist — you can buy a controller box/DVR plus four cameras for your house at Costco — but once again the existing products suck and don’t work together. Your home cameras don’t work with your ADT home monitoring system, you can’t control the ADT box or your thermostat away from home, etc. 
        Why should leaving the house and worrying that you left the stove on, or left a heater on, or forgot to arm the alarm, even be problems? WHy can’t you just check the status of the whole house anywhere you are?

        - car electronics. Yet another area with plenty of players, pretty much all of whom suck. As a trivial example — why do I need to subscribe to something like OnStar? Why can’t I buy aftermarket electronics with a built in GPS+cell phone system that either I can contact, to ask where the car is, or which will contact me if the car moves without my having entered a PIN?

    • Iamnot-EINSTEIN

      Ding ding ding, we have a winner. No damn chart is gonna do you any good when your entire company is based on 1-2 products and you miss sales because something happened down the production line or someone disrupted you. Upside vs downside even if Job was cloned tilts heavily towards staying away from apple.

      • Anonymous

        Iphone and Ipad will end up being what 80% of revenues?

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

        Yes, and after Apple TV, iOS will account for even more.

      • Anonymous

        You make it sound like it doesn’t depend on what the product is. But by all means, sit on the sidelines while the rest of us make a absolute shirtload of money….

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

        When the iPhone was becoming a juggernaut, the company relied on one product and reached a P/E of over 40. Exuberance was abundant. The company now relies on three products that are growing even faster. Despondency is the result.

      • http://openid.aol.com/iphonerulez AppleKilledMobileFlash

        Is it possible that investors only like underdogs and once a company gets to a certain size, they lose interest?  Investors might not like Apple just sitting at the top of the heap.  I often wonder if any of these investors actually use Apple products.  Why are consumers crazy about Apple products and investors aren’t?

  • elsaul

    What about the P/E 5 years ago and future 5 year growth rate? Is the stock market any better at predicting future earnings? (I would guess not.)

  • Stefan Sidahmed

    At some point, p/e will stop compressing and the stock will grow at the rate of earnings, otherwise cash will eventually exceed market cap.
    Can you imagine a theoretical point where EV is negative, but buy-out valuation is so high no one can raise the capital to pull it off?

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

      Yes, this is certainly possible in theory. It would imply that the company, as an asset, is no longer liquid.

      • Stefan Sidahmed

        Exactly.
        Now, if they started paying a dividend that would change the value proposition.

    • Anonymous

      If EV is market cap minus cash, then if it were negative a buyer could use Apple’s cash to pay for it.  But even with the EV being hugely positive  like it is, I think a buy-out is still possible because Apple has no debt and their cash flow is so high.    

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

        I addressed this very scenario in January 2011:

        There is some perverse merit to this logic. With $64 in cash, $25/yr in earnings and 75% growth it’s so cheap that if credit were available, it would make a tempting candidate. Private equity could take it private and use the gigantic cash flow to pay off debt (in about four years). In bygone days, this would have been an easy pitch.
        Alas, the capital markets may not have liquidity for the size of the market cap Apple holds and I don’t see any competitors able to get the leverage for an acquisition either. Or can they?
        ( http://www.asymco.com/2011/01/24/wall-streets-infinite-loop-the-tragic-tale-of-apples-valuation/)

      • Anonymous

        The article “Is Apple a candidate for acquisition?” was very good.  And the comment from JonathanU was very thoughtfully written, really good too.  For anyone who hasn’t read this, Jonathan explains why private equity companies don’t have the capital for a buy-out.         

        If the companies can’t afford it, maybe there are some individuals who can.  Bill Gates, Sr., the father of Microsoft’s founder, said that the top 1% of U.S. households may have combined wealth as high as $136 trillion (not a typo)[1].  He said this in 2003.  If he’s right, and if they invested after the credit crisis, they’d have a lot more now.  And together, couldn’t some of them do a buy-out without leverage?  I’m not saying they should, just that it’s possible.

        I don’t understand why this would be perverse.  It would be unusual, but Wall Street isn’t down on buy-outs.    

