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Why Apple is cheap

Imagine it’s late 2005. Apple’s fiscal year just ended and they reported their performance. You’re an analyst whose job includes forecasting the company’s performance for next year. This is a weighty responsibility.  Your forecast will be blended with those of your peers and used as a “consensus” average. That consensus for the next year will be used to measure the current value of the shares in a ratio called the forward PEG or Price/Earnings/annual earnings Growth. You are supplying the earnings and hence growth forecast while the market offers a price.  As a stock is meant to measure future earnings, your forecast is a crucial and frequently cited figure about whether a stock is priced fairly.

There is some comfort in knowing that there will be many others who will offer such a forecast and your contribution is thus not the only way investors can calibrate the price. However, you should think hard about what you are predicting as it also will reflect your skill in predicting such a visible company.

Apple just had a tremendous two years. 2004 and 2005 saw EPS grow at 274% and 337%. This is largely due to the runaway hit iPod. Given all that is known about the company, what will you put forward? While you’re at it can you also forecast two years forward, namely provide a growth forecast for 2006, 2007 and 2008?

Here is what you and your cohorts publish as a consensus:

You go with a 13% growth for 2006,  15% for 2007 and 5% for 2008. The chances are, you reason, that the iPod will not carry the company’s growth much longer. The competition is sprouting all over and Microsoft is rumored to be launching its own music player.

It makes sense to be conservative and offer a modest growth of 13%. At the same time you can rate the stock a buy as it is still growing. The stock just doubled in the last 12 months and the law of large numbers says that growth cannot last at the same rate as we’ve just seen.

 

 


It’s now late 2006. Apple just closed out another big year. Contrary to your forecast last year, the company grew at a rate of 46%, more than three times faster than you expected.

It turns out the iPod still has some legs and the company’s Mac business seems to be growing. Looking forward you take your 15% growth for 2007 and increase it to 20% and suggest 16% for 2008 and 32% for 2009.

There are rumors of Apple getting into the phone business.

 

It’s now late 2007. Apple just launched the iPhone and even though it was available in limited numbers on one carrier for one full quarter, the company still turned in an amazing 73%. Again more than three times faster growth than you forecast. What do you do about 2008?

It might make sense to increase the previous 16% estimate to 17% but since there is a real estate bubble brewing, the 32% growth for 2009 should come down to 22% and defer that growth out to 2010, dialing in 27%.

It’s now late 2008. Apple closed out another huge year. 73% growth was once again more than triple your forecast of 17% growth. It’s clear that the iPhone is a huge hit.

However, there is a credit crunch and talk of a huge recession, even depression looming. Apple is a luxury/premium brand and it is unlikely that those expensive products will sell well into these “macro headwinds”. You predict a decline in the earnings of 13% in 2009, inline with many other tech stocks. You are optimistic however that 2010 will be a year of recovery and predict 18% increase from recession lows followed by a more reasonable 11% growth in 2011.

It’s now late 2009. To everyone’s surprise, Apple grew through the credit crisis. It turned in 34% growth (vs. your predicted 13% decline). The success is hard to believe but the iPhone had a lot to do with that. There are new competitors coming and the recession has proven resilient. With unemployment still high you predict 2010 will still be a tough year. You go with -14% growth for 2010 and postpone recovery out to 2011 with 24% “bounce”. Longer term you see 2012 as a flat year, with Apple earnings shrinking slightly by 1%.

2010 ends with Apple achieving 67% growth. Shocking relative to a -14% growth forecast. But then again, Apple launched the iPad and who could have thought that was a hit? Apple achieved growth throughout the recession and it looks like it might keep going. Your 2011 forecast of 24% looks weak so you increase it to 25%. The 2012 decline thesis is abandoned in favor of 16% growth and, given the likely competition in smartphones, you tone down growth in 2013 to 6%.

It’s November 2011. The company turned in 83% growth. It’s  more than three times faster than your forecast. Some people are suggesting that Apple may have a lot of headroom with the iPhone and iPad but the law of large numbers is what it is. The company became the largest by market cap in the world and Android is gaining huge market share. However, in deference to their strong recent performance you increase the 2012 forecast from 16% growth to 24% growth. 2013 goes from 6% to more than double: 13% and 2014 is when growth begins to slacken, though still a healthy 8%.

As the following chart shows, look ahead one year accuracy has not been all that great, but you are at least consistent. In any case, everything you based your decisions on showed remarkable consistency with consensus. You’re just reflecting common sense.

Note:

  • Though the numbers are all real, the narrative is fictitious. I suspect however that the truth is actually stranger than this fiction.
  • Kgbraund

    Bloody brilliant, Horace!

  • Anonymous

    20/20 hindsight !

    • http://twitter.com/bennomatic bennomatic

      Well, that’s the thing, isn’t it? Analysts are supposed to take that hindsight and make reasonable forecasts, and that clearly is not happening, at least not at the macro level.  I think part of the reason is that most analysts don’t seem to approach their misses with any level of humility or introspection.

      That’s one of the reasons I like this site.  Horace makes reasonable–and often accurate–forecasts, doesn’t make guesses on things that he doesn’t have enough information about, and most importantly goes back and examines his mistakes.  Look at 
      http://www.asymco.com/2011/07/20/how-did-i-get-the-iphone-number-so-wrong/ to see a great example of what all analysts worth their salt should be doing.

      For most analysts, they could get nine things wrong and the tenth write, and then they’d have you believe that the right one was the only one that mattered.  Horace, in the aforelinked article gave himself “a very mediocre C”, and went on to show what lessons could be taken.  That’s what makes his analyses worth reading.

      • Jzlatic

        I wholeheartedly agree. Horace seems most interested in what’s right, not who is right or simply being right. If more of us could be like this the world would be a much better place.

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

      So how do we measure the foresight?

      • Walt French

        ex-post

      • Duane Bemister

        The question that I would like answered is why does anyone sell Apple stock? 

      • http://twitter.com/bryanilee2 Bryan Lee

        Now see, this is how bubbles get started.  Look, it keeps going up!  It’s not playing by the rules!  If only I had bought more four years ago, look how much more money I would have had!  I need to buy now while the price is still down at this level!

        I got fooled by that sort of thinking once – now, my motto is “Past performance does not guarantee future results.”

      • Duane Bemister

        The question that I would like answered is why does anyone sell Apple stock? 

      • Duane Bemister

        The question that I would like answered is why does anyone sell Apple stock? 

  • Anonymous

    These numbers are really unbelievable, Horace. (I know they’re right. They’re just stunning.) 

    These analysts are baffled by companies not playing by the same old rules.

  • http://twitter.com/simonboulle Simon Boulle

    Good job Horace. These are all plausible comments, I would be really interested in knowing what the truth is, as you put it.

  • Omar Grant

    The iPhone 5 has the highest level of demand when it comes to Apple products, 2012 will be a good year of performance for AAPL.

  • http://twitter.com/bennomatic bennomatic

    I think Homer Simpson summed up analyst reticence regarding all of the iOS products when his long lost brother asked him to fund his baby translator invention:

    “People are afraid of new things. [Apple] should have just taken an existing product and put a clock on it or something.”

  • janeshepard

    Brilliant storytelling.

    “The appearance of right oft leads us wrong” – Horace (your Roman namesake)

  • Anon

    I love that you added “Nostalgia” as a tag for the story

  • http://www.facebook.com/christian.peel Christian Peel

    Wow!!    The consensus does appear to have caught much of the general trend, but they’ve been off by a bias of 50 percentage points of growth. 

    We often focus on the innovation in the product space that Apple has done, and some mention has been made of the things they’ve done in the supply chain; I wonder what other less-visible innovations they have had to make in order to maintain this growth.   To maintain their average (last 6 years) of 60% growth, they may have to innovate not just in computer and mobile products, but move to distinctly different product areas, and in other hidden ways.   I guess that a (new) Apple TV will not be enough.

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

      Apple is cheap because the growth is not foreseeable. When growth does happen, it’s seen as something that cannot continue. When it continues, it’s seen as something that cannot continue. Ad infinitum.

      • http://whereandynerds.com Andy Assareh

        How can we say the growth is not foreseeable when anybody can plot the adoption rate of smartphones? (the rising tide)

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

        That is indeed the question.

    • Walt French

      “I guess that a (new) Apple TV will not be enough.”

      That’s the happiest thought I’ve come across in a while. The opiate of the masses is increasingly helping define the divide between the active and passive parts of the country. A really smart Apple TV might be like making a fabulously better box for Mac Ribs to come in: lipstick on a pig. 

      I feel sad for people who watch hours of commercials a week in order to enjoy some entertainment. I’d be happy to see a new TV industry that valued people’s time at above $8/hour (which is about what the median salaryman’s eyeballs are good for); a “one-hour” show priced at $3.99 would be a great bargain.

      So it’s not the TV per se that needs disrupting, it’s the value model. If that was Jobs’s Aha! moment, there’s indeed plenty of growth opportunity.

      • Ian Ollmann

        TV is so much more than broadcast or the standard cable model now. In fact, I watch neither. It’s all Netflix, other netbased on demand like PBS.org when I do watch. In this sphere, there is a lot your TV can do for you as a content aggregator.

