Back to the balance sheet

I first noted a correlation between Apple’s share price and its balance sheet a year ago. In February, when I last checked, Apple’s share price was priced nearly at 4.6 times its cash value. The stock has had a brief rally but has returned to the trend line it’s had since late 2008.

I should emphasize that this correlation between cash and price is abnormal. It should not be happening. Share prices for growing companies should be tracking its future potential, not its assets. I’m only presenting this data to highlight this abnormality. There is no fundamental basis for this happening. In fact, there is a basis for this not happening.

The relationship above is a symptom of another pattern called multiple compression that can be seen in the following charts: 

The last chart in particular shows how as a function of earnings and growth, Apple is priced near a low. Certainly lower than during the depths of the 2009 recession.

Given this disconnect from the income statement, the pricing by balance sheet multiple seems to be a symptom of something deeper. Reasons vary with the seasons, but the company is not perceived to have sustainable growth.

  • They are betting against the iPhone (and the iPad too).
    The only successful android company is the one that copied the iPhone more, rim is falling, windows phone is falling, smartphone market is rising, I wander what and if are they thinking.

    In tablets android is not selling even at a loss, windows 8 has no tablet software nor has proven to have enough battery like, nor it has media services, all has to be built.
    I just don’t get it.

    • Accent_Sweden

      I think we have to distance ourselves from Apple to understand this behavior by Wall Street. Yes, Samsung is successful because it is copying Apple. But Wall Street respects that very behavior. They assume nothing is unique about Apple that can’t be copied, in spite of the evidence. Ignoring this rationale just sets us up for frustration. Wall Street doesn’t believe in long-term success, only long-term defeat, when it comes to Apple. Perhaps that is why the share price doesn’t stray too far from a steady multiple of cash.

      • Of course you are right about Wall Street behavior, but my point was different: why Wall Street does not believe Apple to have sustainable growth since the only successful phones are the iPhone and the android most iPhone like?
        Why they think this will change soon? 
        It is not a problem for me that samsung copies apple, it is wall street that does not sees that the success of samsung is due to their copy machines and that it is the iPhone concept that gained almost 90% of the market profit (78% apple, up to 90 considering the iPhone clones made by samsung).

      • Joe_Winfield_IL

        I think you missed the point @Accent_Sweden was trying to make. As investors, Wall St. Sees Samsung’s success through copying as a NEGATIVE for AAPL. In theory, if Samsung can do it, so can everyone. If everyone does it, Apple won’t be unique and won’t be able to charge a premium for its products. If Apple can’t charge a premium, forward profit assumptions aren’t safe. If future profit assumptions aren’t safe, the company can only be valued based on what is guaranteed. The only thing that is guaranteed is the current cash.

      • Gonji

        Hence why Apple is throwing everything into its lawsuits on copycats to ensure it does stay unique.

        The reason I see Wall Street betting against Apple is that Apple has too few products for Wall Street’s liking. One major iOS failure can effect all iOS devices and thus around 60% odd percent of sales. 

        In Wall Street’s eyes Apple is just not diversified enough.

      • Merelywords

        These comments about Wall Street’s perception (copying, too few models, etc.) are all too true.  They are all flawed, but all too true.  This “return to the mean” drumbeat doesn’t always happen though.  Think Ford in the 30’s or IBM post WWII (split 15 times).  In the long run we’re all dead, in the mean time fortunes have been made waiting for WS’ fears to come true.  Hence the compression.

      • neutrino23

        I find the discussion about what Wall Street thinks to be very fascinating. Of course, Wall Street is not one individual, it is millions of individual investors making decisions. The behavior of stocks like Amazon and Apple give lie to the notion of the efficient market. It seems the market is driven as much by fads and fashions as by facts on the ground.

      • Dajhilton

        I am not sure that I would agree with your dichotomy between ‘fads and fashions’ on the one hand versus ‘facts on the ground’ on the other.  It seems that the fads and the fashions ARE, or can be, the very facts when it comes to these valuations.  And nowhere of course is this more apparent than with respect to Apple.  If it’s brand were not so fashionable, even faddish, it would not be so valuable.  That’s a fact.

      • neutrino23

        My point was that we read about the “efficient market” which is based on sober information like profits and sales and such.

        And yet, some stock prices seem to be pushed one way or another on all sorts of rumors and whispers and guesses and hunches. Amazing.

      • Kizedek

        Ironic isn’t it. So, if Apple got into some other stuff that it thought it wasn’t ready for, or couldn’t do as well at, or hadn’t “cracked” yet, Wall Street would love it.

        If, say, Apple was MS and got outside their core competency and made an X-Box or a phone — something that would lose billions and have to be propped up by the core business. That would be hunky dory, then, wouldn’t it?

      • Dajhilton

        Yes, and with specific reference to your suggestion that Apple ‘could’ if it wanted to out-Google Google and Amazon with respect to cloud services, that is precisely where Apple’s extraordinary cash hoard gives it the upper hand.  Hollywood and the music industry are not simply going to allow their copyrighted works to be endlessly streamed for free from ‘clouds’ operated by Google and Amazon, no matter how cloud subscribers obtained their original copy of the work being streamed.  Only Apple, among the potential competitors in this space has made public noises recognizing that the creators of these works will need to be paid and their works licensed before a viable cloud service can work.  Given that Apple actually does have the dough to license all the films and all the music in the world just by drawing from petty cash, it can actually be disruptive by being anti-disruptive in the cloud:  by propping up the copyright holders and their moribund industries, Apple gains the inside track on providing a legal cloud service that no one else could match. 

      • BigApple

        Apple’s lack of diversification (i.e., focus) is precisely why it is eating the world’s lunch.  I sure hope it doesn’t change that.

      • Gonji

        I,too, hope that Apple doesn’t change as focus give quality. But, Wall street doesn’t look at quality, it looks at risk and Apple presents a risk.

      • BigApple

        So how/why does Apple succeed in charging a premium in PC’s, where it has only 8% market share?

      • Joe_Winfield_IL

        To be clear, I don’t believe a word of what I wrote to be justifiable. I am just backing into the logic that others use to value AAPL. I’m long since $90, and I’ve added to the position several times along the way. To me, today’s “outrageous” price estimates of $1000+ are no more crazy than the $500 targets of a couple years ago. I’d love to see the multiple expand, but I’m not counting on it – I may disagree with the logic, but I accept that it’s widely held.

      • mieswall

        OK. Even then, cash is increasing at a rate of 15% per Q. That would mean that, a year from now, stock should be trading at: 570*1,15^4=997. That is in line with some target prices published recently. Have to be traced the impact of dividends on this.

        So, even with this fear on sustainable growth, capitalizing on big realized earnings (that will occur, in a fast growing market of smartphones and tablets is impossible that apple suddenly switches growth from 100% to 15%, less than the very market that created), as this growth favors cash, would mean the stock is quite cheap.

        Btw, I believe AAPL itself is constraining its market share, since it is not able to produce at the same rate of market growth. Here in the tiny market of Chile, for example, tablet sales have grown more than 500% last year (to 11% of total computer sales), even without the new iPad, that still have not arrived.

      • Joe_Winfield_IL

        Isn’t it great? AAPL is the gift that just keeps on giving. Even with the most conservative valuation imaginable (cash based), the company has a very clear path to double an investment at today’s price, then double it again. Of course the company needs to continue executing to make it happen, but we have seen no evidence to suggest that they won’t.