        1.  Jim Hopkins.  USA Today.  Gates Sr. supports estate tax.  Jan 12, 2003.

      • Anonymous

        And all the shareholders would sit on their hands while this happens? ” Hey, here’s an idea; let’s kill the goose that’s laying golden eggs so we can add, like, 20% to our stock value.” Of course the stock value would be zip after they did that. What shareholder in their right mind would go along with a stunt like that?

      • Anonymous

        Very good points.  I’ll try to answer.  

        I think 70% of shareholders are institutions, and I think that means mutual/hedge/retirement funds.  I think they’d be okay with a buy-out if the stock price jumped 10 – 20%.   But for individuals, there would probably be a mixed response, but if we didn’t like it, I don’t think there’s anything we could do.  And if there actually were a company that could buy Apple, they’d want their investment to be as successful as we do so I don’t see why the share price would drop so drastically.              

      • http://openid.aol.com/iphonerulez AppleKilledMobileFlash

        What you’re saying seems frightening when talking about the power the institutions have.  As an individual investor, I hate thinking about those greedy “investors”.   However, why would Apple’s management go along with such a buyout?  That’s like giving the company away considering there’s still a lot of growth left.

      • Anonymous

        Apple’s board of directors could oppose the buyout, but the buyer (called the “bidder”) could contact the shareholders and try to persuade enough of them, usually only a simple majority is needed, to replace the board with a new one that would approve it.  And a majority might be in favor because the stock price would jump 20%, maybe more.   Another method for the bidder is to go into the open market and try to buy enough shares to effect a change in management this way. Or they could contact the shareholders and invite them to sell their stock.  When the board opposes the buy, and the bidder pursues it anyway, it’s called a “hostile takeover.”   It’s scary that this could happen — I guess that’s the risk when a company goes public.  Wikipedia has a good article that explains some of the regulations in takeovers, and I put a link to it below.

        Wikipedia.  Takeover.  November 25, 2011.

      • Stefan Sidahmed

        I don’t think this would even get to the BOD. 
        There is a market price and then there is the buy-out price.  If a credible bidder came along, the stock price would skyrocket and put a buy-out out of reach.

      • Anonymous

        When a buyout is announced, the market price jumps but that doesn’t change the buyout price.  For example, Warren Buffett announced that he was buying Burlington Northern for $100/share on Nov 3, 2009 [1].  The price jumped to $97.00 that day from $76.07 (previous day closing) [2], but that didn’t change the buyout.  If a bidder were to call Apple’s board today and offer $500/share, I think a majority of shareholders (institutions) would approve it.   And I think this price is within reach for a small fraction of bidders (1% of US households whose combined wealth may be $136 trillion [3]).  But if it’s too low, it could be raised and wouldn’t be out of their reach.      

        1.  Wikipedia.  BNSF Railway.  November 11, 2011.
        2.  BNSF Railway Company.  BNI Historical Stock Prices. 2011.
        3.  See link in my reply below  to Horace

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  • kevin

    I agree that P/E ratios seem inconsistent. With a quick glance, there does seem to be some consistency when one considers that there might be a market cap threshold, and a bias against foreign companies (from the US perspective). (Neither of these fully explains Apple.)
     
    For example, Amazon, Baidu, and VMware have market caps under $100B.  As does EMC, Qualcomm, and SAP. And they all have P/Es over 20 or above (even though their growth might not be high). But not a single company with over $100B market cap has a P/E over 20. Is it the case that once companies grow over $100B in market cap, that their growth is then devalued?
     
    For those under $100B, Baidu, SIemens, ABB, and Taiwan Semi seem to be undervalued, while Amazon, VMware, and Cisco seem to be overvalued. Do foreign firms get undervalued?  (SAP is an outlier.)