  • Anonymous

    A couple of recent articles by Andy Zaky in AppleInsider
    http://www.appleinsider.com/articles/11/12/12/how_to_properly_use_apples_guidance_to_accurately_forecast_earnings.html
    and
    http://www.appleinsider.com/articles/11/12/13/why_apples_guidance_is_still_conservative.html
    make it more than clear that the focus should be on Apple’s growth in revenue rather than Apple’s growth in earnings. What would these charts look like if the focus were on revenue predictions rather than earnings predictions?

    • Ian Ollmann

      Andy certainly did make a credible point that you need to look at revenue to make credible earnings projections. However, I think it is a mistake to try to replace EPS with revenue.  The investor wants return on his investment. Revenue doesn’t capture that, because it doesn’t tell the margins story or tell you anything about the number of shares outstanding. Without those, you can’t price the stock. 

  • http://kaizenity.blogspot.com/ FalKirk

    Winston Churchill once said: “The farther back you can look, the farther forward you are likely to see.”

    Horace, your long looks back often help me to see much farther forward than ever I could before.

  • Fahirsch

    I wonder, most people that predict the future, how often are they right? Aren’t they called astrologists?

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

      The ones that are right are called the crazy ones.

  • http://www.aaplpain.com Travis Lewis

    Excellent article Horace.

    This is why I believe conventional Wall St forward P/E is useless. Example, in Jan’09 when AAPL bottomed at $78 share. Wall St said AAPL was relatively inexpensive at a 10-12 P/E on 2011 forecast. Turns out we have 2011 numbers and AAPL was trading at a 2 P/E in reality.

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

      That would make an interesting post. What was the forward P/E at the points in time when these forecasts were made?

      • http://www.aaplpain.com Travis Lewis

        I need to find my numbers. In December 2008 Barclays had FY’10 EPS at $5.70. Going from memory, everyone was looking at 15%-20% long term growth. That would get us $6.55 – $6.84 for FY’11. 

        01/20/09 (day before earnings) AAPL had a low of $78.20. Wall st analyst were saying AAPL is now trading at a forward P/E of 11.4 – 11.9 based on FY’11 estimates. Remember this was in 2009. 

        We now have facts. FY’11 EPS was not $6.55-$6.84. It is factually $27.67. Therefore in reality AAPL on 01/20/2009 was trading at a real forward P/E of 2.81. 

        (I do not recognize accounting change as this was not known at the time. Only looking at data that was used at the time)

        This is an example why I do not use Wall St forward estimates. They mean nothing. This is why I use factual data or trailing twelve month etc. There is no better metric than PE/TG (PE/ttm-ttm growth)

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

        Amen.

  • Nick

    Very entertaining.So to return to the title of the post – you are arguing that Apple is cheap because the market offers a price based on a consensus prediction of future earnings that is a consistent underestimate of the true value. But if this is the case, why does the market not correct for this when presented with the new earnings data? Do none of these financial types understand Bayes rule!!?

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

      The consensus has been for quite some time far more pessimistic than reality but regardless of what actually happens, the consensus remains pessimistic (and the price remains cheap.)
      Imagine that you’re trying to make a bet on the outcome of a coin toss. Everyone knows that a coin toss is a memory-less system. The outcome of the next toss has nothing to do with the outcome of the last toss. And yet, when witnessing a long sequence of “heads” the tendency of many people is to vote on “tails” because the run of “heads” clearly has gone on too long. This is innumerate but common. In the case of Apple, the bet is similar. If Apple beats this quarter by a huge amount, the bets are not that it has shown sustainable success but that it will slow down. I.e. the winning has clearly gone on for far too long. And yet Apple’s performance is not a memory-less system. It has a bias for repeatable performance. Knowing something about disruptive theory gives you insight into how the machine works. But the bet is that the exact opposite is the case: That Apple is worse than random; that Apple is lucky and luck is perennially running out. That’s what I tried to satirize. What must be the rationale be of someone who sees a streak of success as evidence of imminent failure?

      • Nick

        Fantastic explanation, thank you Horace.

      • Ian Ollmann

        > Fantastic explanation, thank you Horace.
        It would be a good explanation if the APPL earnings were truly a stochastic process. The outcome of the next toss does have something to do with the last one, because it is the same product mix competing in the same economy, and the same people (sans Jobs, Johnson and Serlet) calling the shots. 

        The argument for slowing is not innumerate at all. Instead it is based on a quite numerate analysis on the problem of continuing exponential growth in a finite sized market. You can extend the pattern by moving into new markets, but to keep that growing, you’d have to expand into exponentially more markets. There are only so many multibillion dollar markets. Eventually there is no where to go and growth must stop or at least drop down to something like growth in gross world product. 

        Apple’s market share really isn’t that large in most of the markets it is in,, and some of those markets are growing at a good clip, so there is room to grow yet. However, mathematically, growth must slow to single digits in the fullness of time.

        But, yes, I agree that Apple makes its own luck.

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

        I did say that the future of Apple is not stochastic. And yes, exponential growth is not sustainable. But my trip into history shows that this is not a valid analysis. Mathematics can be used to “prove” ultimate failure, but that is no way to go through life. 

      • Advill

        We are nearer now finish the exponential growth (more than last year) obvious, but that is not meaning that this year or the next will still have it.

        Perhaps as with many other things in life there could be a final crazy growth explosion before having a “back to reality” growth rates.

        Perhaps what is happening now with Apple (for different reasons) is more related with the bulb mania and crash in XVII century in Holland pattern.

        But in the Apple case a very important variable modify the normal model…innovation.

        If Apple´s team is able to continue the innovation rate as the last decade then the “bubble” can be feed for a longer time, that do not mean that Apple is in danger of anything simply will then land in the world of the rest of blue chip companies.

        Excellent article.

      • Marcos El Malo

        I suspect that whatever rationale we can come up with would be cover for deeper fears about the economy as a whole, maybe even the capitalist system as a whole. I think there is a lot of unconscious doubt about the sustainability of the global capitalist system. Wall Street operates on two emotions: Fear and Greed. After the whipping that was taken when the real estate crash triggered the global financial crisis, there is a heavy bias towards fear, and this will continue for some time.

        The analysts are not performing rationale analysis. They’re not doing their homework. Instead they are basing their work on underlying emotions without any self-analysis. Their lack of confidence in the system and of themselves is projected onto a company

      • Marcos El Malo

        [discuss really sucks. It's truncating my comments]

        Their lack of confidence in the system and indeed in themselves is projected onto an exceptional company. Their lack of understanding of this company and of disruption in general is due to laziness, a laziness that breeds fear. Or perhaps it is the other way around. The fear breeds laziness.

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

        The problem is that accuracy of prediction and these PEG ratios are more reasonable for other companies. If the concern were over macroeconomics then all equities would be “cheap”, and they might be, but Apple today is considered even “cheaper” than the S&P 500.

      • http://twitter.com/viralant viralant

        Horace, what events could you imagine that would help shift the consensus to a less pessimistic view, or is it something, as in the coin-game, that is merely a ‘gut feeling’.
        One could imagine the analyst being this pessimistic to protect themselves, for they have essentially two outcomes, they either aimed high, or aimed low.
        Is the consequence of them aiming low as damaging to them professionally as aiming high?

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

        We’re in uncharted waters. I believe the consensus does reflect “common sense” or “conventional wisdom”. What is happening is unprecedented and there is nothing that can be done to change perception of the fundamental notion that innovation is not a repeatable process. It may be just a matter of time. A long time.

      • Anonymous

        The rationale is daily uncertainty whether the sun will continue to rise the next day. There can be no givens. They are not allowed.

    • Walt French

      What they understand is that at the end of each quarter, their customers and management both review the list of forecast errors and those who dared forecast outside the consensus ket killed. This particular beauty contest (pace Keynes) is against the competition, not against reality. Just as the market investments are.

      • Anonymous

        In which case they are political sheep, not analysts.

  • http://www.florence-journal.com/ af

    Sorry Horace I just have to comment on the new logo – it seems strangely corporate and ominous for some reason. Is ASYMCO just a name or some kind of acronym? The logo to me doesn’t fit you (from what I get when I listen to the podcasts). 

    • Anonymous

      I like it.  It does scream “large sprawling international conglomerate”, but so does the name Asymco.  It sounds like an enterprise that assimilates all in its path.

      Its also forward looking.  Much better to pick a serious name and logo now than wait until he has 100,000 employees and 100x that many sentient machines doing his bidding across the globe and realize the name “Dediuville” splashed over a logo of a llama were terrible ideas.  Think of the hand wringing at that point!

      • http://www.acid-product.co.uk Ian Davies

        It reminds me of the Clockwork Orange movie poster for some reason.

        Not a bad thing :)

    • Anonymous

      ASYMCO = Asymmetric Competition

      • http://www.florence-journal.com/ af

        If that is actually where the name comes from, then the balanced pyramid with the strong foundation is indeed not what I would expect for a logo!

  • Grandybennett

    Great piece. I love it. Apple Analysts really are clueless

  • http://twitter.com/borrodell James Brown

    (Long time fan/reader, first time commenter).  So Horace, I must confess that I don’t always entirely understand all the economic/finance fine-details of your and Dirk’s articles, although I generally do get the points you make. But this article.. this is in a different class…

    It’s seems so clear and compelling that you are correct, while hundreds (is it that many?) of full-time employed professional analysts and research/finance organisations (is that who they are?) are wrong.  What I’d love to know is: what’s the variability between these analysts’ predictions?  Are they almost all flocking toward the consensus view? Or is it quite a wide distribution of somewhat positive and also very negative views making this average? And so then where do your predictions here fit into that – are you just at the edge of the positive group, or are you way off the scale? Thanks!