  • Appero

    Perhaps fear of post-Jobs is kicking in…

    • Vendrazi

      As Horace pointed out some months ago, fear of a post-Jobs Apple was factored into the pre-August 2011 stock price. If WS is still wondering about Apple’s performance in the two quarters since he left, they’re simply blind. 

      • Dajhilton

        Yes, Apple has added $200 billion in market capitalisation post-Jobs.  If that’s what ‘fear’ looks like, I can live with that.

    • famousringo

      Fear of post-Jobs kicked in two years before he died.

  • Francisco Moreno

    Irrational doom.

    Apple is afflicted by the disruptor’s general ill repute, and any and all missteps are magnified and seized on by the competition.

    For example, Final Cut Pro was the up-and-coming solution in the professional video market and momentum was such that everyone was either in the process of switching to it or about to.   Apple released FCP X, an absolutely revolutionary, leapfrogging, disruptive product… and no migration path from FCP 7.   The whole industry seized on this opportunity and FCP is currently in abject decline (and this helps explain very well why Mac Pro is in such a lull, BTW).

    In the long run, all video editing will be done in FCP X or its copycats.  Nonetheless, today anyone in the industry who defends it or even tries to explain it gets rammed down.  Similarly, in the fullness of time AAPL price will bloom, but meanwhile it’s quite the money sink.

    • marcoselmalo

      FCP X didn’t address the job for which it is ostensibly for hire, i.e., despite its revolutionary aspects, it didn’t meet the needs of many pro users.

      Part of the (over all) job-to-do that the pro community expects is to have a reliable vendor that is perceived to be actively engaged with the community. In the early days of FCP (roughly 2000 – 2005), Apple engaged in a great deal of evangelizing for FCP, which gave the community confidence to invest money and time into it. There were, iirc, more frequent hardware refreshes of Powermacs. This also instilled confidence.

      FCP X arrived out of left field. The revolutionary disruptions disrupted the customers’ workflows. Combine this with a slower pro hardware refresh schedule, and you can understand why pro customers are doubting Apple’s ability to do the job for them. Lacking confidence, customers are looking for other solutions, especially the original king of the Non Linear Editing (NLE) hill, Avid.

      Disrupting your competitors is one thing, but if you disrupt your customers’ business, that’s another thing entirely!

      • JohnDoey

        That is the PR that you just enumerated. It is the same PR that is run on all of Apple’s products. It is the same complaint as the people who wanted terabyte iPods in 2005. Apple gave them iPod nano. Apple will always do that. Other manufacturers will always use that kind of moment to make hay about their hard disk MP3 players or giant video edit suites.

        The reality is, the typical Avid system is about 20 times the size of the typical Final Cut system, which is usually a notebook. You are not typically going to swap one for the other, same as if you need a terabyte of music with you at all times, you were never seriously considering an iPod. Avid is right to point out that they are a bigger truck. But Final Cut Pro always served the small truck market. The PowerBook G4 Titanium was sold as a mobile Final Cut Pro studio in 2001. Final Cut Pro X on SSD MacBooks with Thunderbolt is what Apple was always cooking.

        No customers were disrupted. Apple supports the current and previous versions. With an “X” version, the previous version becomes a Classic version and is expected to have an even longer life than otherwise. If 7 was serving your needs, you don’t even need to know X exists and may not even know it exists. If you buy X, 7 continues to work. There is a transition to the X version. Most longtime users are expected to come late, after the 3rd party infrastructure is updated and debugged.

      • marcoselmalo

        If you don’t believe me about how users felt, you need only check forums where professional users congregate. I suggest

        I think you are confused if you think a mythical terabyte iPod is anything near the equivalent of a professional tool that professionals rely on to make art and make a living. You really need to check yourself over this one as your comparison is risible.

        Regarding using a TiBook as a “mobile FCP studio”, you are overstating things. At best it was a FCP sketch pad in the field. If you wanted to edit on the TiBook, you had to downrez your footage. So, it was doable, and might be useful, but I don’t know of any features that were edited on the “Mobile FCP Studio” in 2001. Maybe you can cite one if you know of one.

        Professional users need product continuity (and I feel they have a right to demand it). For example, when their NLE is upgraded they have the right to expect that they can import old projects. They have a right to continue to use their older workflows, on which they may have spent enormous amounts of money, even if they are being presented with a new better way.

        Now, I have a clarification to make. I haven’t touched FCP since about 2006. Before that, I learned it from Michael Wohl, one of the original developers that came to Apple from

      • marcoselmalo

        Continued: from Macromedia with Randy Ubillos. That was during my year long internship at the American Film Institue in 2000. After that I worked for about a year as a Trainer at DVCreators, then went on to freelance as a FCP trainer. I’ve worked on many many low budgets features. I’m no longer doing this work, but I still know a few feature editors and TV editors. They are still nervous about where Apple is going. There’s a lot of uncertainty.

        I’d like to give some additional background on pro users general fear that Apple might leave them in the lurch. In the 1990s, Avid worked on both Macs and Windows. At some point, I think with the G3 towers, Apple limited the number of open slots on the motherboard. About this same time (maybe just prior), Apple had also shut down the clone makers that made Mac clones with plentiful slots. Avid stopped supporting the Mac for many years because of the lack of slots on the MB. So, pro video and film users have been left stranded because of Apple’s decisions before. Once bitten, twice shy.

        There are genuine concerns about Apple and FCP in the pro community.

        Also, one suggestion from a former FCP evangelist. If you’re going to evangelize a product, avoid blowing smoke up the ass of professionals. Some of them might know better, and your reputation and credibility will suffer.

    • JohnDoey

      No, Final Cut is not in decline. It may be in decline in large edit suites, but it remains as ever the most popular pro editing solution on the planet. Final Cut Pro X is the most popular version ever. Apple has overwhelming market share in pro, consumer, and mobile video editing. What has happened is Avid and others went bigger and more high-end than Final Cut, while Final Cut continued to get smaller, more mobile, more available to lower budget projects. Same distruption as 10 years ago. Nobody should be surprised.

      Mac Pro is in decline for many reasons, none of which is Final Cut. Apple hardware sales to video editors are up. Studios that used to have 25 Mac Pros now have 5 Mac Pros, 20 iMacs, 10 Mac mini servers, 25 MacBooks, 25 iPads, and 25 iPhones. The decline of Mac Pro is a form factor switch. A MacBook Air with i5 and Thunderbolt is faster and has faster interconnects than almost all Mac Pro and Power Macs ever shipped. Something has to give there in Mac Pro demand. iMac is more powerful than that and you can rely on the color the screen shows you. You can install Final Cut Pro X from Mac App Store in no time and get working without IT support.

  • It will be interesting to see what happens to the first chart once Apple’s dividend starts draining off cash. Presumably the slope will flatten somewhat, since only the US cash accumulation seems likely to be affected, and I think it will get pretty much tapped out for the dividend, if I remember the numbers right. However, the overseas cash should continue to grow.

    • ronin48

      No.  The rate of cash growth is increasing even after the dividend and buybacks begin.

      The slope for the line fitting share price as a function of total cash will continue to increase – albeit at to a lesser degree.  It will not decrease (flatten).

      • Wups, misread the graph; for some reason I was thinking the x-axis was time, but it isn’t. So the price/cash ratio may hold, but the actual data points may not move up the graph quite as quickly in the future.