    • Ian Ollmann

      After $100B the growth is not devalued. The market (reasonably) just doesn’t believe that exponential growth can continue indefinitely.  At some point, in order to grow, the company would have to exceed the size of the market it sells into. That it can’t do.  To get further growth, you have to branch out into new markets. This is hard for a number of reasons:  you lose focus, the new markets aren’t your core competency, to continue exponential growth, you have to expand into 1 then 2 then 4 then 8 then 16 new markets concurrently. At some point, it can’t be done and you stop growing, or at least grow much more slowly.  Consider that if PCs had to compete with non-consumption and the world added another 100 billion people, Microsoft would be a no-brainer of an investment. As it stands, however…

      • kevin

        In that sense, you are right that the growth isn’t literally “devalued.” Investors look forward and can’t believe that a company can keep growing, so continually underestimate the future earnings. But after that growth occurs quarter after quarter for a large company, because they continue to look forward, they do not reward the growth that just happened by having a greater belief that it can happen again. Instead, the projected growth is reduced even more, because the markets left to conquer have just become smaller.

        Jobs pointedly said Apple was like a startup. Investors refuse to believe it and so will not reward it with a higher P/E for its projected growth.  

      • Anonymous

        Close. Investors aren’t valuing Apple at all on its past performance. They only value its proven performance. And as they continually underestimate its future performance, quarter by quarter the P/E shrinks. Apple has NO BUSINESS selling for less than $450/share, let alone less than $400/ share! Apple’s own forecasts tell us that it’s going to add another $6 to its EPS this quarter.
        (read this http://seekingalpha.com/article/311859-apple-unlocking-the-patterns-in-their-quarterly-guidance )

        I.e., it’ll exceed $33/share! Do the math: 400/33 equals a P/E of 12!

        Investors have NO CLUE of the monster they’re dealing with.

  • gbonzo

    High P/E means that market expects high earnings growth in the future. Low P/E means that market expects low earnings growth in the future.

    So, your 5 year growth chart shows historical growth and your P/E chart shows estimated future growth.

    Yes, you are allowed to disagree with the estimated growth, but the way you present this data seems to imply that for all companies, their future growth should be derivable from their historical growth.

    • Anonymous

      P/E ratio is also determined by risk as well as manipulation (intentional and otherwise) by large shareholders.  

      The markets are, essentially, a gambling forum for the individual investor.  By going long on AAPL, I feel that I will have good growth of my investment, despite shrinking P/E and P/Eg ratios.

      For the life of me, I can’t figure out how Amazon can maintain it’s insane P/Eg ratio.

      • gbonzo

        The stock market sees Amazon as a potential disruptor in the retail sales of everything. Now that is a huge market.

        But I must say that I agree with you. Amazon seems overvalued and Apple seems undervalued. But this opinion is not based on exact calculations of historical growth. It is based on shaky guesses of future growth of these companies.

      • http://openid.aol.com/iphonerulez AppleKilledMobileFlash

        However, the god of investment, the Oracle of Omaha, Warren Buffett sees fit to invest in Amazon while thumbing his nose at Apple.  He must see something that you don’t see since apparently he can see into the future or so it’s been claimed.

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

        Can you provide a link or citation to Buffett’s investment in Amazon?

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

      I thought I clearly stated in the last paragraph the exact opposite of what you think I implied.

      • http://twitter.com/moosebump R L

        I don’t think it is that clear. you should have said: “the market does not have any “rule” of rewarding HISTORICAL growth with a high P/E.”

      • gbonzo

        I would make a clear distinction between historical growth and future growth. They should not automatically be assumed to be directly related.

        There should be strong correlation between estimated future growth and P/E.

        The last paragraph that you refer to, says that there IS no strong correlation between [historical] growth and P/E. The implicit assumption seems to be that there SHOULD BE stronger correlation between these two. Why? It is the estimated future growth that should be seen in P/E.

        Should the market have estimated the future growth of Apple to be very low when the historical growth was low? No. The market would have been right if it had assumed that the future growth will be high even if the historical growth was low.

  • Anonymous

    The combination of high growth rate and company size (market valuation and/or revenue) makes the company appear to be risky.  It can’t keep growing at that rate if it’s so big, so it must be a bubble.  In other words reward by growth appears to be improbable, and a bubble burst may happen at any time.  High risk/reward ratio.

