## What is Apple’s Realized P/E ratio?

The Price/Earnings ratio is a very simple measure of the “value” a company has. The Price is the current share price and the Earnings is usually the sum of the last 12 months’ earnings per share. In other words it measures how many of the last year’s earnings are built into the share price. Put yet another way it’s the answer to the question “If earnings don’t change, how many years will I have to wait before I’m paid back for my share purchase with retained earnings.”

So a company with a P/E of 10 implies that if nothing changes, in 10 years a share owner would “earn” back the price they paid for the share. Any earnings after 10 years would be “profit” for the share owner. You can imagine it even more simply as buying not shares but an actual small business of your own. You pay up front for it and then wait until it pays you back. After getting paid back for the initial purchase you then make money that you can set aside.

Obviously this figure of P/E is very sensitive to growth in earnings. Consider paying \$100 for a share of a company having just earned \$10/share last year. It would have a P/E of 10. If earnings stayed at \$10/yr for 10 years, you’d “get your money back” in 10 years. However if earnings grow at 20% then next year the earnings would be \$12 then 14.4 then 17.3 then 20.7 etc. Adding these up means you’d get your \$100 back in five years, not 10.

So with a company growing at 20% the “realized P/E” is 5. You realized the price of \$100 in five years’ worth of earnings. In the scenario above you paid expecting to wait 10 years but you got paid in five. If that’s your retirement plan then you can retire five years early. Not bad.

Let’s then look at what Apple gave investors as “realized P/E.”

If you bought shares in the first Friday of 2006 you would have paid \$76.3/share. At the time the company had \$9.36 in cash so you actually paid \$66.94 for any future earnings. The P/E ratio at the time was around 35.

The company went on to earn \$2.78 in 2006. Another \$4.63 in 2007,  \$7.47 in 2008 and 10.24 in 2009 and 17.91 in 2010. Then in 2011 it earned \$35.11.

If you add these values up you realize that Apple reached your price about two thirds of the way into 2011. So the company earned your purchase price in 5.7 years. That becomes the realized P/E if you bought in early 2006. The following diagram shows the time period as a box encompassing the earnings (and cash) for a share purchase in early 2006.

I repeated this for purchase in early 2007. The result is a Realized P/E of 4.9. I did it for 2008 as well[1] and got 5.4 then 2009 yielded an astonishing 2.9. 2010 was not much different with 3.2.

Investing in Apple between 2006 to 2010 meant obtaining a payback period of less than 4.5 years, on average. In other words, regardless of what the trailing or forward P/Es getting quoted at the time (trailing is illustrated below), buyers actually paid for only about 4.5 years of earnings. In other words they actually bought Apple for a P/E of about 4.5.

Using our small business analogy, buying Apple in the past few years has meant getting paid back in less than five years. That makes it a very low risk opportunity.

I could try to repeat the process for years 2010 onward but it would require making forecasts beyond 2013, something I leave as an exercise to the reader.

Notes:

1. I had to make assumptions about full year 2012 and 2013 earnings. I used \$55.4 earnings for full calendar year 2012 and 60% growth for 2013.
• Ittiam

Its surprising that Apple P/E remained so low even after visible success of iPhone…

Apple had a hit product, with high margin, in the fastest growing industry of smartphone and yet its P/E remains low….

• http://www.isophist.com/ Emilio Orione

I know that it is really surprising, it depends on how emotional and irrational stocks market is.
But it is weird that P/E should be the contrary of what buyers pay for?
Horace smart as ever shows that even if Apple’s as a P/E of about 15, the realized P/E is about 5 and diminishing.
As a consequence of that we all say that P/E should be higher because it is low risk, so the lower if the realized P/E the higher should be the price and hence the P/E.
So P/E is just an index of risk, the higher the lower wall street see the risk in investing in that company, the lower the more risk, but realized P/E is the outcome of the risk and history says that Apple was not risky at all.
Rational people should therefore diminish their risk expectations, so P/E index should increase basing on historic data, but irrational reasoning goes like this: this success can not continue (why? no one knows but it goes on in pundit’s comment since 1992/93) so the more the success the higher the risk because a fall must come.
That’s nonsense obviously but is the only reason I can imagine for such a low P/E

• Sacto_Joe

You’re right, Emilio. It is fear that’s keeping investors away from Apple. But it’s fear that’s purposefully manufactured. There are many who are threatened by Apple’s ascendancy, and for good reason! And then there are the rabid anti-Apple hordes, who jump at even the slightest opportunity to find fault, and who swell the blogs with their posts. In this day and age, that is not a force to take lightly. Finally, there are some who are uniquely placed to benefit by volatility in Apple’s stock price. And the more the volatility, the more “risk” is associated with a stock. It isn’t provable, but the potential is there for these individuals to profit handsomly by tipping the “news” in a positive or negative direction at certain opportune times.