  • Horace, it would be interesting to hear what you think about this Warren Buffett comment vis-a-vis a) the abnormal behavior of Apple’s stock and b) disruption theory:

    “We couldn’t predict what would happen to Apple 10 years ago and we can’t predict what will happen to it 10 years from now.”

    Buffett only invests in companies he understands and which have future earnings that he can predict. It seems one could almost write a book comparing Apple to the companies that Buffett buys, and what that says about Apple re: disruption and stock price.

    • Buffett does not try to understand disruptive companies. He is solely focused on understanding undervalued sustaining business models. In many ways that makes sense. Since there have been almost no companies that are consistently disruptive, those that do disrupt are seen as accidentally successful. That would not be the basis for an investment strategy.

      • Gary Stein

        Buffet’s claim to be able to  predict a companies fortunes 10 years into the future was given lie in his statement immediately following that discussion where he would not admit he has sold P&G but strongly hinted that it was a former holding of Berkshire Hathaway when not two years ago he was singing  there praises.

      • BigApple

        More than that, just look at the shoe company he bought whole (H.H. Brown?), and NetJets.  Although that might work out very long-term, a decade after he purchased the company it was a dog.  He also invested money in Irish banks (although a small sum) just before they dragged down the entire nation.  Once you move beyond Coke and Gillette (and maybe the railroad/utilities), this “I can see the future” stuff seems questionable.

      • Exactly. So my point is, since Apple is a company that specializes in disruption and Buffett and most investors look for predictability and sustainability, how is that affecting Apple’s share price? I’d guess that when investors try to decide what to pay for Apple, using their normal investment lenses, it’s cloudy. Hence the low PE.

        And thus Buffett’s statement  is the simplest, most perfect way to understand Apple’s low valuation.

  • Matthew Slayton

    if you were to invest in apple purely based on its cash then would it still be a good investment? looks to me that it is. based on your model adding 35 billion over the next year would drag the share price to $700ish. but don’t get me wrong, basing a growth company like apple on a multiple of cash is absolutely crazy considering how we value every other growth company in the world.

  • Cpollakb

    Certainly cash will is given a higher value now that dividends were anounced. Prove of that is that last year the correlation formula you fount was a factor of 4.6x and now is 4.9x. 
    Have you tried doing the correlation starting a couple of month later when when the P/E ratio started to loose rationality and break the expected recovery after the crisis, about January 2010?  The correlation should be also more meaningful.

    I dont believe it was the crisis that modified the way WS valuates apple, it was something that happend after that. What was it? 

    That’s about the time Android started growing over apple and with that planting doubts on apple’s future…..  perhaps

  • John S.

    I think it may be a combination of things:
    – Steve is gone, and in the past many companies who lose super-hero leaders falter within 4 or 5 years.  Will Apple falter?
    – Apple needs a new product line to keep the growth engine humming.  What is their next new, killer product?
    – Apple’s ability to defend its patent rights appears to be uncertain at best.
    – China appears to be a big “if” for Apple, and Apple’s growth curve could be severely damaged if political/legal forces cause Apple to stumble there.
    – Can Apple maintain its product quality without Steve at the helm?
    – Apple share prices have enjoyed an amazing run.  People are fearful of a pullback.
    – etc.

    However, to me the upside appears to be much greater than the downside:

    – Smart phone market potential is beyond huge.
    – Tablet market potential is beyond huge.
    – People who buy phones tend to upgrade every 2 to 3 years.  Probably less frequently on the tablet side.
    – The China opportunity is beyond huge, and if political and legal forces remain reasonably stable it will result in huge profits for Apple.
    – Steve is gone, but he didn’t make Apple a success by himself.  There are many strong leaders at Apple who understand their businesses very well.

    I’m buying on the dips.

  • Gprovida

    I remain convinced that stockholders treat Apple like a boom and bust media company with mega-hits and mega-flops so they discount the future and value based on the current situation.  I might argue this is due to Apple’s secrecy but Amazon is just as secretive and a lot less revealing in its quarterly statements.  

    Of course the irony, like PIXAR, is that Apple has had enormous success over the last 10 years, huge assured growth just on its current customer base, and even bigger opportunities with a world wide customer base.  

    At the end of the day, perhaps it is just too hard to accept or understand and people believe “its too good to be true.”  The danger of there being no credible precedent on this scale.

    • JohnDoey

      There is precedent with iPod. It is just hard to believe that making an iPod is so hard that all of the companies in the world other than Apple were only able to sell 25% of them, and Apple satisfied the other 75% of demand. Well, making iPhones and iPads is much, much harder than making iPods. Now that the phone has been redefined as an iPhone and the tablet PC has been redefined as an iPad, I fully expect Apple to go on to satisfy 75% of the demand for phones and tablet PC’s, and the other 25% of the market will be everyone else. Where Apple products are available, they already outsell everyone else combined, and they have most of the world left to expand into, and they are 5 years ahead in technology from everyone else and intend to stay there.

      It is just hard to wrap your mind around all that. I had an original iPod in 2001 and loved it, but I thought it was a music player for Mac users. I didn’t think it was going to be 75% of all music players sold that decade.

  • Joe_Winfield_IL

    Meanwhile, AAPL remains the easiest buy and hold I’ve ever seen.  All they have going for them is: a P/E multiple below that of the S&P 500, insane growth, dividends/buybacks, talented and deep management team, expanding operating margins, a twelve-figure cash balance, and the world’s best and most profitable product line.  There is almost no fear of regulation, oil spills, labor revolt, tariffs, anti-trust, or product stagnation.  In front of the company are large, obvious and mostly untapped opportunities in home entertainment, education, publishing, payment processing, and simple increased distribution.

    I keep telling myself I need to diversify my retirement portfolio to reduce the weighting in AAPL.  Every week, I spend a couple hours looking for another business in which to invest.  It needs to be something I can understand.  Ideally the business will be one that controls its own fate, has a long way to go before flat growth, carries a reasonable valuation, doesn’t require a strong economy, and isn’t subject to the whim of a single large customer.  Each week, I end up right where I started – with AAPL as a “dangerously” large piece of my portfolio, but the only piece that allows me to sleep at night without fear.

    • Matthew Slayton

       Joe, I have the same exact “problem”

      • Junglejackmock

         I always find it strange that Google stock is more expensive than Apple stock, when Google earned 33 bucks per share in the last year but Apple earned 41 bucks in the same year! Simple math…
        Plus, Apple can and IS expanding into China while Google is basically blocked out. Apple makes numerous excellent and globally desired devices, Google sells advertising. To me, AAPL is a rock solid investment like no other tech stocks that I can find. I saw 15 ipads in use on my way to the bathroom on the last flight I took. Everywhere I look people are migrating into the apple ecosystem. So I am long AAPL.

      • Doug Williams

        I’m another one with the same problem. 

    • Sacto_Joe


    • Same situation here, except I’ve retired, so I have to decide whether to sell Apple stock, or other assets, when I need to produce income. (Yes, my assets aren’t in the usual recommended “balance” at this stage, so I don’t get much dividend income.) It will be a bit easier when Apple starts paying a dividend.

      The “problem” is Apple’s share price growth rate; it used to be a rather small part of my portfolio, but I’ve held onto it for years. Now it dominates the rest….

      Despite the market irrationality, over a span of a couple years or more, it’s very hard to find a better place to put money.

    • capnbob67

      Twelve-figure cash balance… LOL.

    • Dajhilton

      I know it’s sacrilege in some quarters to say it, but perhaps ‘diversification’ actually is the enemy of the goals of most investors in a market in which AAPL is traded.