    This view is reinforced by the apparent ‘miss’ last quarter:  only 39% revenue growth and 52% net income growth, YOY, due to the late introduction of the iPhone 4S.  Further, statements like Apple ‘iPhone growth will miss because of a shortage of an unspecified critical component’ don’t help, even if it is a blatant lie (I believe that is the case).

    What will happen in January when revenue growth exceeds 60% and income growth exceeds 75% YOY?  Panic buying?

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

      By the logic you put forward, there will be panic selling in January because if the company grew 75% then clearly it cannot grow any more. It’s like looking at a long sequence of “heads” on coin flips and betting on “tails” because the run has been so long.

      • Anonymous

        Logic has nothing to do with irrationality.  Either scenario is possible.

      • Ian Ollmann

        To claim the entire world (the part that invests anyway) is irrational is quite a strong statement — almost implausibly so. It seems most likely to me that there is a reason for this.  It could be asymmetry of information, but I can only imagine the funds are reading this blog like the rest of us.  I think instead, the market honestly feels that AAPL is going nowhere.

      • Kizedek

        I fear you may be right. There just doesn’t seem to any other explanation.

        Evenso, I just don’t get it: all these beard-stroking concerns about Apple’s growth rate and size.

        OK, so Apple *can’t* grow at a super rate for ever. Let’s accept that.

        OK, so growing by 30% when your market cap is 300Bn is harder than growing by 30% when your market cap is 100BN. Let’s accept that.

        Moving on, why is there apparently much more faith in the likes of Amazon and Google (higher multipliers, etc.)? Are there really that many more people who supposed to do more and more of their shopping on Amazon.com? Are there really that many more people to introduce to Google? As far as I can tell, all PCs I have seen already have Google.com as the home page of their browser, and many people use the Google search field like the URL address field. Where else can Google really go at this point that it hasn’t already? If anyone is a one-hit wonder, perhaps it’s Google?

        Apple? So, all their growth is apparently down to disruption and first mover advantage with a lucky string of vulnerable one-hit wonders that cannot possibly continue, all the while their current products and production are on a knife-edge?

        I think it only appears that way because all the business they have created since the Mac has grown so quickly (and each new product is growing sales quicker than the last). Don’t people realize Apple could stop introducing new products and still grow significantly for years to come? Horace has shown repeatedly that even if Apple’s 5% share of the growing phone market is capped at 20%, they still have a lot of growth ahead. And iPads and Macs are just taking off. I guess people point to the iPod and how sales have leveled off and dipped over the years; but that is because people are buying phones for the job. But, in fact, Apple simply showed they could “walk into that market” and change it, too.

        So, why do analysts and naysayers act like Apple is going to stop selling all its current products tomorrow if they don’t come out with another hit, or if an Amazon comes up with a Kindle Fire? (BTW did Amazon sell 4 million in the first weekend, I don’t know the figures?).

        OK, Apple may not grow at 60-80% year on year forever (without producing another hit — the next three of which are probably in the pipeline), but why couldn’t it be assumed “safely” that they will grow at least the 15-25% that other companies may show, just by continuing to develop the business and products they have already and executing as well as they have?

      • Anonymous

        I did not say that the entire investing world is irrational only a portion that invests in Apple.  It is emotional.

        Here ar some things that could change the p/e:

        - Apple gaining unit market share with the iPhone;

        -Amazon losing significant money due to the Kindle Fire;

        -An early refresh with the iPhone, say May

        ;-An early refresh with the iPad, say February;

        -A new successful product, say TV sets next year;

        -Major wins in the patent wars;

        -Continued insane growth for the next two years.

        These are the worries that prevent people from prey on investor’s minds.

      • Anonymous

        I keep thinking that the anomaly of last quarter’s so-called “miss” in Apple earnings has a lot to tell us. And there may be a tie-in to the previous quarter’s analyst miss, which was especially large, as I recall.

        Is it possible to compare the degree of the analyst misses each quarter to the degree of P/E compression in each following quarter? Does the P/E compress more or less when the analysts miss more or less?