    • nikolaihoffn

      I believe you will find they “flock”.

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

      There is analysis under way to plot variability on a quarterly basis. This post is the first analysis I’ve seen on the yearly forecasts and I don’t have access to the individual votes that made up the consensus. I’ll post more on the quarterly work shortly (keep in mind that we have to deal with thousands of data points.)

    • ak13

      You might want to check out this blog post by Daniel Tello. It has a very detailed analysis of bloggers vs pros quarterly estimates. Horace is doing quite well, on average underestimating revenue just 2.2 percent.

      http://aaplmodel.blogspot.com/2011/10/aapl-analysts-pros-telescopic-aim-low.html

  • http://www.facebook.com/people/Graciela-Cattarossi/667239856 Graciela Cattarossi

    brilliant

  • Nangka

    This only shows that wall street are a bunch of incompetent nitwits who despite consistent failing to perform, still allow to keep their jobs. “This is crap!” as SJ would say about these D-players.

    Well, at least Huberty is trying to see the light with a “out of the park” analysis for 2012 for Apple.

    It would be interesting to see the performance of the bloggers in the above charts.

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

      You can’t just blame the analysts.  They do show high price targets for Apple.  Let’s face it, new investors want nothing to do with this stock.  Since the stock is completely manipulated what chance due recent shareholders have coming out as winners with any decent share gains.  If men like Corzine are the ones who are running Wall Street, you might as well give up on Apple and get into some flaky, one-trick pony stock for a fast ride up.  Set a goal and just bail before it collapses when the crooks pull their pump money out.

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

      I would disagree that analysts are incompetent. They are highly competent. They have access to a lot more information about the market than we do. They are paid well for doing exactly what I showed is done in the post. In fact, it is precisely because of their wisdom that they are always wrong.

      • Plantsman223

        I agree…they know exactly what they are doing! Their legal departments are dictating the uber conservative estimates to avoid potential lawsuits filed by people who get all excited by all the good news, jump in without doing their own due dilligence and then panic at a retracement and bail at a lose. That lost money has to be somebody else’s fault!!

        Disclosures are easy to get around!! I can hear it being whispered now…..’sell the stock…write the analysis…wait the stated 72 hours…buy your stock back. Repeat as necessary!

        Is my cynicism showing??

      • Alarik

        Mr. Dediu,

        I’ve been reading your posts for a long time, now, and never fail to be impressed. I am grateful to you.

        You are quite right, of course, that the analysts are doing what they must do and are doing it correctly. It’s the minor counterpart to “normal science.” Well, I hate the trivial uses of “paradigm shifts.” Suffice it to say, that the wisdom of the analysts is indeed what constitutes wisdom. But just as reason and logic are often enough wrong, on occasion, so wisdom is sometimes folly. Apple is an exception to the received wisdom, and it would be unreasonable to expect those who are wise to perceive it. (There are familiar paradoxes here that could easily segue to your notion of disruption as a proof of god–though I’d draw the line there!). In any case, it takes an Erasmian fool to detect the brilliance of Apple. Which is to say, I think what you do is marvelous.

        I have a question. May I ask you? 

        Who or what are the markets? The markets “speak.” Our common lingo attributes a kind of single being/consciousness to the markets. The markets pass judgment. The markets are anthropomorphized. In fact, they cease to be plural. The market is a virtual allegorical entity. But what on earth does it represent? Am I to imagine innumerable investment companies combined with innumerable individual investors? Worldwide? Whence the endless churn? Does wealth generation depend on volatility? Do the market(s) represent the “1 percent” of world wealth while the rest of us watch?

        The “markets” seem to be personified as a character, the chief character, in a daily financial news narrative, a kind of ongoing story told to us by . . . ?

        Sorry to go on so. Damn thing really bewilders me. Thank you again!

      • Alarik

        Mr. Dediu,

        I’ve been reading your posts for a long time, now, and never fail to be impressed. I am grateful to you.

        You are quite right, of course, that the analysts are doing what they must do and are doing it correctly. It’s the minor counterpart to “normal science.” Well, I hate the trivial uses of “paradigm shifts.” Suffice it to say, that the wisdom of the analysts is indeed what constitutes wisdom. But just as reason and logic are often enough wrong, on occasion, so wisdom is sometimes folly. Apple is an exception to the received wisdom, and it would be unreasonable to expect those who are wise to perceive it. (There are familiar paradoxes here that could easily segue to your notion of disruption as a proof of god–though I’d draw the line there!). In any case, it takes an Erasmian fool to detect the brilliance of Apple. Which is to say, I think what you do is marvelous.

        I have a question. May I ask you? 

        Who or what are the markets? The markets “speak.” Our common lingo attributes a kind of single being/consciousness to the markets. The markets pass judgment. The markets are anthropomorphized. In fact, they cease to be plural. The market is a virtual allegorical entity. But what on earth does it represent? Am I to imagine innumerable investment companies combined with innumerable individual investors? Worldwide? Whence the endless churn? Does wealth generation depend on volatility? Do the market(s) represent the “1 percent” of world wealth while the rest of us watch?

        The “markets” seem to be personified as a character, the chief character, in a daily financial news narrative, a kind of ongoing story told to us by . . . ?

        Sorry to go on so. Damn thing really bewilders me. Thank you again!

      • Alarik

        Mr. Dediu,

        I’ve been reading your posts for a long time, now, and never fail to be impressed. I am grateful to you.

        You are quite right, of course, that the analysts are doing what they must do and are doing it correctly. It’s the minor counterpart to “normal science.” Well, I hate the trivial uses of “paradigm shifts.” Suffice it to say, that the wisdom of the analysts is indeed what constitutes wisdom. But just as reason and logic are often enough wrong, on occasion, so wisdom is sometimes folly. Apple is an exception to the received wisdom, and it would be unreasonable to expect those who are wise to perceive it. (There are familiar paradoxes here that could easily segue to your notion of disruption as a proof of god–though I’d draw the line there!). In any case, it takes an Erasmian fool to detect the brilliance of Apple. Which is to say, I think what you do is marvelous.

        I have a question. May I ask you? 

        Who or what are the markets? The markets “speak.” Our common lingo attributes a kind of single being/consciousness to the markets. The markets pass judgment. The markets are anthropomorphized. In fact, they cease to be plural. The market is a virtual allegorical entity. But what on earth does it represent? Am I to imagine innumerable investment companies combined with innumerable individual investors? Worldwide? Whence the endless churn? Does wealth generation depend on volatility? Do the market(s) represent the “1 percent” of world wealth while the rest of us watch?

        The “markets” seem to be personified as a character, the chief character, in a daily financial news narrative, a kind of ongoing story told to us by . . . ?

        Sorry to go on so. Damn thing really bewilders me. Thank you again!

  • Wee

    a well -written mockery, so well-deserved.

    eventually the broken-clock predictors will be right. but not this fiscal year when Apple will surely earn at least $45 per share.

  • Prazan

    As Mr. Jobs knew, the trick is to know what people want before they can articulate it; I’ve been looking for this analysis for a long time without really knowing it.

  • Amelnyk

    Just to illustrate the bias in analysts forecasting, how about posting a similar history for Amazon or Google.

  • Chris

    I really enjoyed this article because it makes Apple an example of one of those great long term investment opportunities, that is companies that are able to grow at extraordinarily high levels for many years, if not decades.

    Analysts are often conservative in projecting future growth for companies because of uncertainty. If they are projecting future cash flows and using a ten year DCF model, then they will have to start projecting a decline to the growth of cash flows right away just so they can reconcile it to a more mature growth rate in their terminal value. Of course they can use an even longer DCF model like twenty years and show a more moderate decline to growth rates, but projecting twenty years out brings up its own set of difficulties. It’s just that it boggles the mind of the analyst to have growth continue at these extraordinary levels year after year for a long time.

    And yet, this shouldn’t be the case. There have been examples of companies that have grown year after year, if not decade after decade at extraordinary levels. The example that comes to mind is a company like Intel. An analyst that started to project a declining growth rate after the first decade of extraordinary growth at Intel (the 70s), would have shortchanged the company for what was to come in the ’80s and ’90s when their technology found its expression in different mediums and they continued their growth trajectory.

    This is exactly the kind of shortchanging that analysts are doing to Apple after only six-seven years of extraordinary growth. They can’t imagine it going any further. It’s because it stretches the imagination to imagine the second largest company in the world by market cap  may one day be a trillion dollar company if it keeps up this growth within the next five years. But it’s entirely possible.

    I think another reason for this is because analysts tend to look at Apple’s future under today’s conditions, instead of trying imagine Apple future under tommorrow’s conditions. If any one whose reading my comment is inclined, it’s really, really helpful to look back at the very early annual reports of companies like Intel or MSFT and then compare them with their annual reports decades later. You can just see how even the people leading these companies early on were trapped in their own time and even they couldn’t have imagined how they would have grown into a different world than the one they were familiar with. But an analyst looking back over both these companies’ histories can see that conditions will be different for a company, like Apple going forward, possibly for the better .