    • Secular_Investor

      Great Post,

      I too have the same problem. But, try as I might, I just can’t find a better investment than Apple.

      Despite being extremely overweight in Apple, the one thing I am sure of is that the downside risks are minimal. It has such good growth prospects, so many competitive advantages, such good products with such high consumer satisfaction and retention ratings, such excellent management and it is so incredibly undervalued

    • frankcapra03

      There is only thing that worries me, the DOJ. I get concerned with the growing size of Apple to approach what appears to be $200 Billion in cash in the next 12-18 mths that it will become a target of the DOJ much the way AT&T did 25 years ago and be forced to divest into many companies. This way the DOJ can try to weaken it by seperating some of the synergies. Any thought on that concern? Thanks

  • Jeff G

    On the chart titled…. share Price as a function of cash:

    Re the Y = formula

    Would like to see you carry out the coefficient of X a few more places (just kidding … So rare of an opportunity to be able to apply, math humor/sarcasm:)

    I work in a finance world where 99% of people don’t understand math or statistics at the level you explore or write about. Your work is a refreshing treat for me. If I werent married (and if I were gay) and you would have me, I would marry you! Ok, now I will probably be banned from the board… It’s been nice reading with you…

  • Markgoldmd

    Unfortunately a stock is worth what people are willing to pay for it. If no one wants your stock it is worthless, no matter how great the earnings collected or future potential. Cash on hand is easy to understand. I recall the tech boom when companies with no earnings were given fantastical valuations and people were paying them. This is the opposite but no different. To believe that the markets always act rationally is naive. Horace is a great analyst who is pointing out the irrational pessimism of the present market, but to me this is like complaining about “split milk”. Let’s look forward. I am long Aapl and I believe that the market will eventually catch up (it took years to sort out the tech boom, I suspect it will take the market years to sort how to value Apple).

    I would prefer to know at what point in the future will Apple size and dominance (cell phones or tablets) market incur the wrath of government antitrust regulators (like Microsoft, AT&T, Standard oil….73% of all cell profits, 70% of the Tablet market are we getting close?

    • It’s not illegal to have 100% of the profits.

      Having a monopoly isn’t illegal either – it’s only illegal to abuse that monopoly power.

      Apple only has a small percentage of the phone market – it’s hard to argue that they have any type of monopoly there with only 20% of smartphone sales.

      As far as tablets, it’s strange to segment that off from the overall computer market – after all, it’s just a PC without a keyboard, and therefore difficult for anyone to argue that they have anything approaching a monopoly there. Besides, what illegal thing did they do to prevent people from buying Android or other tablet machines? People are choosing iPads freely. It’s not Apple’s problem that competitors can’t make a product that anyone wants.

    • ChKen

      You mean like Instagram, and even to some extent Facebook and even Amazon!

      A monopsony is legal. A monopoly is legal. The abuse of one’s monopoly power is illegal. The key word is “abuse”.

    • “I would prefer to know at what point in the future will Apple size and dominance (cell phones or tablets) market incur the wrath of government antitrust regulators…” -Markgoldmd

      – Apple has 70 plus percent of the MP3 market and 90 plus percent of the profits but no one cares about this declining sector.

      – Apple has 90 plus percent of the iPod Touch market (it doesn’t even have another name!) and 90 plus percent of the profits but no seems to even notice this 4 to 6 billion dollar segment of the market.

      – Apple has smart phone market share in the high twenties with profit share in the seventies. It only has eight percent market share of all mobile phones. It’s going to be pretty hard for the Department of Justice to take on the Apple “monopoly” when Apple holds so little market share; when Android hold so much market share; and when everyone keeps declaring that Android is “winning”.

      – Apple has market share between 50 and 70 percent the in tablet space and near 90 percent of the profits. This is a little deceiving. If you take out the 7 inch tablets then Apple’s market share zooms up to 90 some percent. Even there Apple actually has a higher than reported market share since their tablet sales are reported and many of the so-called competing tablet shares are mere estimates and mere estimates of shipments, not sales, at that.

      So let’s assume we only focus only on the 10 inch tablet sector. Is Apple a monopoly? Hardly. There were 400 million traditional PCs sold last year. There were only 50 million tablet sales all of last year. The tablet market is expected to grow and then surpass traditional PC sales within the next three to five years. Further, there is no barrier to entry. Anyone can make a tablet. (Making a competitive tablet is another matter altogether.)

      When evaluating monopolies, the Department of Justice looks to see if the alleged monopolist’s position can be contested. In such a rapidly growing market; in a market where there are so few barriers to entry, it’s hard to see how Apple can be called a monopoly.

      I will throw in one caveat. iOS is growing ever stronger as a platform while Google’s version of Android seems to be stumbling. If iOS becomes the new Windows – and we’re a long way from that yet – then my position – and the position of the Department of Justice – could change.

      Finally, Apple has 8 plus percent of the PC market with some 35 percent of the profits. ‘Nuff said.

      Conclusion: Apple is the dominant company of our times, but they don’t have anything even close to resembling a monopoly at this point in time. 

      • Markgoldmd

        As the “new windows” of the mobile world can Apple keep competitors out of access to iTunes? 

      • Anyone can build an iTunes but no one else has. Amazon tried to out iTunes the iTune store by selling songs at a discount. What they discovered – as so many others have had to discover – is that people are willing to pay for convenience. Clicking a button and having the tune instantly and seamlessly placed on your Apple device and then synched to all of your other Apple devices (and even your PC) via the Cloud is worth a few pennies to most individuals.

        As far a monopolies go, I don’t see the danger. iTunes doesn’t own the content (vertical monopoly) and it’s not the only online distributor in town (horizontal monopoly). It’s just the best online (meritorious monopoly).

      • capnbob67

        The beauty of iTunes is the asymmetry of the competition (see what I did there?). Since Apple doesn’t care to make profit from it, it doesn’t leave much room for others to come in and be competitive. Apple keeps improving the features (Match, TV shows, etc.) and growing coverage and will continue to do so but it’s lack of profitability is a key reason why it is so defensible. Amazon has a similar store with similar content (based off Apple’s pioneering contracts) and tries to slightly undercut Apple but savings are minimal and that strategy contributes to its 1% margins. They can’t invest in the service like Apple can.
        The whole tech market is full of asymmetric “unfair” fights. MS with its Win/Office monopoly and Google’s internet ad revenue both subsidizing adventures in mobile. Apple’s ownership of hardware profits “subsidizing” content stores, etc.

      • capnbob67

        And for all the hmming and hawing, MS who has an actual monopoly has never had that seriously threatened (Windows/Office) – only the leverage of that monopoly to strong-arm their way into other areas (like browsers, etc.). Anyone gunning for Google and their near monopoly over internet advertising?

        In fact the Tech industry might be reduced down to the battles between three monopolists (all more or less legally acquired), none of whose monopolies was seriously threatened by the other until recently. As they and their hordes of partners (sounds like Game of Thrones) engage more directly (MS moving into search and internet ads, Apple threatening the Win/Office hegemony as mobile takes over, and Google trying to commoditize Apple’s hardware markets with Android and devalue Win/Office via Chrome/Cloud), the battles will become more heated than the 2024 Fast Food wars* in which Taco Bell will emerge victorious as the only remaining FF vendor.

        Long live our Tex-Mex overlords!