• http://twitter.com/fivetonsflax fivetonsflax

I am grateful to the fear-mongers, who have allowed me to enlarge my AAPL position at a relatively modest cost. Without them, the stock would have been priced more rationally, and I would not have had the same opportunity to profit.

Tongue somewhat in cheek here …

• aharon

According to my model If we buy now we would cover the investment Q4 2017

Not bad!

• Fleming

aharon can you please provide what your model assumptions are. Thanks.

• huxley

I’d be interested in seeing some comparisons, like for example what Amazon’s realized P/E would be.

• Tatil_S

With a P/E ratio of 271, I doubt its earnings will ever realize its price paid at any time during the last two years.

• http://twitter.com/JessiDarko Jessica Darko

You mean you don’t expect to live to be 350 years old?

• ChKen

It could take 100 years or more if Amazon doesn’t expand margins. You’d think using their so-called market power they could leverage some of their product lines for higher margins, while still maintaining their huge capex. You’d think Bezos would be a little curious to see his grand plan work. Makes you wonder. Maybe he knows the grand plan won’t work, so he’s ponzi’ing it and keeps expanding and expanding all the while running the most successful non-profit around, convincing shareholders of profits around the corner that never come. Remarkable.

I probably made little sense. It’s late, I’m tired, but Amazon’s ability to fool its shareholders to wait for the big prize is amazing to me. Even Steve Jobs didn’t have that kind of RDF.

• http://twitter.com/JessiDarko Jessica Darko

You’re onto something. Amazon is a ponzi scheme. I have inside info. Not the kind of stuff that would let me write an expose, but an understanding of the players, such as Bezos, whome I’ve met.

Amazon is a retailer like Walmart, with walmart type margins. But it pretends to be a “high tech” company and gets a high tech PE. Everything about this is designed to get good margins on Amazon’s real product: Their own company stock.

So as the board gives Bezos and others more and more stock, that stock sells really handsomly in the market, and the insiders profit.

Amazon as a company is never going to be very profitable. It simply can’t, given its business. Further, as a company it is very incompetantly managed, and thus it can’t compete with Apple and other companies that are competantly managed, even if it somehow decided to be a high tech business. Things like the kindle (outsourced design) and AWS (a low margin business, commoditized already.) will never compete with the iPad or even something like Google.

• MitchdeG

Jessica, you’re out of your mind about Amazon. It’s extremely well managed, very strong leader in its field, though today in a low margin business. But also expanding in higher margin businesses

• Walt French

Her comments are entirely within the scope of reasoned investment analysis of Amazon. She may not be right, but she is not “out of her mind.”

Im more distrustful of opinions from somebody who doesn’t know how to communicate civilly.

• http://twitter.com/JessiDarko Jessica Darko

I’m out of my mind? I used to work there. I have talked to Bezos. I have seen the quality of people they have managing the company, from Bezos down several levels.

I’m speaking from experience.

Amazon has an excellent PR team– and this creates the perception that they are a great company and “well managed” and that Bezos is a “visionary”, etc.

But the PR is not reality.

• http://www.asymco.com Horace Dediu

Can you name these higher margin businesses? Rumor today has it that they are targeting TI’s chip business which TI is exiting due to low margins.

• Walt French

I imagine that Mr. Bezos believes as many of his shareholders do, that Amazon is inventing a new business model enough ahead of the competition that his share and profitability will grow sharply.

As Walmart did a few years before him.

Will it work as well as he wants? Time will tell. (And I don’t give investment advice.)

• Sacto_Joe

Can’t even begin to argue with this. Couple this insight with the reality that the severe compression in Apple’s P/E is largely due to huge increases in the E, especially in Apple’s 1st and 2nd quarter (see Andy Zaky’s latest missive), and you see a juggernaut of a company creating massive returns into the far future for those gutsy enough to jump on the Apple freight train. It’s literally rescued my wife and I from a prospective hard-scrabble retirement to one of considerable ease, and I’m certain we’re not alone – and it’s not done yet!

• Mieswall

Comparison with amazon may be an extreme case, but maybe with msft and goog could be more useful.
If stock does not appreciate in accordance with earnings growth, or is fully paid back to stockowners via dividends, this discussion may be theoretical, since those earnings never arrive to the investor.
Given the fact that the YoY growth of aapl has been shrinking dramatically in the last Q’s (now approaching 30% from the 95% of some Qs ago), the important factor is the expectancy of future growth. Until now, the company has largely beaten those expectations, and thus stockowners have been rewarded ( not in proportion of this growth, the p/e shrinking). Now, how the company will deal with the commoditization of its main products, smartphones and tablets, and how/what will be the post to the next big thing is what matters in first place.
My bet: mobile consumption of content growing exponentially, and done mainly from IOS devices, Appl will take a big part of goog business in the mid-term.