  • Hamourabi

    Horace, 
    I would like you to study the correlation of AAPL (and other stocks) price with analysts evaluation of future earnings for the next 3 to 5 years. I suspect there would be more coherence.
    Then it would be nice to show how undervalued are those future earnings estimates for Apple.

  • Ian Ollmann

    Make the outlier plot a Log/Log plot. Then it will look linear! ;-)

  • Ian Ollmann

    Horace, is AAPL also an outlier for volatility?

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

      It used to be, but beta is now quite low. I should plot beta for this cohort.

  • MD

    Horace, growth too, needs to be defined. Is it a one time thing or has it been steady for 1-5-10 years? Apple has had an amazing run, but sustainable growth at their size is harder to achieve.

    Google on the other hand is growing but only by over monetizing search results to the point that small businesses are driven out of top spots to make room for ad-paying brands. Eventually this will hurt the Google brand, people will speak out and call Congress.

    The biggest disruption from Google might come from FTC asking Google to separate ads from content and place a “SPONSORED LINK” on top of links, not a faint ‘ad’ way too the right. After looking my non-techie family search I am amazed at how deceiving those ads are to average searchers. It’s scary to even think how many of those clicks and revenue associated with them could go poof! That would be great for consumers and sites but horrible for Google.

    The main reason MS, Berkshire, Exxon, KO and others do well is safety. Safety is not a bad thing, especially when accompanied by a 2%-4% dividend.

    The main reason MS, Berkshire, Exxon, KO and others do well is safety. Safety is not a bad thing, especially when accompied by a 2%-4% dividend.

  • Anonymous

    Horace is to be congratulated for yet more original charts which brilliantly illustrate something value investors have always known, namely that the market is far from perfect when it comes to valuing companies, that there are always significant apparent discrepancies and anomalies to be found.

    In a nutshell, for whatever reason, the market believes that Apple’s growth is about to slow significantly – even slower than analysts are forecasting. 

    The art of value investing is in spotting the companies which are significantly undervalued – the Warren Buffets of this world.

    The art of growth investing is in identifying companies which are undervalued in terms of sustainable future growth.

    IMO, and in the opinion of most us who bother to do some proper research, Apple is one of the very few companies which is extremely undervalued, both as a value and growth stock.

    My preferred valuation measure for most, if not all, Horace’s red set of companies, is PEG ratios

    If we look at the Yahoo data we can see that Apple is presently on a forward PE of 10.11 and a PEG of 0.58 9 (i.e. well below PEG fair value of 1.00). This an immediately signal that there may be a disconnect between how the market is valuing Apple compared to Analysts’ consensus of the company’s future growth.

    Yahoo’s consensus EPS growth forecasts are presently: 25.10% this year, 12.20% next year, 19.28% pa for the next 5 years (compared to 61.14% pa over the previous 5 years).

    For whatever reason, the market values Apple as though it is going to grow at around half the rate the analysts are forecasting.

    But like most who do their own research, we come to the conclusion that Apple will grow a lot faster than the professional analysts are forecasting. Personally I believe Apple will beat analyst’s 5 year growth forecasts by 2 or 3 times.

    However, the fact that Analysts’ are too conservative and the market has got it so wrong about Apple is a good thing, because it means that it will continue to beat market expectations for the foreseeable future, which has the effect of ratcheting up the share price, quarter after quarter, year after year.

    Despite the considerable PE compression which Horace has repeatedly highlighted, the share price has grown remarkably steadily, with little downside risk, for the past 2 years, bouncing off, and staying above, the 200 DMA.

    http://finance.yahoo.com/echarts?s=AAPL+Interactive#chart1:symbol=aapl;range=5y;indicator=split+sma(200,50,20)+volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined
    Apple has so many sustainable competitive advantages that it will continue similar share price growth for years to come. However much the market may get it wrong, Apple’s growth will keep trumping their low expectations.

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

      The trouble with PEG is that it relies on the consensus of analyst opinions which have been proven to be consistently wrong by huge margins. I use the PE/trailing Growth as a measure which admittedly does not reflect the future, but then neither does consensus.