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

      DCF analysis cannot be reconciled with disruption analysis.

      • gbonzo

        What are you talking about? Just use your disruption analysis to estimate the cash flows or earnings far enough to the future. Then discount that to present value. So, I am waiting for your earnings estimates for, let’s say, the next five or ten years.

      • Anonymous

        You sound like an impatient, but fee-paying client :-)

      • Chris

        This reply may be after the fact. But I found a video that is still pertinent to this discussion. While DCF may not be wholly reconcilable to disruption analysis, continuous future disruption may be indicative of further upside to the value of an investment. 
        Maybe people can still watch the video and comment.http://bigthink.com/claytonchristensen#!video_idea_id=13093 

  • MOD

    This is highly entertaining. At the next Apple earnings conference call, after all the Jews from New York call in, Apple Investor Relations should call a certain Romanian from Finland.

    After disrupting electronics, Apple might disrupt Wall Street analysis.

  • Westechm

    WOW!  I’m speechless.  This is the best presentation you have made on this blog.  It clearly shows the disconnect between the analyst’s view and what Apple actually does.  Thank you.

    Now if we could understand why the disconnect…

    I do have a theory. Most businessmen don’t really understand or use best business practices, and most analysts are no better.  Apple is an extremely well run company, and some of the things they do seem wrong to the rest of the business world.  Therefor Apple’s success is incomprehensible and the competition and the analysts expect Apple to implode at any moment. 

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

      I have a different theory on why analysts are so far off on AAPL.  Go back to 2005 when this narrative starts.

      As humans, we make judgment of the world based on our own small and personal surroundings.  For example: If you judge the tech world based on being at WWDC, you would think Apple is running the world of tech with no competition.  Likewise, if you live your life in corporate America, you would think Apple is nothing but a niche company with no significant market control or penetration with limited growth potential.  Sure, you might see an iPod here and there but computers? Seriously.  Apple makes some iPods.  They make some computers that almost no one uses.

      We judge the world based on what we see around us and there is no better example of “corporate America” than inside any Wall Street or trading firm.  Apple has the same presence in this area as man has on Mars.  Not much.  None of our friends use Macs and think the Zen is a better player anyway.  Of course, all of our friends do the same thing we do.  As humans we seek advice not to question our views but to reaffirm our beliefs.  This is why disruption is so easily missed.  Since we surround ourselves with people that view the world as we do, we miss that there are huge numbers of people that might like something else.

      • Ktodack

        Well put, I think your right on how AAPL analysts think. Old viewpoints are hard to change, but looking back at early Apple I feel Steve Jobs craziness was great in pushing a window/mouse OS with a developer toolkit that allowed consistency between applications. Yet at the same time he pushed some crazy ideas the allowed the PC to win– the Mac was too small, tiny B/W screen, insanely expensive and too frequently used non standard peripherals which kept prices artifially high. Apple as company now is far different from the early dictatorship of Steve, as has a far more smarter take on staying ahead of the competition.

      • Anonymous

        Except that a surprising number of ordinary people all around the world seemed to be moved by the loss of Steve Jobs. To me this implies that even the ordinary Joe or Jane can become aware of, and come to admire (sometimes even to revile) the man and yet they all tend to revere him for being extra-ordinary and true to his vision. 
        With Apple, it all ultimately comes down to belief. I remain long in Apple because I see no cause for any concern in any of its metrics. If there is any cause for concern, it is in the long-term possibility that the poachers may come to inherit the orchard.
        I agree with an earlier comment. As a world-class brand, Apple must now focus on strengthening its differentials in every way.
        There is a lot of money to be made here by this company and by its investors.
        As the great Spock might say:
        It computes.

  • Ian Ollmann

    Horace, I believe you have made your case that the market has no idea how to value disruption and associated competitive moats surrounding recent disruptive products.

    Now, for the Nobel Prize, develop a model to price the value of these. Once you have done that, I believe we can expect the market to fairly price AAPL and we can expect a new disruption futures market to bubble.

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

      I’ve thought about this and I am now of the opinion that a reduction of the problem of disruption forecasting leads to an existence proof of God.

      • Anonymous

        Never mind that – it is the ultimate imponderable.
        This needs doing Horace.
        If it is possible to model uncertainty, how much of a challenge can this be.
        Perhaps an academic copy of iThink or its sister products may point the way.

  • Michael diCanio

    Gadzooks! An analyst with a sense of humor! This was worthy of The New Yorker.

  • Guest Dude

    HORACE NEEDS TO BE ON THE EARNINGS CALL! YES!

    • Kristian

      Excellent idea. Apple are you listening? (Of course they are.)

      • Kristian

        Then again Horace might do too razor sharp questions :)

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

        I believe (would like to know for sure) that those invited to be on a call are “certified” in some way. Let’s not forget that in order to be a real analyst you need to go through testing such as CFA (chartered financial analyst.) Those who are permitted to interrogate management must be the wisest of the wise.
        https://www.cfainstitute.org/pages/index.aspx

      • Kristian

        “Wisest of the wise”. That illusion has long gone. Especially after the Asymco was introduced. ;) One of the things what I am interested of is to hear more details about the subsidiaries (Braeburn Capital and FileMaker Inc) and is the Apple diversifying (latest catastrophies) and ramping up the manufacturing enuff. Of course the retail expansion. Now the list is getting too long.. But these kind of things for starters.

      • Kristian

        Braeburn Capital = “The Bank of Apple”

      • Anonymous

        Oh they have definitely been ‘certified’ alright Horace. Believe it.
        imho, if you do what you do, as well as you do, then my vote goes to the uncertified – no hesitation!

  • Laurent Cavalie

    Fascinating narrative.
    There is still one thing still that I have a problem with – why do we all follow what the analysts tell us? why cannot people use their own judgement and make decisions accordingly. Is the stock market solely priced based on what the analysts tell us?
    I keep hearing financial networks, reading blogs and newspapers – almost every day there are stories about sales of iPhones and iPad being much higher than anticipated, about demand being higher than supply or barely keeping up even if you demonstrated that Apple is on track to double it year over year.
    So why are all those signals ignored?
    Does that mean that we have to wait till January to get Apple real sales numbers for the holiday season until the market believe that the growth is actually here just like all those signals are telling us already.
    As an analyst are you supposed to be skeptical by nature or are you suppose to accurately forecast the evolution of a company (or try to). If you are consistently off by a factor of 3, for several years, like you demonstrate here, than there is clearly a problem with the methodology you use to establish your forecast.

    • Anonymous

      Yep. As soon as the “disappointing” results for the last quarter came out in October, I said, we’ll have to wait until Apple’s blowout results in January before the market sentiment has a small chance of changing. Even then, the market will temper the good news by citing the extra week, the launch of the 4S goosing results, and how it’ll all come to naught in the March quarter numbers.

      • Anonymous

        You got it. The market is totally reactive. Projections are a veneer over analysts who are otherwise frozen by fear, like deer caught in a headlight.. The P/E compresses because each growth spurt has to be verified before it is priced in, creating a “lag” as E repeatedly overwhelms P.

      • Anonymous

        You got it. The market is totally reactive. Projections are a veneer over analysts who are otherwise frozen by fear, like deer caught in a headlight.. The P/E compresses because each growth spurt has to be verified before it is priced in, creating a “lag” as E repeatedly overwhelms P.

      • Anonymous

        You got it. The market is totally reactive. Projections are a veneer over analysts who are otherwise frozen by fear, like deer caught in a headlight.. The P/E compresses because each growth spurt has to be verified before it is priced in, creating a “lag” as E repeatedly overwhelms P.

  • http://twitter.com/jonasgh Jonas Hermansson

    I love to be contrarian so here we go:

    There are 2 real threats to Apple as I see it:

    1.Copies becomming “good enough”. Like the PC became a good enough copy of the Mac and took the bulk of the market. Android is getting closer by the day and Microsoft who has huge resources needs to bet the farm to catch up. They actually do a bit more than copy, they have ideas of their own. MS  is way behind, no question about it but they can not afford to fail, they are a cornered rat and hence dangerous. It is not clear that Apple is successful in defending itself with patents, the jury is still out on that.

    2.Business model and value. Devices will be more of a commodity which will be the window to cloud services. The value will migrate to the cloud. Google is a fomidable player with long experience in massive cloud infrastructure and Microsoft is again a challenger. Amazon is also lurking with a business model that allows them to make sales from their shop rather than devices, thereby eroding value for devices. 

    My theory is that the market is fearing a repeat of what happened with the original Mac in competition with the PC and that the 1 is the reason the market is cautious in the valuation of Apple.

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

      Your ‘real’ threats to Apple are the same as were present in 2005 when my narrative began. In fact they have been cited more frequently than I can remember for over half a decade. It seems to me that rather than contrarian, they are in fact the overwhelming consensus. A contrarian view (meaning one which I have not heard) is that Apple has a repeatable innovation process, (which is unique, but need not be.)

      • Edward Sices

        I am long apple and agree with your article and comment here.  That said, another possible ‘contrarian’ view is that Apple HAD a repeatable innovation process that was UNIQUE, and his name was Steve Jobs.  :)

        I still believe the shares to be massively undervalued anyways, though.