        * US release of Demolition Man (1993)

      • Apple was never able to dent the Windows monopoly, so they flanked it. Windows did not work on phones and tablets so Apple created a separate OS and made it the standard for mobile devices. Now mobile is growing so fast that it’s swallowing the PC and Apple’s victory is doubly sweet.

        Similarly, Google’s search monopoly can never be overturned by a frontal attack (like Bing). If it is overcome, it will be by maneuver, not brute strength. 

      • capnbob67

        I agree – all the “monopolies” are highly defensible. In fact Apple’s is probably most vulnerable in theory, though in practice it seems hard to dent. That is why this war will play out for a very long time – more cold than hot.

        Apple may not have dented the MS monopoly per se but it has ensured that most of MS’s OEM partners are going to the poor house. OEM PC margins have never been thinner and MS and Intel have to be worried that they will be forced to give back some of their super-profit as PC’s become even more commoditized and their OEMs make money in places that don’t require any MS or Intel input.

        There are also outside risks to everyone… Samsung coming for Apple but out-Apple-ing them if Apple become complacent? China/India protected future giants coming after Google (coming for their Ad revenue more than their raw search capability), etc.

      • Sacto_Joe

         Samsung is in deep doo-doo. Thievery will only take you so far. Googerola will only escape by finally coming clean and making a walled garden of their own. The only reason the fig leaf they’re buying from Motorola will work at all is that it doesn’t have much to cover. And not having much to cover is going to make building a viable walled garden extremely difficult for Googerola.

         Apple isn’t being complacent. If they were, you wouldn’t see half the court battles going on.

      • capnbob67

        I don’t see Apple being complacent nor do I see Googorola being successful either but I also don’t see Samsung in any doo-doo, deep or otherwise.
        They have increased their profit and industry profit share and are building a defensible Apple-like ecosystem through their “emulation” of Apple. When they fork Android, take control of their own destiny and plow their profits back into the photocopiers, they will continue to do well. They will be a shadow of Apple but they will be ecstatic – it is/will be better than they ever could have managed via their own strategy. Apple will try to sue but as so-far it will do either nothing or maybe net design changes or even some royalties. Copying a strategy or even features or capabilities doesn’t seem to be illegal. I don’t like what they are doing but let’s not pretend it isn’t successful.
        They will build a massive defensible base with their 150M smartphone installed base, 200M+ smartphone sales this year (even at lower ASP and profit than Apple) given that Apple explicitly leaves many market segments untouched. Once you lose a smartphone customer, it is hard and gets harder to switch them off a platform.

      • BigApple

        I believe it is an enormously important point you make regarding Apple’s commanding 35% of the PC profits despite only having an 8% share and competing against a single competitor with a near-monopoly.  Assuming the factors behind that carry over to smartphones and tablets (which I believe they do/will), Apple’s profitability will be high even if competitors steal market share.

        It is really amazing how little is discussed regarding this profit share of the PC market.

      • Great point(s).

        No company is immune from anti-trust but I think that Apple’s model shelters them a little more than it should. People obsess over market share when profit share is all that matters.

        Right now Apple has 73% of the profit from ALL mobile phones, not just smart phones! But they only have some 8% market share. 73% is getting awfully close to monopoly numbers, but no one even cares! There is simply no way the Department of Justice is bringing an action against a company with only 8% market share!

    • BigApple

      Actually, your statement that a stock is only worth what someone will pay for it only applies to short-term investors.  In the long-term, it is worth the discounted rate of future DISTRIBUTED cash flows. So if Apple actually started to pay out a substantial percentage of its huge free cash flows, one could find it quite valuable indeed without ever having to solicit an opinion from Mr. Market as to its worth.

  • Sonnyblue

    Horace, is it true that major portion of Apple’s cash is oversea (aka NY Times piece on Apple’s tax strategies)?  This cash is not accounted for US tax if Apple ever brings it back home.  And what’s about currency exchange fluctuation?  How would that affect this huge amount of cash oversea?

    • ChKen

      One, the overseas cash is mostly held in US dollars, and what small portion that is in forex is hedged.

      Two, about 60% of Apple’s foreign profits have had US corporate taxes accounted for, as Apple has stated that it may bring those profits home. The balance, about 40% Apple has stated in their 10K, that they intend to keep overseas indefinitely, presumably to use as foreign working capital and to fund PPE, etc. That amount does not need to have US taxes accounted for, thus, Apple’s net effective tax rate is about 24 to 25%.

      So, if Apple were to bring the cash home that it states it might bring home, it would have zero effect upon its earnings as the taxes have already been accrued and accounted for.

      Now, if you are raising this point as a way to say all cash is not the same, as some of the cash has not had its taxes taken out yet, that’s an interesting point, as a greater and greater portion of Apple’s cash is overseas. So, if you deflated the cash position, by backing out accrued taxes, you might actually get a better fitting line. Of course, I doubt the market even factors that. Then again, the relationship between cash and price is a strange anomaly to begin with.

    • ChKen

      One, the overseas cash is mostly held in US dollars, and what small portion that is in forex is hedged.

      Two, about 60% of Apple’s foreign profits have had US corporate taxes accounted for, as Apple has stated that it may bring those profits home. The balance, about 40% Apple has stated in their 10K, that they intend to keep overseas indefinitely, presumably to use as foreign working capital and to fund PPE, etc. That amount does not need to have US taxes accounted for, thus, Apple’s net effective tax rate is about 24 to 25%.

      So, if Apple were to bring the cash home that it states it might bring home, it would have zero effect upon its earnings as the taxes have already been accrued and accounted for.

      Now, if you are raising this point as a way to say all cash is not the same, as some of the cash has not had its taxes taken out yet, that’s an interesting point, as a greater and greater portion of Apple’s cash is overseas. So, if you deflated the cash position, by backing out accrued taxes, you might actually get a better fitting line. Of course, I doubt the market even factors that. Then again, the relationship between cash and price is a strange anomaly to begin with.

      • Sonnyblue

        Thanks for the response. Cash usually is a rearview data point.  Future free cash flow is what we really want to know (or predict).  Apple will generate more earning going forward but I’m worried that it will have to spend more capital to sustain growth (i.e. data centers in NC, support staff in Austin, stock dilution for employees benefits).  This is the problem of having so much cash and not having an excellent CFO to manage it.

      • Joe_Winfield_IL

        The free cash flow is accelerating at an amazing rate, net of all the things you mention.  Also, the announced buybacks are aimed specifically at negating the dilution of stock grants.  Add in the dividend, and Apple should STILL have accelerating cash balances.  Check out Horace’s article from immediately after the dividend/buyback plans were announced.

      • BigApple

        Well of course they’re going to have to spend capital to sustain growth!  What business have you observed that doesn’t? The thing that matters is the rate of return on that invested capital.  And so far, that has been exceptional.  The only thing I would fault the CFO and CEO for not doing  is buying back a boatload of stock at this low valuation.

      • ChKen

        They can still do it. Apple is ridiculously cheap.

      • ChKen

        Good point, and something Amazon shareholders should worry about! The more cash they generate, the more plans they seem to have to spend it! They’re now going to make movies and tv shows and sell high-fashion!

      • BigApple

        So they’ve paid tax on 60% of the overseas, none on 40%.  If they bring home a portion of the cash, will the gov look at that as the taxed or the untaxed?

        If they can bring home first the “taxed” portion, then it is simply poor capital allocation that they haven’t.  That cash is earning less than inflation, and there is no conceivable way that they could use all that for appropriate operations.  And, the stock is ridiculously cheap.  So NOT using that cash for buybacks is simply foolish…unless they would be taxed (and even then it is foolish, unless they’re just waiting a short time hoping for a repatriation holiday).