      • Anonymous

        Yes, you would be right if one did rely on the PEG resulting from the consensus of analyst opinions. However, that is not what I do or advocate, because as you rightly say, the professional analysts have proved hopelessly wrong with regard to Apple, consistently under estimating the company’s growth.

        I believe an important element to successful investing is to be really diligent about one’s own research, so that one really gets to know the sector in which the company operates and the company’s strengths and weaknesses within that sector. This approach means that one can only properly analyse a handful of companies, but it does have the advantage of meaning that one often gets a better insight into whether or not the analysts assumptions and forecasts are reliable or whether they are underestimating or overestimating a company;s growth potential.

        All my research convinces me 

        Firstly, that the sector the 4th Wave Post PC, Mobile computing is at an early stage of a strong secular growth cycle of around 30% to 40% per annum for the at  5 and perhaps 10 years or maybe even more i.e. to 2016 to 2021.

        I have been researching and investing in the mobile sector years before Apple entered this market, in companies like Psion (who as you know developed  Symbian, later bought by Nokia), CSR (the bluetooth specialists who had a fantastic run) and Arm Holdings (whose IP is in more than 95% of mobiles and virtually 100% of Smartphones, which I still hold).

        Anybody thinking of investing in Apple really ought to read these articles and look at the charts.

        http://www.forbes.com/sites/oreillymedia/2011/11/01/post-pc-computing-and-the-next-tech-revolution/&http://www.economist.com/blogs/dailychart/2011/10/personal-technology

        The above and all the other research I have read over the years confirms what you say in your Business Insider article: “Looking forward, these 450 million combined points of use are but a drop in the bucket of a future 5 billion connected smart devices.”

        The sector’s massive future growth debunks all these ignorant “law of large numbers” arguments. As you have pointed out, with around just 5% of the mobile phone market there is huge headroom for Apple to grow, The iPad is just at the beginning of a probable 2 decade growth opportunity These two high margin products make up 70% of Apple’s revenue and profits. Revenue from Apps downloads and digital media sales are growing just as fast.

        Secondly, Apple enjoys so many sustainable competitive advantages that it will continue to outperform the sector as a whole. This is where historic growth and your trailing PE/trailing growth come in, which highlights how Apple has performed since 2007, with the launch of the iPhone and gives an indication of Apple’s future growth rate potential.

        If we then look at Yahoo’s consensus EPS growth forecasts which are presently: 25.10% this year, 12.20% next year, 19.28% pa for the next 5 years (compared to 61.14% pa over the previous 5 years) and we apply the knowledge from the sector research, the inevitable conclusion is that Apple will grow a lot faster than the Analysts’ predict. 

        In the light of the above we can look at a range of reasonable probabilities/ possibilities

        If one takes a PEG of 1.00 as being fair value,with a forward PE of 10.06 and Analysts Consensus PEG of 0.58  this means the market values Apple on the expectation it will grow at around 10% pa i.e. around half of Analysts’ consensus of 25% this year, 12.2% next year and 19.3% for the next 5 years. This indicates a clear disconnect.

        Who is wrong, the market or the analysts?

        I am convinced that both the market and analysts are wrong, because they significantly under estimate Apple future growth, just as they have done for more than five years (with the exception of last quarter)

        My own expectation is that Apple will grow at least double, perhaps triple, what Analysts are forecasting. This means that Apple is on a PEG not of 0.58 according to them, but rather half or a third of that, or a true PEG around 0.2 to 0.3

        Does that mean Apple share price will rise to meet fair value of 1.00? Given the past history of PE compression that seems highly unlikely. 

        But I am convinced that Apple will continue to beat Analysts’ forecasts and market expectations, and there is no stronger mechanism than to keep ratcheting up the price.

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

    This analysis is interesting in a general sense, but its utility is limited. It is not possible to explain something complex (here, P/E) with only one variable (historic earnings growth).

    In statistical language, the P/E is the ‘dependent variable.’  No statistician would explain movements in a dependent variable by relying on a single explanatory, or ‘independent,’ variable. A person’s weight is influenced by the number of calories he/she eats, but also by such things as the amount of physical activity, genetic makeup and other factors. If one charts weight and calorie intake, the relationship will appear very imprecise or even non-existent; but controlling for the impact of other factors permits a far more accurate estimate to be made of the weight-calorie intake relationship.