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

        Again, the pessimism around growth existed at a time when Jobs was still involved. Pessimism was always there.

      • http://twitter.com/jonasgh Jonas Hermansson

        I had no ambition to be unique, just to have some contrast to the universal agreement and seeking an explaination to why the market acts as it does. 

        The competition may actually learn a bit from how Apple thinks rather than just copying what they do, so what you write about the innovation process is very important. 

        They may even learn to focus on the user experience in the same focused way Apple does. 

    • Anonymous

      As for copies becoming “good enough”, the PC already had a dominant position when they became a good enough copy of the Mac with Windows 3.1. As for Microsoft “betting the farm”, and can’t “afford to fail”, the same was said for music players and search, and every business they’re in. Can they really come from behind, without actually cheating, browsers, or having the incumbent stumble, consoles? And, as for patents, Apple doesn’t “need” them to defend itself from competition, as it is doing quite well as it is, but it would do even better if it could create even more differentiation from the copycats.

      As for the cloud turning devices into commodities. Apple is also a player in the cloud, and it remains to be seen whose vision of the cloud as service will be the most successful.

      There is no doubt that the market has long feared what they don’t understand. Interestingly, the Mac has not yet been commoditized after over 25 years, and I believe Apple won the PC wars. Certainly HP didn’t, as they almost spun off their PC business. Dell is hardly a factor. Acer is licking its wounds over the netbook decline and Lenovo makes less than $10 a PC. Those are the 4 largest mfrs of PCs, and I hardly think any of them won.

      • Jbfiacco

        It appears that Apple will be the number 1 maker of PC’s in 2012 as it passes HP in sales.

  • Ahmad.Kadhim

    Horace, I wonder what you think of the AAPL-as-cash theory that mutual funds and hedge fund managers dump AAPL stock first when markets are rough (e.g. Euro-zone uncertainty) to raise cash. The lack of a dividend probably spurs on the short holding periods.

    Of course, this wouldn’t fully justify its long-term low valuation, but it could help to understand why it’s often been slow to react to the market or going completely against the market in recent months.

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

      Going against or in tandem with the market is measured by “beta”. A beta of 1 means perfect correlation. A negative beta means it moves in the opposite direction and a large beta means highly amplified movement. Apple used to have a high beta. As high as 5. Now however bet is 1.2 meaning it’s well aligned with the overall market.
      Apple does have a lot of cash so it can be treated as cash. In fact, it may soon have more cash than the company is worth.

      • Anonymous

        Horace, please explain how AAPL can have more cash than it’s worth? 

      • http://www.facebook.com/people/Joe-Farber/1094386285 Joe Farber

        It’s unlikely to happen, but it has happened before with AAPL in the 90s, so it’s certainly possible.

      • Anonymous

        If you value the operational business negatively, then you could have a company with a market cap worth less than its cash.

        As recently as 2003, Apple had $10 a share in cash, and the stock was only $12, thus Apple’s business prospects were only being valued at $2 a share.

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

        Many companies are trading below “book value” (which is total assets minus intangible assets and liabilities). Recent examples are RIM and Nokia. In Apple’s case the book value is nearly completely its cash balance.
        Apple current trades at approximately a 4.5x multiple of cash, however its cash today is greater than the share price was 18 months ago. You can see a discussion of this here: http://www.asymco.com/2011/12/01/the-thermodynamics-of-apple-share-price/ You can ask the question of how long it will take for Apple’s current cash to overtake its share price as it grows much faster than its share price.
        When a company trades below book value the implicit assumption made by the market is that it is in business to destroy value.

      • Anonymous

        It’s an interesting point of valuation bases that I had not considered in detail before. You’ve given me much food for thought on this one issue.

        But doesn’t the strength of the Apple franchise have value? I understand that it would be an intangible, but the difference between, say (and I apologise for the lack of a better example), McDonalds and Wendy’s has to be based on the sheer size and entrenchment of McDonalds in its market. 
        And, if we accept that there will be, very likely, an enduring and profitable long-term future market for mobile phones, computers and the like, and a player like Apple has demonstrable popularity/demand and significant headroom for growth in such markets…etc., etc., why is it a conceptual problem that some kind of value can be attached to the nature and value of such opportunities. 

        After all, these are among the factors and indicators that VCs look for when they invest in start-ups. Companies that may as yet have negligible traction in their target markets at the time of applying for funding. Do analysts ever look beyond the possibilities and reflect on the probabilities instead? It isn’t always necessary to win outright in such markets in order to deliver stellar growth and profits. Apple has demonstrated this as reliably as clockwork.

      • Spelunker

        Slight correction Horace, Apple’s cash is greater than it’s share price 36 months ago, not 18 months ago.

      • Spelunker

        Actually it might be closer to 32 months ago, but definitely not 18.

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

        Right, sorry. It was January 2009 that it reached below current cash value.

      • Garyscott2

        The px of aapl is acting like it should. It has gone from 85 to 400 since 2009. It went from 306 to 426 in 2011 alone. Right now it is building a base. The next news will be earnings and that should be good. Therefore the breakout should be up.

  • http://ximagin.co/thecw/ The CW

    This post and it’s comments are a perfect course in the pros and cons of investing in the stock market. One wonders if this failure of analysts to accurately predict growth is market-wide or peculiar to Apple. Have you identified any other publicly traded companies so tied to disruption?

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

      Disruption analysis can be a great way to invest in companies. If you observe a disruptive opportunity, you can easily buy the company cheap before the market realizes what’s going on. (I believe that is the investment thesis of Rose Park Advisors. http://www.roseparkadvisors.com/ )
      A company will typically “pop” in value after the market catches on to what’s happening. However, the problem with Apple is that it’s a serial disruptor. Once it popped, the market decided the story is over. If the company innovates and grows again, there is a deep disbelief that it’s happening again. If it happens a third time, more disbelief.
      As far as I know the investment model for serial disruptors has not been studied. It’s so rare as to be a data set of one, maybe two.

      • http://ximagin.co/thecw/ The CW

        An example like Safeway, which was really a single disruption of it’s market space, wouldn’t apply but it maintained ridiculous growth for nearly 30 years. I wonder if the lifespan of success of a given disruption is tied to the lifespan of the founders.

      • Anonymous

        I would look at DuPont or 3M as serial innovators, but not serial disruptors.  The market seems to grasp and accept that these businesses will continue to find new revenue streams out of existing business units.  They build proprietary products with the objective of solving problems, then continually enhance the products throughout effective life cycles.  In this regard, they are similar to Apple and the parable of the polished stones.  A look at trailing P/E shows that these companies carry similar valuations.

        P/E (ttm)
        MMM  13.33
        AAPL 13.69
        DD   11.71

        However, when adding in growth (trailing), the story changes

        EPS Growth (ttm)
        MMM  4%
        AAPL 83%
        DD   9%

        P/E/tG
        MMM  3.25
        AAPL .16
        DD   1.3

        I would suggest that Apple’s ability to grow rapidly has been predicated on its ability to disrupt, while these other businesses survive solely on their ability to innovate and iterate.  Because analysts cannot predict disruption, they discount disruptive innovation entirely.  Apple gets credit only for the basic innovation, never for its disruptive potential (think about the initial yawning reaction to almost any Apple product or service).  This is why PEG is always so low.  

        The good news is that Apple also innovates and iterates.  Even if they never again stumble on another world changing disruption, they have demonstrated the ability to flush out products and milk cash cows.  If after another 2 years of torrid growth Apple becomes more of a typical blue chip, they are still more than capable of finding ways to keep their products at a premium to the market through relevant tweaks.  Most of us believe that Apple has quite a bit left in the tank, but even assuming all disruptive prowess died with Steve Jobs, there is plenty of precedent for stable growth through innovation once his product pipeline is fully realized.  These two other companies, along with plenty of others, have shown that persistent innovation and good IP can drive growth for decades.  Only if a day should come when Apple is no longer a disruptor, will the analysts have any ability to accurately forecast future growth.  Until then, the ride continues.

      • Anonymous

        I agree. The focus on disruption masks the ability to continually innovate, which ultimately allows Apple to utilize the disruption. Even for Apple, disruption cannot be predicted. The best they can do is promise their customers that they will continue to be part of the cutting edge. And eventually, that will be recognized by the stock market, by virtue of Apple simply continuing to grow.

      • Anonymous

        I agree. The focus on disruption masks the ability to continually innovate, which ultimately allows Apple to utilize the disruption. Even for Apple, disruption cannot be predicted. The best they can do is promise their customers that they will continue to be part of the cutting edge. And eventually, that will be recognized by the stock market, by virtue of Apple simply continuing to grow.

      • Anonymous

        I agree. The focus on disruption masks the ability to continually innovate, which ultimately allows Apple to utilize the disruption. Even for Apple, disruption cannot be predicted. The best they can do is promise their customers that they will continue to be part of the cutting edge. And eventually, that will be recognized by the stock market, by virtue of Apple simply continuing to grow.

      • Anonymous

        I would look at DuPont or 3M as serial innovators, but not serial disruptors.  The market seems to grasp and accept that these businesses will continue to find new revenue streams out of existing business units.  They build proprietary products with the objective of solving problems, then continually enhance the products throughout effective life cycles.  In this regard, they are similar to Apple and the parable of the polished stones.  A look at trailing P/E shows that these companies carry similar valuations.