      • ChKen

        Well, I’m not a corp tax expert, but I think it’s fair to say if Apple repatriates any portion of its foreign cash, that up to about 60%, will have already had its US taxes accounted for. That doesn’t mean they’ve already been paid, just that they’ve been accruing, and now payment is due. The difference is that shareholders won’t see any EPS restatement, as Apple has already backed out potential US taxes on that amount.

        Well, it’s your opinion, but I think most shareholders would agree, that waiting to see what the Administration and Congress decides regarding corporate tax reform is appropriate.

    • US companies have over $1 trillion of off-shore cash. It’s not going to be brought into the US unless there is a change in the tax laws. (By the way, the US may be the only industrialized country which demands tax on repatriated profits.) This does not affect the value of that cash. Apple does not need to repatriate it. They may choose to spend it abroad as well buying assets or investing in production.

      • BigApple

        You are wrong that repatriation taxes do not affect the value of the overseas cash.  Since Apple is U.S.-based, if they are ever going to distribute that cash to shareholders (buyback or dividend), they would first have to pay the tax.  And if they NEVER distribute it, it is by definition worthless.

      • They don’t need to distribute it in order to make use of it. Indeed, spending it on value creating assets is what investors hire management to do. Repatriation taxes affect the value of the cash only if the cash is repatriated. If the cash is deployed outside the US then its value could conceivably be greater than if it was repatriated tax-free.

      • ChKen

        It’s not worthless, as Horace notes, they can use it for PPE, or buying foreign assets, like Microsoft buying Skype.

  • Ian Ollmann

    What happens when earnings grow exponentially?

    E = e**kt       E=earnings   t = time   k = rate of exponential growth, a constant

    and P/E is constant:

    P/E = c          c = 15
    P = Ec

    Integrate E over [0,t] to get cash on hand:

    Cash = Integral(E, [0,t]) = (e**tk)/k – (e**0k)/k =  (e**kt – 1) / k =  (E-1)/k

    Calculate Price / Cash:

    P/C =  Ec / ((E-1)/k) = Eck / (E-1)

    Approximate  E is much, much, greater than 1.  E-1 is therefore roughly equal to E. 

    P/C  = Eck / (E-1) ~= Eck / E = kc = k’   a constant

    Therefore, P = k’C,  which is your plot.

    For exponential growth and constant P/E and large earnings.  So, I believe your first chart, while unexpected of the typical company, should be happening for Apple.

    • Ian Ollmann

      That actually would be a number of companies. You also have to act to preserve cash with great rigor, so no blowing it on share buybacks, mergers, investment losses, etc.  

      • Sacto_Joe

        “Blowing it” is a relative term. Apple’s recent apportionments to buybacks and dividends is the merest trickle from a stream that may soon become a river.

    • Sacto_Joe

      Interesting. The point is, however, that the P/E hasn’t been constant. That happens IMHO because the market continually discounts the ability of Apple to grow earnings now that it has the world’s largest market capitalization. It is literally unfathomable to the market that Apple can continue an exponential growth pattern. Ergo, they adopt a “wait and see” attitude, and are consequently totally reactive. That reactiveness is growing by the quarter as Apple’s earnings account for a larger and larger impact on the P/E ratio when earnings are announced, presently up to 2 1/2 to 3 points. What’s going to happen in a couple of years when Apple’s earnings announcement drops earnings by 4 to 5 points instantaneously?

      From the options player point of view, this is manna feom heaven! A very low P/E ratio coupled with an immense point swing every quarter equals huge volatility. And since AAPL is now such a huge chunk of the Nasdaq, it can literally induce huge volatility to the whole market!

      However, IMHO, this is very unhealthy. Note, for example, how the “pulldown” in AAPL of last week was largely exaggerated by the poor unemployment numbers, which negatively affected the market as a whole. As a result, Apple was pulled down to a P/E of 13.7, far below any sensible valuation. It wouldn’t have taken much at that point to start a “run” on AAPL, and that could have stampeded the market as a whole. Fortunately, that doesn’t appear to be happening – this time.

      • Ian Ollmann

        P/E has been roughly constant. Over the period covered by the top chart oct ’08 through the present, it has been in the 15-20 range.  We see  deviation from the line in the expected direction when it was closer to 20.  Basically, if you don’t spend the cash, and growth is constant exponential, cash is a proxy for earnings, because Cash = Earnings/k.  The 1/k term explains the price to cash multiplier. Nobody in their right mind would pay $5 for each $1 of cash (or whatever it is) if they really wanted to buy the cash.

        A friend of mine suggests that at current growth rates, AAPL will exceed world GDP in 12 years or so. The implications are sobering. If rest of the market is  destined to go to zero, there is only one investment choice! 😉

    • Dajhilton

      I just don’t understand the focus on earnings growth at all.  If a company is reporting annual earnings of $50 billion or more (i.e., an amount that exceeds the market capitalization of 80% of the Fortune 500) in the midst of a recession, and it continues to achieve earnings on that scale year after year, why the pressure continually to ‘grow’ the earnings?  It seems that growth is the enemy in such a case, as it is sure to attract the attention of antitrust and competition authorities if Apple continues to vacuum up the actual value – never mind the perceived value – of money changing hands in the market.

    • Dajhilton

      I just don’t understand the focus on earnings growth at all.  If a company is reporting annual earnings of $50 billion or more (i.e., an amount that exceeds the market capitalization of 80% of the Fortune 500) in the midst of a recession, and it continues to achieve earnings on that scale year after year, why the pressure continually to ‘grow’ the earnings?  It seems that growth is the enemy in such a case, as it is sure to attract the attention of antitrust and competition authorities if Apple continues to vacuum up the actual value – never mind the perceived value – of money changing hands in the market.

      • Sacto_Joe

         What “pressure to grow earnings”? Apple is growing earnings as a result of it’s success. Why should it ever want to limit its success?

        Besides, the market has been clearly not all that interested in earnings per se. It’s far more interested in the degree to which a company exceeds expectations. Look at Amazon: It literally had negative earnings growth from the same quarter a year earlier, but was rewarded with a huge increase in share price because it “exceeded earnings expectations”! That’s how much our modern market has sunk to the level of a casino.

      • dajhilton

        What pressure to grow earnings? Well, the pressure represented by comments such as yours above: ” . . . the market continually discounts the ability of Apple to grow earnings.”

        This is the central charge in the indictment against Apple that is said to be embodied in the market’s view of the share price; I thought it was what this thread was about.

        I am only questioning why ‘growth’ should matter at all in an environment where earnings are already so substantial. It’s like a baseball team that wins 100 games a year. Why worry whether or not they can win even more games next season, when winning 100 is usually enough to capture the championship.

      • Sacto_Joe

        If Apple were growing by the use of unfair or unlawful tactics, then I’d say they need to worry about anti-trust issues. They aren’t. Their growth is a natural result of their competing exceedingly well. It makes no sense to speak of “indictments” under those circumstances. And as a stockholder, I applaud Apple’s ability to grow fairly to the maximum extent possible.

      • Chandra

        The answer is quite straightforward. Apple will then trade like a regional bank ( and actually Apple does trade like one today which is the thrust of this thread). Here a regional bank is a proxy for low risk zero growth company where the earnings streams are simply treated as known future streams. Discounted cash flow analysis using a 8% discounting rate will get you a constant P/E of around 12.5 . Any growth should be reflected in the P/E on top of this 12.5 base.