    This is, of course, the difference between simple correlation and multiple regression. 

    Previous comments implicitly recognize this by suggesting reasons that Apple’s P/E doesn’t correspond as expected to the company’s earnings growth rate. The company is large, and therefore it is more difficult for it to continue growing rapidly; Steve Jobs has been in poor health and died, while the ability of Tim Cook and others to innovate is still an unknown; Apple has only a few key products and therefore is not as diversified (more risky) as other companies. 

    As much as I appreciate the presentation, it is impossible to achieve a clear understanding of Apple’s (or any other company’s) valuation by using a single explanatory variable. Impossible. We’re simply asking the analysis to do something it is not capable of doing. And such issues as ‘multicollinearity’ between different explanatory variables and ‘serial correlation’ over time prevent one from gauging the relationship between the two variables included in the analysis (P/E and historic earnings growth rate).

    • Anonymous

      Hosni 
      I am sorry but you appear to have completely misunderstood the question that Horace was asking:

      “Can we look at comparable companies and determine whether the relationship between growth, size and valuation are consistent?”

      As his brilliant charts clearly demonstrate THE ANSWER IS NO – there are numerous discrepancies between many companies’ PE ratios and their growth rates, both historic as well as analysts’ forward forecasts.

      You have listed a  number of reasons suggesting why “Apple’s P/E doesn’t correspond as expected to the company’s earnings growth rate. The company is large, and therefore it is more difficult for it to continue growing rapidly; Steve Jobs has been in poor health and died, while the ability of Tim Cook and others to innovate is still an unknown; Apple has only a few key products and therefore is not as diversified (more risky) as other companies.”

      Anybody who does proper research into Apple and the sectors in which it operates comes to the conclusion that all of the above reasons are nonsense. Anybody who believes these reasons have failed to understand 

         * firstly that Apple is the market leader gaining market share in the very fast growing  4th Wave Post PC Mobile Computing - see

      http://www.forbes.com/sites/oreillymedia/2011/11/01/post-pc-computing-and-the-next-tech-revolution/

      http://www.economist.com/blogs/dailychart/2011/10/personal-technology

         * secondly, that Apple has huge headroom to grow its market share in its main growth areas: the iPhone (which has only around 4% of the global mobile phone market) and the iPad, which is just at beginning of disruptive revolution. Those two devices now make up around 70% of Apples revenue and profits  causing Apple to grow exceptionally fast 

          * Thirdly, that Apple  enjoys numerous, sustainable  competitive advantages which means that Apple will continue to grow well above market expectations for years to come.

      The short answer to Horaces’ headline question “Does Growth Matter? is YES, GROWTH DEFINITELY MATTERS. 

      It does not matter that the market has low expectations and Apple has suffered incredible PE compression, as long as Apple continues to grow faster than expected then actual results will always trump such false low expectations and the share price will continue to grow strongly.

      http://finance.yahoo.com/echarts?s=AAPL+Interactive#chart1:symbol=aapl;range=5y;indicator=split+sma(200,50,20)+volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined

      PS It is also total nonsense to say: “Apple has only a few key products and therefore is not as diversified (more risky) as other companies.”

      Apple is in fact by far the most diversified company amongst its peers/competitors in the 4th Wave Post PC Mobile Computing era: it is the only company which is both vertically and horizontally integrated with its own software, its own hardware covering the whole range of successful devices (PCs, Smartphones, Tablets and iTouch), its own retail operation and its own digital media eco-system.

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

        @westech:disqus Secular Investor: You say that I misunderstood the question Horace was trying to answer (“”Can we look at comparable companies and determine whether the relationship between growth, size and valuation are consistent?”)  Nope.  I just said that the answer to that question is no and must be no because the method of analysis is too simple.  It tries to explain something complex with one variable, which is impossible from the get-go. And his chart with its random pattern proves no more than that.
        Not only is the statistical method flawed, but so is the economic analysis is employs. There is NO theory which says a forward-looking P/E bears any relationship to earnings in previous years. The price of a stock is theoretically the discounted present value of a company’s future earnings (or dividends).  