        P/E (ttm)
        MMM  13.33
        AAPL 13.69
        DD   11.71

        However, when adding in growth (trailing), the story changes

        EPS Growth (ttm)
        MMM  4%
        AAPL 83%
        DD   9%

        P/E/tG
        MMM  3.25
        AAPL .16
        DD   1.3

        I would suggest that Apple’s ability to grow rapidly has been predicated on its ability to disrupt, while these other businesses survive solely on their ability to innovate and iterate.  Because analysts cannot predict disruption, they discount disruptive innovation entirely.  Apple gets credit only for the basic innovation, never for its disruptive potential (think about the initial yawning reaction to almost any Apple product or service).  This is why PEG is always so low.  

        The good news is that Apple also innovates and iterates.  Even if they never again stumble on another world changing disruption, they have demonstrated the ability to flush out products and milk cash cows.  If after another 2 years of torrid growth Apple becomes more of a typical blue chip, they are still more than capable of finding ways to keep their products at a premium to the market through relevant tweaks.  Most of us believe that Apple has quite a bit left in the tank, but even assuming all disruptive prowess died with Steve Jobs, there is plenty of precedent for stable growth through innovation once his product pipeline is fully realized.  These two other companies, along with plenty of others, have shown that persistent innovation and good IP can drive growth for decades.  Only if a day should come when Apple is no longer a disruptor, will the analysts have any ability to accurately forecast future growth.  Until then, the ride continues.

      • Anonymous

        I would look at DuPont or 3M as serial innovators, but not serial disruptors.  The market seems to grasp and accept that these businesses will continue to find new revenue streams out of existing business units.  They build proprietary products with the objective of solving problems, then continually enhance the products throughout effective life cycles.  In this regard, they are similar to Apple and the parable of the polished stones.  A look at trailing P/E shows that these companies carry similar valuations.

        P/E (ttm)
        MMM  13.33
        AAPL 13.69
        DD   11.71

        However, when adding in growth (trailing), the story changes

        EPS Growth (ttm)
        MMM  4%
        AAPL 83%
        DD   9%

        P/E/tG
        MMM  3.25
        AAPL .16
        DD   1.3

        I would suggest that Apple’s ability to grow rapidly has been predicated on its ability to disrupt, while these other businesses survive solely on their ability to innovate and iterate.  Because analysts cannot predict disruption, they discount disruptive innovation entirely.  Apple gets credit only for the basic innovation, never for its disruptive potential (think about the initial yawning reaction to almost any Apple product or service).  This is why PEG is always so low.  

        The good news is that Apple also innovates and iterates.  Even if they never again stumble on another world changing disruption, they have demonstrated the ability to flush out products and milk cash cows.  If after another 2 years of torrid growth Apple becomes more of a typical blue chip, they are still more than capable of finding ways to keep their products at a premium to the market through relevant tweaks.  Most of us believe that Apple has quite a bit left in the tank, but even assuming all disruptive prowess died with Steve Jobs, there is plenty of precedent for stable growth through innovation once his product pipeline is fully realized.  These two other companies, along with plenty of others, have shown that persistent innovation and good IP can drive growth for decades.  Only if a day should come when Apple is no longer a disruptor, will the analysts have any ability to accurately forecast future growth.  Until then, the ride continues.

  • Anonymous

    Brilliant narrative! While reading it, I kept being reminded of the Flying Spaghetti Monster for some reason.

  • Vishnu Konduru

    Wow. One of your best, surely. Thanks, made for excellent reading, especially the high quality of thoughts exchanged in the comments.

    I am not a financial expert, not at all. But, I was wondering if there’s something worthwhile in all this low (and getting lower) P/E.

    Would it come low enough such that it may be a tempting proposition for Apple to to buy back shares with all the not insignificant $$ they have/generate regularly? Not to forget the borrowing costs are what they are, it may even make for a great way to lower tax rates somewhat.

    They should just go private, innovate in peace and be done with all the obligations of a public company. Stock options for employees may find reasonable alternate liquidity avenues, I would imagine.

    I would love to hear from any/all/Horace. Happy Holidays, all.

  • Rocko

    “I’ve thought about this and I am now of the opinion that a reduction of the problem of disruption forecasting leads to an existence proof of God.”
    Funniest comment I’ve read in a long time.

  • http://profiles.google.com/ropeadopedope scott millhouse

    On the eventual growth termination concept and the therory of large numbers.  In the “end” (declining and eventuallu negative growth), what would Apple be left with given its current trajectory?  A massive pile of cash, a huge brand, a proven efficient global business managent system, innovative designers and engineers, and more.  What entity would be in a better position to lead global technology into the future than Apple?  Think about it.  I think it comes down to whether top management wants to lead or sit on their laurels.  I guess the idea is that the company will either have a big “mission accomplished” party and everyone involved will go home rich, or the company will slowly squander their cash and disintegrate.  However, neither of these concepts describes Steve Jobs or the company he built.

    • http://pulse.yahoo.com/_IW6WQYIJ357HUGAMNXM7QCZT6U seward

      The problem is that eventually the slowing growth prediction will come to pass.  When that occurs, those who had been predicting it (wrongly) for the better part of a decade will exlaim, “Aha!  I knew it!  Apple is too big to continue growing!”, conveniently forgetting that they had been wrong for the better part of a decade.  Sadly for Apple shareholders, the prevailing view that the end is near for Apple has kept a lid on the share price and thus Apple shareholders have been poorly rewarded for being exactly right, an investing feat that is becoming increasingly more difficult.  Year after year after year, Apple –as Horace so clearly hs demonstrated–has destroyed the expectations placed on it, but shareholders have not reaped the rewards that should have been theirs for the reaping.  Given all the company’s strengths, analysts could easily construct a case for Apple carrying a trailing p/e of 20.   The would put present value at $550 and I for one would feel much better about the decision I made to invest in Apple.  Don’t get me wrong, I have done well but Apple is one of those once-in-a-lifetime investments.  Generally, you have to catch one of these in its infancy, but this one is right here before everyone’s eyes.  It is the most visible publicly traded company in the world and the investment community is squandering this opportunity. Of course we are frustrated.  Will the rest of the world ever wake up? 

      • Anonymous

        I’m sanguine about it.  The company may not generate the kinds of returns that we would like, but it still looks like a once in a lifetime buy and hold if you take a history.  AAPL has beaten the S&P almost every single year for the past 10.  In two of the three years that it lagged the broad index, it followed up with more than a 100% performance beat.  Check out my little tables below.  My Favorite column is the compound beatdown.  I personally didn’t get in until December 2008, but it is still good for more than 3x what I would have made in a boring index fund.

        Annual performance vs. S&P

        AAPL

        S&P

        2011
        20.57%

        17.48%

        -3.09%

        2010
        38.01%

        53.07%

        15.06%

        2009
        105.75%

        132.21%

        26.46%

        2008
        -19.19%

        -56.19%

        -37.00%

        2007
        130.88%

        136.37%

        5.49%

        2006
        -2.29%

        13.50%

        15.79%

        2005
        118.35%

        123.26%

        4.91%

        2004
        191.75%

        202.63%

        10.88%

        2003
        15.70%

        44.39%

        28.69%

        2002
        -16.40%

        -38.50%

        -22.10%

        2001
        59.07%

        47.18%

        -11.89%

        Compound
        performance vs S&P
        AAPL

        S&P

        2011
        20.57%

        17.48%

        -3.09%

        2010-2011
        75.06%

        85.94%

        10.88%

        2009-2011
        302%

        332%

        30.47%

        2008-2011
        117%

        101%

        -15.99%

        2007-2011
        360%

        346%

        -13.76%

        2006-2011
        402%

        397%

        -5.42%

        2005-2011
        992%

        994%

        2.49%

        2004-2011
        3631%

        3641%

        9.68%

        2003-2011
        4952%

        4986%

        33.81%

        2002-2011
        3095%

        3099%

        3.69%

        2001-2011
        4536%

        4530%

        -6.36%

      • Anonymous

        Horace, is there any way to clean this up?  I can email you the table, but it’s telling.  It looked good until I hit send, the the formatting went out the window.

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

        Take a screen shot of your table and post it as an image.

      • Anonymous

        Here’s the table.

      • Anonymous

        Joe, thank you so much for taking the time to do this.  I’ve never seen a year-by-year compound history.  Wow.

      • Anonymous

        No problem.  I’m glad to see somebody read it!  I didn’t expect anyone to see it once the thread was a couple days old.

    • sidsilver

      Great post.  At an ex-cash PE of 6X it means the market expects the company to be dead in 6 years or so. 
      > What entity would be in a better position to lead global technology into the future than Apple? <Any company that was lead by a creative dictator CEO — and creativity can sprout wherever it happens to be — i.e. anywhere.  

      However, momentum, product pipeline and brand will let aapl handle any challenge for the next 3 years or so. 

      • SidSilver

        The commenting software on this site screwed up my post.  

        Great post.  At an ex-cash PE of 6X it means the market expects the company to be dead in 6 years or so. 
        “What entity would be in a better position to lead global technology into the future than Apple?” 
        Any company led by a creative and visionary founder.  
        However, momentum, product pipeline and brand will let aapl handle any challenge for the next 3 years or so. 