        So a purely fundamental analysis interpretation of Apple’s low P/E is that the market does recognize the growth in the short term but somehow is fearful that the growth is going to go down to zero or even negative in the out years shrinking the P/E to almost the zero growth P/E

      • Chandra

        The answer is quite straightforward. Apple will then trade like a regional bank ( and actually Apple does trade like one today which is the thrust of this thread). Here a regional bank is a proxy for low risk zero growth company where the earnings streams are simply treated as known future streams. Discounted cash flow analysis using a 8% discounting rate will get you a constant P/E of around 12.5 . Any growth should be reflected in the P/E on top of this 12.5 base.

        So a purely fundamental analysis interpretation of Apple’s low P/E is that the market does recognize the growth in the short term but somehow is fearful that the growth is going to go down to zero or even negative in the out years shrinking the P/E to almost the zero growth P/E

      • JohnDoey

        There is no pressure to grow earnings. The earnings are like smoke from a fire. The pressure is to feed the fire, which is consumer demand for computing. Apple makes the best products in the world, and then consumers give Apple money. Later, accountants write all that up. The pressure on Apple is to continue to make the best products in the world. If they do that, earnings will grow because we are nowhere near the peak demand for computing and Apple is selling the best phones for $0 and $99 and $199 and best tablet PC for $399 and up and the MacBook Air is the Lamborghini of laptops and it is only $999 every 3 years. The pressure on Apple is to keep doing that because they have proven that the people want iPod-style computing in a big, big way.

      • Sacto_Joe

        Exactly right. And as long as they keep their metaphorical nose clean, they have nothing to stand in their way.

    • This is a great analysis. Does it follow that if a pattern is observed where the equity is priced as a constant multiple of cash and has a constant P/E then it has to be growing earnings exponentially? But if it has exponential growth in earnings why is its P/E constant?
      You still reduce the observation to an absurdity.

      • Ian Ollmann

        No. Just because a simple rational pricing model predicts an observed trend does not imply that if we see that trend, the market is rational.

        I merely wanted to point out that based on what Apple has been doing (relatively constant growth around 100% / year, and not spending the cash) we expect that price/cash to be constant, provided that the irrational markets behave rationally, and other factors don’t meaningfully contribute. Thus, I disagree with this particular assertion in the article above:

        “I should emphasize that this correlation between cash and price is abnormal. It should not be happening.”

        Apple’s success is what is abnormal. However, the correlation is well predicted by this simple model. We may conclude that the market behavior in this case is not shown to be irrational, if we agree that it is actively ignoring any potential for future earnings growth.

      • Sacto_Joe

        This is REALLY getting interesting! We all agree that the market is ignoring any potential for future earnings growth. But I’m not convinced that it is actively doing so. Rather, I think it is reactively doing so. The market is responding to Apple’s growth, but it isn’t responding proactively at all. It is being dragged along by a seemingly never-ending series of mind-boggling earnings reports, and before it can properly respond to the last one, another begins building right behind it.

        It reminds me of when I used to body-surf in the Southern California area. Waves would come in sets, and sometimes the waves would keep getting bigger and bigger, forcing you to swim farther and farther from the shore….

      • Chandra

        >”But if it has exponential growth in earnings why is its P/E constant?”

        One answer is ‘Because the price goes up equivalently to keep the P/E constant. This of course does not answer the question why that constant P/E is low?

    • Chandra

      Ian, I like the math and the logical formulation.

      One question. When does one use e**kt vs (1 + k )**t to calculate when $1 of earnings today will be worth after t periods? Are they equivalent for this purpose? When I calculated it, for smaller values of ‘k’ ( 0.01, 0.06 or even 0.1 ) they were close but at higher values like 0.4 the e**kt produces significantly higher values. Thanks for any clarification.

  • If the relationship is to be taken seriously, it says that if Apple pays out $100 billion in a one-time dividend, the price of the stock will fall to about $50.  That is not realistic, so we know the price of the stock isn’t really based on cash and equivalents carried on the company’s books. 

    $100 billion in cash (after paying all taxes) translates into $100 billion in market value unless the company has a history of wasting cash — which Apple doesn’t. The rest of the company’s market cap reflects the present value of its prospective future earnings.Is there multiple compression?  Yes.  But the company’s share price is related to Apple’s cash holdings only coincidentally. Ian Ollmann, above shows mathematically why that would happen with a company who’s earnings are growing exponentially AND which pays no dividend. 

    This cash-share price analysis is a red herring that distracts from key issues determining share value. 

    • Sacto_Joe

      Many have said that this relationship between cash and share price is a coincidence. That’s really not Horace’s point. He is using it as a vehicle to indicate the illogic of Apple’s stock price over an extended period of time, i.e., that investors are not pricing in Apple’s future potential AT ALL. Yes, we can subtract the (now $110 billion) in Apple’s cash and securities from its stock price. But that only serves to magnify that disconnect. When a stock is in the low P/E’s that AAPL’s is, and sees a 25% drop from its high a month earlier (from 18.3 down to 13.7), then something is very wrong with the manner in which that stock is being valued. Frankly, at the rate the P/E compression is going, AAPL could conceivably see an instantaneous 33% P/E compression a couple of years from now. That’s huge volatility, and hugely disruptive, not just to AAPL, but to the market as a whole. The only possible way to combat it is to boost the P/E ratio markedly higher ASAP.

      • The point that “investors are not pricing in Apple’s future potential AT ALL” can be made without bringing an irrelevant issue (cash) into the discussion.  

        Granted that Apple’s future earnings aren’t being recognized by investors — something that we’ve known for a loooooong time — the only relevant question is WHY?  Anyone can provide WHAT statements (i.e., descriptions of the situation), but it takes deeper understanding to explain WHY we observe something.  

        The fact that no WHY is offered by the article and the fact that it emphasizes an irrelevant issue (cash) suggests that the article doesn’t accomplish much.  Horace is REALLY good at many types of analysis, but not valuation issues.  IMHO.

      • Sacto_Joe

        You said: “The point that “investors are not pricing in Apple’s future potential AT
        ALL” can be made without bringing an irrelevant issue (cash) into the
        discussion.” Horace said: “I’m only
        presenting this data to highlight this abnormality.”

        IMHO, if it makes a point, it’s not irrelevant.

        You said: “The fact that no WHY is offered by the article…”. Horace said: “Given this disconnect from the income statement, the pricing by balance
        sheet multiple seems to be a symptom of something deeper. Reasons vary
        with the seasons, but the company is not perceived to have sustainable growth.”

        So there’s your “why”.

        The importance of the article is in articulating 1. that Apple is provably not being valued for its future earnings, 2. being undervalued for its future earnings is causing the P/E compression, and 3. the basic reason investors undervalue it is they just don’t believe it can continue its pace of growth. Now, you can argue that any one of these three points is incorrect or incomplete, but to say that they’re “irrelevant”? I don’t buy it.

  • Guest

    I am sure if one tries to correlate the Apple market cap to anything that is a by-product of its earnings (say vs Tim Cooks net worth, anyone?), one will find a similar correlation.

    A nice chart would be in order.

  • “… the company is not perceived to have sustainable growth…” – Horace Dediu

    I accept the premise that the company is not perceived to have sustainable growth. Since I did not have a pre-existing answer as to why that was so, I read each comment carefully in order to see if a consensus – or a particularly perceptive insight – might emerge.