        In other words, if you value a company based on past earnings results, it is inevitable that your opinion of that company will differ from those of actual investors, who care only about a company’s future prospects.  Amazon, for example, barely earns anything today; yet, its share price has performed well because of what investors believe it will achieve over time. 

        Apple’s relatively low value in the marketplace means that investors doubt its ability to sustain market share in key markets and its large profit margins in light of the competition it faces GOING FORWARD.  Apple shares aren’t being held back by past earnings or other historical events — such as the antenna-gate scandal of 2010.  

        In fact, your own discussion (in the following post, below) talks about Apple’s ability to grow faster than analysts’ forecasts OVER THE COMING FIVE YEARS.  So why don’t you see that Horace should use projected future earnings to explain P/E rather than past earnings?

        I acknowledge the hard work and good intentions that went in to doing the analysis of this article, but that work is wasted if it reflects flawed economic and statistical analysis.  The analysis conducted by Horace on other matters — such as those relating to capital investments and the balance sheet — is far more useful. 

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

        Projected future earnings? Projected by whom? I am acutely aware of the relationship of the share price to the past (namely that there is none.) However I will never accept projections from anyone whose methods are unclear and whose track record is abysmal. It’s like passing a verdict solely on the evidence from a convicted perjurer. The alternative is to use *my own* projected earnings but why trust me? The bottom line is that as a consequence of the way the universe works, we have no data about the future and the only data that we do have is about the past which may have no semblance to the future. I make no claims that it should guide us but show that indeed it does not guide the market.

      • gbonzo

        Now that is a great idea. A blog post that describes and rationalizes YOUR projected earnings for the next five years. There we would have a basis for stock valuation.

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

        @asymco:disqus :  ”I am acutely aware of the relationship of the share price to the past (namely that there is none.)”
        Well then what’s the point of your discussion?  You simply proved what you say you already knew — namely that your analysis is not useful.  I agree!

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

        @asymco:disqus :  ”Projected future earnings? Projected by whom? … I will never accept projections from anyone whose methods are unclear and whose track record is abysmal.” 
        How about predicted by Tim Cook?  He offered sales and earnings projections during the company’s October earnings announcements. 

        How about predicted by a multitude of analysts?  Yahoo finance (and others) compile an average of earnings and sales forecasts from dozens of analysts. 

        How about projections implied by your own previous work?  You have examined capital spending decisions made by Apple, and that should be useful in gauging the company’s productive capacity going forward. Since the company sells pretty much everything it can produce, that should give you some pretty solid evidence about the company’s future sales revenues and earnings. 

        What about using all three?

        The fact that you’re uncertain whose future sales & earnings forecasts are most reliable is not a good reason for using data you acknowledge from the outset is irrelevant.  It is, however, a good reason for not saying anything at all on the subject.  

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

        Tim Cook or Peter Oppenheimer project one quarter at a time. They do not project a full year which is what is needed for a PEG analysis. Furthermore, their projections have also been shown to be very poor and are likely subject to “sandbagging” to signal prudence rather than accuracy.
        The ideal projections would be from a group of analysts who are open about their methods and are typically accurate. That group would be amateurs as tracked on the Apple 2.0 blog at fortune.cnn.com. Perhaps PED can maintain such an estimate.
        Your reading of the post is not the way I intended it to be read It’s a discussion of data that is commonly cited as a justification of value. I conclude that the data “shows is that the market does not have any “rule” of rewarding growth with a high P/E.” You object to this on the grounds that this is information that should be well known but I’m a publisher and my decision to publish is based on the belief that this information is not well known, hence it still has value. I will also write posts on “Does market share matter” or “do earnings matter” or “does cash matter”. These are meant to educate and spur debate rather than discover a new theory of valuation. No such theory can exist so it’s futile to even suggest such a goal. As I state on my podcast, Apple is a lens through which I look at many things, and that includes the stock market. The purpose is to educate and learn.