  • Anonymous

    As a shareholder, how is this knowledge actionable?

    The only thing I can think is that an investor needs to be patient. Eventually, Apple will issue a dividend or like. If Cook were to decide that they have enough cash for whatever purpose they have in mind and were to return any future cash earned, then you’d see $40 to $45 a share in 2012, etc. That would quickly force people to reassess the value of Apple’s present and future cash-flow. The current stock price would clearly be seen to be too cheap relative to the cash-flow generated. This brings the future expectations out of the hands of the underestimating analysts and the market, and put it in the hands of actual investors. I think only then will the stock more accurately reflect the value of the company’s earnings.

    • Anonymous

      Great point.  Until then, it is the easiest, safest stock on the planet to own for long term appreciation.  We may see further compression, but I seriously doubt AAPL will ever trade at a hefty discount to the S&P.  It’s basically at parity now (on a trailing basis), meaning that the “shock” of future earnings should propel the stock in 2012.  Even if the share price rises at a 40% discount relative to performance and compresses the multiple further (i.e. profits increase 50%, AAPL increases by 30%), the stock should outperform all major indices.  Your statement regarding cash will ring more and more true until  the company has no choice, but along the way it will just get even easier to own, in terms of downside risk.

      If the easy money is in AAPL, the big money will continue to be in the options market.  There is no better way to capitalize on “surprising” news than owning long-dated expiration calls.  I won’t pretend to understand the pseudoscience behind weeklies and max pain, but the fundamentals that drive LEAPS are very easy to comprehend.  

      I’d love to see an analyst dedicate some time to exploring what effect dividends might have on the various Apple derivative products that dramatically impact share price.  My guess is that a nice dividend (even a modest 2-3%) would normalize the swings a bit.  I don’t advocate depleting the current cash pile, but if Apple returns only their US-held cash flow to shareholders we could see a decent dividend.  This would avoid the double taxation that everyone hates while attracting a new class of long term investor to the holding.  Most of the company’s capital expenditure is likely outside the US today anyway, and can be funded with foreign held cash.  This week’s reported acquisition of Anobit (Israeli company) is a prime example.

  • mysterio

    Love this data. Most publicly-available forecasts (Gartner, Forrester, IDC, every sell-side equity analyst…) follow this pattern. This is actually a factor strengthening the innovator’s dilemma. Companies look at projections like this an systematically underestimate the disruption facing their business.  Add in confirmation bias and you have a hard time convincing anyone who reads analyst forecasts that there’s anything disruptive going on.  

    Good on you for outing this!

  • Steve Coleman

    Horace:

    You can get on Apple’s call.  You do not have to be a CFA.  The only credential that you need to have is competence.  ASYMCO is all of the proof that you need.  I will email you the call-in number and conference code when it is released, generally two weeks before the call.

    Steve

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

      I can listen to the call but what does it take to ask questions?

      • Anonymous

        It takes Apple accepting you as a professional.  I’ve tried a few times to get on the conference call.  But if you’re not with Morgan Stanley or Goldman Sachs, they pretty much tell you to f-off in so many words.  

        Same reason Bullish Cross hasn’t gotten an invite to a product launch event even though the site was getting almost 5,000,000 visits a month.  I’ve noticed it’s really not easy to get Apple to put you on their list unless you’re associated with a large publication or firm.  

      • Anonymous

        Which begs the question – what makes the bank sell-side analysts professionals?  To most businesses, I would say that the banks represent access to capital through lines of credit and bond auctions.  The banks also advise on M&A activity, secondary issuances and the like.  But Apple is not most businesses.  They could tell everyone in the room to f-off in so many words.  Their financial strength and absence of debt render the banks powerless.  

        To me, they should either cancel the analyst Q&A entirely, or democratize it.  You, Horace, and a few others could easily be vetted by the company as legitimate private analysts.  The company wouldn’t be obligated to let in anyone who wants, nor should they be.  But bank affiliation really shouldn’t be the determining factor.

      • pds

        It would be great to hear you on the call.  Like you I approach the earnings with more anticipation than any keynote. 

        There is a delicate dance between the analysts and AAPL finance and it is all a pretty conservative affair.  It would be interesting to hear what you think should be asked that isn’t and could be answered ( even if you’re not on the call ).  My sense is that AAPL has a very clear sense of what details they are willing to reveal.  What would they be willing to discuss that isn’t being addressed by the current analysts?

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

        There are many questions that don’t get asked but that I think will get an answer. There are also many questions which waste people’s time since they will never get answered.
        Questions which should get asked are related to their capex. Basic stuff like what is the split between process equipment and data center equipment.

  • http://www.facebook.com/profile.php?id=521766158 Larry Fritzlan

    I have a paranoid fantasy that The Street is angry that AAPL won’t give dividends or buy back shares and have collectively dissed the stock hoping Apple will relent and give dividends.

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  • Anonymous

    Why is Apple management against a stock split? Once the share price is cheaper this might be a catalyst for more widespread ownership and subject to less manipulation by options and hedge funds. It is also a catalyst to increase share price. One can see on a 10:1 split that Apple could more easily go from $40/share to $80/share then from $400 to $800. BIDU did this with great results. It does not cost the company 1 penny.

    • jawbroken

      This conventional wisdom seems as suspect as the above analyst predictions. Where is the evidence that it would be easier to go from $40 to $80 than $400 to $800? Why do you presume Baidu significantly benefitted from their stock split? Why doesn’t every stock split 100:1 right now?

      • Chris

        I agree with you jawbroken. 100:1? I love it. At a price of less than $4 per share, Apple would be cheap by any measure, and truly undervalued…(/sarcasm)

      • Anonymous

        I believe Horace said 1:100, or $38,300 per share, bringing the float down to 9+million shares.

      • George Henry

        I like the Berkshire Appleway plan…. lol

      • SidSilver

        You would argue with the founding fathers as to why anything should be considered self-evident :)  

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

      Why not go the other way? Why not do a 1:10 split or a 1:100 and reduce the value of the company? If nobody will want to own “expensive” shares they could then pick it up with leverage for a song and take it private. A trillion dollar value priced in the billions.
      If you can change the perception of value through share splits then they should have dedicated teams trying to engineer the best ratio. Perhaps hire a CSO, a Chief Split Officer with experience in these matters. Leave Cook and co. to worry about making more phones.
      If you want to read more about the benefits of financial engineering I suggest: http://www.reuters.com/article/2011/12/16/us-olympus-masterminds-idUSTRE7BF0FB20111216

      • sidmehta

        Not on, Horace.  You are ignoring the right brain.  Did you forget that the right brain – emotion — is one of the main reasons people buy aapl products?
        Logic alone doesn’t justify my buying an iPad.  And by logic I should buy the cheapest phone that does the functions I need.  Which is certainly not the iPhone.   And do I really need an expensive car????  Splits / Number psychology works because everyone human being on earth has a right brain.  It’s like the difference between 99 cents… and One dollar.  It’s easier for people to imagine a stock going up from $40 to $80, rather than from $400 to $800.   Not logical, true.  But man doesn’t live by left brain alone.  BTW the right brain is why many analysts don’t make the logical projections they should:  fear, possible shame, ridicule, etc. if they are wrong.   It’s also why human beings are risk-averse (remember your ME class).  Illogical? Yes.  Is it reality? Yes.    Not understanding reality, demanding it shouldn’t be this way, and that reality should be ignored? Denial. 

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

        Product purchase decisions are influenced by many factors and are in service of jobs people need to have done. It’s nothing to do with right brain/left brain. Vanity is a big job and there are products designed for it. Emotion is its own logic. However, the job to be done by a manager is not to appeal to the emotions of stock traders.

      • George Henry

        To be fair, however, the use of the word “vanity” here is limited in its meaning and scope simply because Apple makes products that have the fit and finish that you want and expect from your technology.  My girlfriend just bought a $450 toshiba laptop, and it’s everything I expected – cheap build quality and the trackpad is erratic.  You pay $1000 for a Macbook Air, and you get a slice of engineering genius… look at studies of total cost of ownership, and you note you even end up spending less to have a better product.  That’s not “vanity,” … that’s conservative common sense.

  • Davel

    This is a great article.

    You clearly illustrate reasonable assumptions that go so wrong.

  • nontekkie

    Great article, great discussion.

  • http://twitter.com/zzbar Joe Zou

    where are the “behavior finance” theorists? surely they have an explanation. 

  • Bowman

    While rare, there are a few examples where the professional advisors and leaders are incapable of understanding a major disruptive force and remain clueless, even after the facts prove them wrong.  Apple, to be very brief, is perhaps the first well managed vertical technological ecosystem with large scale financial impact (the only comparison is Henry Ford).  Like a Black Swan, it may be impossible to analyze its true impact for years after it occurs.

    The example I would compare Apple with is the judgement by the U.S. Government in 2003 that Iraq was certainly engaged in a nuclear weapons program.  Throughout the ’90s and through 2003 I was involved in developing a new “Integrated” nuclear safeguards inspection system to replace the weak piecemeal system that previously existed.  In effect, we developed and implemented in Iraq an inspection system that amounted to a true safeguards ecosystem which intimately combined all relevant safeguards factors under one central administrator.  At the time, many of us relatively low-level technical officials believed that it was nearly certain that Iraq had no ongoing nuclear weapons program (for example, after years of onsite inspections using the latest intelligence actionable findings, there was absolutely no evidence of an Iraqi nuclear weapons program).  We reported these findings to our senior political and intelligence leaders at the highest levels.  These leaders and decision makers, refusing to understand the effectiveness of the new integrated safeguards system, strongly disagreed.  In effect, they literally started a war for the wrong reason.