    The comments were, as usual, exceptionally intelligent. In essence, the commentators concluded that Wall Street felt that Apple wasn’t diversified enough; that Apple was not unique; that Apple’s products could be commoditized; that Apple was a boom or bust company who was eventually going to bust, to fail, to return to the norm; that Apple’s success was too good to be true so it could’t be true and must be an illusion.

    But I think that Horace, once again, has put the matter most succinctly:

    “Since there have been almost no companies that are consistently disruptive, those that do disrupt are seen as accidentally successful.”-Horace Dediu

    There you have it. Apple is either a serial disruptor – and one of the few of its kind – or they are accidentally successful. Wall street clearly believes the latter. I have no idea what it would take to convince Wall Street that it was the former.

    • KirkBurgess

      They are being valued like a Big Pharma company.

      Big pharmaceutical companies products have a limited sales life, and they can never guarrentee they will develop another successful drug ever again, but still manage to do it year after year because they have the appropriate development practices in place to do it.

      Apple is the same, there products have a supposed limited lifespan, and they can’t guarentee that they will ever have another blockbuster new product, yet they seemingly have proven (to some at least) that they have the appropriate product development practices to commercialise it.

      • Joe_Winfield_IL

        I was grasping for the right comparison, and I think you’ve nailed it – at least in terms of market perception.  I think a more apt analogy (in terms of actual performance) is with companies like 3M and DuPont.  These companies derive growth from constant innovation, even when it isn’t disruptive.  Apple is an amazing disruptor, but they are also very good at incrementally improving products in meaningful ways to generate repeat sales.  While there are plenty of catalysts for future growth, I think Wall St. spends too much attention looking for growth.  Over the next couple of years, the growth is already under their nose; sales will continue to grow organically even without a major new product launch.

        The company does not release trivial updates; instead it spends considerable resources improving on existing lines.  Each (of five) versions of the iPhone has been appreciably better than its predecessor, in terms of both measurable benchmarks and user experience.  Today the market is growing by leaps and bounds, but as the smartphone market matures, Apple will rely on its ability to constantly iterate and differentiate.  They will need to do this not only to take share from competitors, but also to encourage users to continue upgrading every 2-3 years.  

        The way I see it, we are a minimum of two years away from single digit growth in the smartphone market, and the tablet market is still in its infancy.  As long as this maturation is still obviously in the future, there’s no reason for all the paranoia that surrounds Apple’s supposed imminent doom.  I sincerely hope (and expect) that the folks in Cupertino are hard at work on the Next Big Thing, but the rest of us need not obsess over it.  

      • capnbob67

        I like the Pharma reference in terms of the process of serial successful product development (although a lot of pharma success comes from me-too-ing a successful new drug – Cialis for Viagra, every successive heartburn remedy, the endless refined statins, etc.), but what makes Apple so unique seems to be that they have:
        1) the product pipeline of big pharma
        2) the disruptive intent and agility of a (good) startup
        3) the supply constraints of gold/rare commodities
        4) the production control of big oil (or Walmart)
        5) the addictiveness/user-dependency of drugs (legal/illegal)

        NOTE: this is just an initial gut response to the ongoing attempt to map the DNA of Apple

        To me it is the fact that Apple combines so many critical success factors at a level of intention, design and excellence most other companies would kill for in just one area.

        Anyone have better chromosomes for Apple (I know you do)?

      • Dajhilton

        I think you’ve missed something here.  The sense in which Apple products may be said to have ‘a supposed limited lifespan’ is a good thing, not a drawback.  That’s what generates repeat sales, especially sales of upgraded and more expensive replacement products.  It’s built-in obsolescence.  

        But the sense in which Apple products are limited is diametrically opposed to the sense in which the products of large pharmaceutical companies have a limited lifespan.  And this is, for Pharma companies, a very bad thing.  In the former (the case of Apple products), the limited lifespan is physical.  Apple customers will come back in only a year or two and buy the same expensive product again.  But in the latter case (for Pharma companies), the limited lifespan is non-physical – it is purely a function of intellectual property rules (ie., the very short patent term on inventions).  The customers for the drugs will come back to buy them year after year, they just won’t have to buy them from the pharmaceutical company that developed them.  They can get lower-cost (in theory) generic substitutes.  Apple’s customers, by contrast, if they want genuine Apple products, have to come back to Apple. Pharma companies wouldn’t need a blockbuster new product to continue to make money if their patents didn’t expire.  Pfizer or Merck would happily continue to sell their best drugs for a century if they were given exclusive rights to do so.  And their shareholders would be happy.But Apple CAN continue to sell a range of products powered by their operating system for a century – well, for 95 years – before their copyright expires.  (Of course, a new, and newly copyrighted, operating system will have been deployed in the intervening period).  I predict their shareholders will be very happy indeed. 

      • KirkBurgess

        Thanks for the reply. I pretty much agree with everything you said – I should clairfy that when I said limited lifespan, I was referring to the view (misguided as it is) by some that apples entire product lines are all of limited lifespan – they see the death/shrinkage of the ipod line as also happening to the iPhone, iPad in short order. (“They are fads”). I do not agree with this view myself, and would point to the health of the Mac in its third decade as a signal of apples capability in successfully guiding a long lifecycle for a prodcut category.

      • marcoselmalo

        This certainly fits in with something I recently read on PED’s blog:


    • There may be a point where repetition of success sinks in — Wall Street certainly values repeated success in CEOs (without much justification, as far as I can see). It seems if someone has a string of 3-4 breakout successes in a row, they can do no wrong. Until they fail….

      I don’t know if this will apply to companies as well, or whether they’ll only believe it for personalities. (I think this may be some of where Wall Street gets its Steve Jobs jitters from — they’re willing to believe in CEOs, if only they see a string of successes. Steve’s “magic touch” is gone, hence who knows what will happen.)

  • Tjorwynn

    Hi Horace,
    I’m new to your podcast, having discovered it a few weeks ago.
    I’ve no formal financial or business training, but to the uneducated ( ? ) eye , Disruption Theory sounds uncannily familiar to Black Swan phenoma. Have you read Nassim Taleb ? I realize that Disruption Theory ( as discussed in this podcast ) seems to be applicable to industries or products, yet if we regard these industries or products on a larger time scale, they too will begin to look like individula events ( points on a graph ) instead of being spread out through extended time.
    Perhaps , it’s a silly comparison that I’m drawing here, but , I would really appreciate your thoughts on how these two ideas can be made to relate.
    Thank you !

    • Black swan events, as I believe they are defined, are unpredictable, unexplained chaotic movements in valuation. They are also extremely rare events. Disruption theory is different in that the causes are well understood and they happen with a high degree of regularity. They also are not zero sum in terms of value created/lost.

  • Dave

    Hello All, my technical knowledge on these matters is less than scant, please forgive, but I do have a question. Has there been much discussion here on whether Apple, rather than undervalued, is in fact amongst the few sanely valued companies in the major indexes, and that the majority of companies no matter the market, are actually grossly overvalued? What is the standard rationalization that justifies any company having a P/E above 11 or so? This may be too general of a question. Great post, Horace, great site. Kudos.

    • The P/E ratio is not an abstract concept. It’s the number of years in which, if earnings would remain the same, an investor would recover the cost of the shares. Thereafter all earnings would be “profit” for the owner. If earnings grow or decline then the calculation changes. There is no “right” value for the ratio and no “right” value. It’s a matter of perception.

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