    Horace, like us working in the bureaucratic trenches in Iraq, you are almost certainly factually correct in your analyses.  But those who follow you may still lose a lot of money betting on Apple because the senior people who make the large money decisions refuse to understand the disruptive powers of Apples ecosystem.  However, a blow-out quarter in January may do the trick.

    • SidSilver

      Since none of the previous blowout growth had any effect on the analysts, why would this one?! 

      And Iraq was all about the oil not about weapons.  Or they would have pulled out the week they found none.   
      Bowman my jaw drops at your naivete.  

      • Bowman

        I fully agree, but if revenues keep increasing, even with reduced margins, we’ll make it all back in eventual dividends.  All we need is a little patience (although this week’s market gives more than a little hope).

        My jaw drops at your naivete regarding oil being the reason for the Iraqi war.  Granted, certain Pentagon types hoped for massive permanent military bases in the oil region around Basra, but it was never argued, in any of the war planning sessions, as oil being even a secret basis for the war.  

        After 9/11, the war planners made a serious search for a “justifiable” reason for invading Iraq.  At the end, all the major players relied on WMD as the only certain and sellable basis for the invasion.  As Tenet said, WMD was a slam duck (while we, with ground-truth, knew the opposite was the case).  In any event, we could have easily purchased the oil from Saddam at a reasonable price, without killing over a hundred thousand Iraqis.  And our military has now totally left Iraq, leaving Iraq free from U.S. influence to sell their oil to China.  Seriously, the Iraqi war was caused by an over reaction to 9/11 with the key decision made by an ignorant, though well-meaning, President Bush.

        But I digress.  I wish only to make the point that there are other historical examples of where major disruptive developments leave the key analysts clueless.

  • site7000

    So the question for Apple management this year is what are they going to do to maximize shareholder value? Dividends? Splits? Both? That was always a non-concern for Jobs, but I think Cook & Co. should address it. It’s getting pretty negligent for them not to. 

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

      I don’t think it’s management responsibility to maximize shareholder value. That’s a pervasive myth.

      • Westechm

        That will get some comments.  BTW, I agree with you.

      • Advill

        Westechm….you are right, ABSOLUTELY…….BUT, what happen when you do your duty ( as Apple management has done), and then ‘market’ don’t recognize your effort? ….just a question

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

        The answer is “it doesn’t matter”. It really doesn’t.

      • gbonzo

        Normally it does not matter. You can just sit with your stocks and wait for the dividends.

        But if there is no dividends, then the only way you can ever get money out of your investment is by selling. Suddenly the stock price starts to matter.

      • Jbfiacco

        Yes, it matters. If you have held it for a long time you have made an excellent return. Sell part of it and say “Thank you” to Steve Jobs.

      • http://michaelkdawson.com/ TrendRida

        You gotta remember that employees are shareholders also. A part of their compensation is in stock. If the stock price doesn’t increase in value – the company may need to increase cash compensation. In AAPL’s case maybe that’s no big deal, but AAPL is an exception. 

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

        A part of their “bonus” is in stock. Employees should be weary of companies who offer compensation in the form of shares. That would be taking on a huge amount of risk.

      • http://michaelkdawson.com/ TrendRida

        Sorry, that’s the way it’s done in Silicon Valley. There is tremendous competition for talent. Straight cash compensation can’t compete with an opportunity to knock the ball out of the park thru stock. Not only are employees rewarded with stock grants and options – there are employee stock purchase programs – where employees can purchase shares at a discount…

      • Anonymous

        So what is their responsibility?

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

        To maximize the long term value and viability of the company. I quote from this: http://www.businessweek.com/magazine/content/07_22/b4036100.htm

        “At some point, some now-defunct economist seems to have said: “Let us assume that managers’ responsibility is to maximize shareholder value.” This made the mathematics work. And through endless repetition, nearly everyone came to assume that managers are responsible for maximizing shareholder value.

        Through the 1960s, this premise wasn’t at odds with reality: The average shareholding period was more than five years. Managers seeking to maximize the long-term strength and growth of their companies could reward these patient shareholders. But today shares are held, on average, less than 10 months. Should managers really regard such investors, whose investment horizons are shorter than the most nearsighted of managers, as stakeholders whose value they ought to maximize? 

        Perhaps it is time for companies to adjust the paradigm of management responsibility: “You are investors and speculators, not shareholders, and you temporarily find yourselves holding the securities of our company. You are responsible for maximizing the returns on your investments. Our responsibility is to maximize the long-term value of this company. We will therefore act in the interest of those whose interests coincide with our long-term prospects, namely employees, customers, the communities in which our employees live, and the minority of investors who plan to hold our securities for several years.”

        The article goes on to suggest that companies that optimize for long-term value may need to restructure their ownership.

        See also: See also:
        http://content.imamu.edu.sa/Scholars/it/net/hbr-how%20financial%20tools%20destroy%20your%20capacity%20to%20do%20new%20things.pdf

    • Addicted4444

      They have already maximized shareholder value.  Check out all the cash that is sitting in their banks.

      Oh wait, you meant share-traders’ value?  Well, I think apple should do zero to zilch maximizing their values…

      • Addicted4444

        That being said, I do think a dividend might be necessary, to reward continuing shareholders.  I hope a “split”, “buyback”, etc. are off the table because those are just beauty pageant gimmicks to try and reward some lucky folks.

      • George Henry

        All I’m going to say is that there are places Apple could leverage its $100 billion to level up.  I’d rather see an Apple that is aggressively reinventing the world with its money, than one that thinks this cash would grow better in shareholders’ low-interest certificates of deposit.  That’s why I’ve held apple since it was $4, and it’s still cheap – because Apple as a market player has unique opportunities to invest this money for us in ways that yield far greater returns than if we just give it to the banks “to hold for us.”

        Always hear this dividend / buyback crap from institutional idiots who were naysayers the whole ride up.  I say if you thought it was beleaguered back then, you should STFU and GTFO… you have no understanding of the company, the marketplace, the industry, or the moment.

    • Pete Ovnhammer

      Yeah right. Apple has done an extraordinary job for their stakeholders for the past eight years or so. Accusing Cook & co. negligent is absurd. Who are you?

  • Anonymous

    While being on the conference call would be nice, you only get to ask a question or at most two questions. It’d be far better if you got to have one of those private sit-downs with Cook and Oppenheimer that some of the professional financial analysts get. There’s also the annual shareholder meeting where you can ask a question. I know in the past, Daniel Eran Dilger has gone and peppered Jobs, Cook and Oppenheimer with multiple questions.

  • berult

    It’s a case of a foreign agent invading a close-loop, self-reliant multicellular organism. No matter the benevolence and benefits the agent’s synergy with its host might bring to the compact, the defense mechanism, …the immune system will come into play in all its might to fend off the intruder. Obviously relevant in biology, and just as real a defense mechanism in abstract biological systems such as the economy and its vibrant market places. 

    The factor that gets in the way of outright rejection of Apple’s market intrusion , the market immuno suppressor of destiny, speaks loudly of the power of efficiency-based, life-enhancing disruption. People, …consumers ‘immuno suppress’ institutional intolerance to evolution, until the full merit of symbiosis be granted amnesty and divested of a systemic branding as the host’s enemy. An immuno suppressor counteracts the system going haywire over its never invited, congenially fought off and organically repulsed prophet of either doom …or extended longevity.

    What took nature eons to learn about being a host …and a hostage, is being taught to a complex adaptative system within sweeps of ever shrinking technology and business cycles; the curriculum of less and less randomized, of more and more delineated …more predictable revolutions. In that regard, Apple-the-trailblazer ‘serializes’ change into marketable short-story narration …with much reading discomfort to post-narrative entrenchment; …whirlwind of four dimensions …a storyline …and characters iterated along improbable tangents…

    • melgross

      Very nice. Shows how one can obfuscate the issue with complex speech while actually saying nothing.

      • berult

        Thanks for your clarifying contribution…! Your comment was the reality-based element that was sorely missing to make my comment comprehensive, and highly relevant…!

      • Kevin

        Wrong.  What you wrote can not be understood.  Period.

    • Fwa2252

      ok…but should I buy it at $450?

  • Anonymous

    @fb789b193c43f4f3289a2bf75250d6e2:disqus 

  • Marian

    Horatiu, I added (actually multiplied) your numbers.
    Analysts predicted that the revenues will grow 48% in those 6 years. In reality they grew 1689%
    (there might be some rounding errors).

    Analysts predicted 1.5 times growth. But reality has a very strong Apple fanboi bias: 18 times growth.

    • Ido2

      So since they grew fast, they must have fanboy bias??!! – they can not actually have made products that offer value and sell on their merit.

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  • Rt

    Horace,
    I’ve been waiting a long time to see this article in print.

  • Murdock

    This is a brilliant article, Mr. Dediu.  I have a lot of respect for your methods and your clarity of thought.

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