• http://twitter.com/fivetonsflax fivetonsflax

If the physical devices are good enough, the product will have to improve along other dimensions. Services? Software? I think both are run at break-even or less—can they be monetized directly? Alternatively, can they convince people to spend more on Apple devices than on competitors with similar hardware specifications?

The distribution and manufacturing brilliance help hold the line, but the real prize is new jobs-to-be-done. Isn’t that what people mean when they talk about “vision”?

• Walt French

Ask Google whether services are run better than breakeven, or are maybe a growth industry. Ditto, Facebook (its particular valuations notwithstanding). Or Oracle, Salesforce, IBM… these firms are all profitable and growing.

Apple *used* to be in the manufacturing business, but got driven out by its small volumes and need to change techniques so rapidly and dramatically. (Think 6502 —> 68000 —> PowerPC —> X86 —> ARM and now whatever it’s doing with its own silicon.) The company seems to have done a superb job in contracting out, but increasingly integrating into, the manufacturing process over the past 5+ years, making investments that are fully rewarded by the sales of devices they manufacture.

Manufacturing has gone from being a high-cost nuisance to a moderate-cost facilitator of differentiation and distribution.

With manufacturing a modest part of the dollar value of Apple’s product, investments in software, networks and services are taking increasing shares of Apple’s expenditures. Tim Cook’s role is still valuable, but he is CEO primarily for having shown that he can leverage a charter into excellence. I trust that most of his attention is going elsewhere.

• http://twitter.com/JessiDarko Jessica Darko

I agree with most of what you say, but I think manufacturing has a higher cost than you’re accounting for. While it’s true it is a small sliver of the cost of production, the limited manufacturing capacity Apple has as compared to the android rivals has allowed android to take significant marketing share.

I’ve been hoping that Tim Cook is the kind of genius that Jobs is and has been working on a method to get Apple out of the constrained situation it finds itself in so that it can bring supply more in line with demand and thus have much larger market share.

I’ve been hoping for a “made with robots” or the acquisition of upstream component suppliers or something to change this situation which, frankly, has been chronic since 2007.

But maybe what I want is simply not possible due to the nature of the product and the industry… but the market is flooded with android crap sold on a “buy one get one free” basis, while Apple has trouble meeting demand.

That’s a problem that Tim Cook should be uniquely capable of fixing.

• http://search.websonar.com:8080/ Duane Bemister

I expect that is “job one” but he will want to savour that cake, eating it one piece at a time.

• http://twitter.com/fivetonsflax fivetonsflax

Google and Facebook make money on services by selling their users’ attention to third parties. My favorite thing about Apple, in contrast, is that their user is their customer.

• http://twitter.com/Truthwayseeker John R. Josephson

I don’t expect that Apple will face serious commodization of smart phones and tablets. Apple can win any price war (as someone previously suggested), because of supply chain efficiencies, economies of scale from large production runs, and a large war chest.

• chano

What kind of commoditisation do you mean? Is it like the commoditisation of a Mercedes Benz car within the automotive industry domain? Or is it like the commoditisation of refrigerators and washing machines? At what stage, and how, will any Apple product become anything even remotely like a commodity? For the last 3 decades, or more, Apple has been a loner maverick defining the best of breed benchmarks in all the product sectors it competes in. That is the very opposite of embracing commoditisation. It is all about embracing differentiation by defining the high ground – the differences that make a difference, if you will. If we harbour any concerns about the commoditisation of the smartphone and tablet, it would be a better use of our anxieties to pity the future of Android and its OHA members. Now there is a crowded market in which the combatants can only ever arrive at eventual commoditisation. High tech white goods in the making.

• http://twitter.com/WalterMilliken Walter Milliken

I don’t think there’s much evidence that Apple is being much affected by commoditization yet, and in recent US market poll data, I see some signs it may actually be pulling share back from Android “commodity” phones now, though I don’t think there’s enough definitive data to call a trend. Outside the US, the market is mostly less mature, and different factors are in play, so it’s hard to extrapolate much.

@twitter-14291351:disqus I agree that Apple is likely to push into more services and software to help keep their edge, but I think they may simply keep their current monetization model: buying the device basically gets you free or lost-cost services of significant value to the user, and that enable the device to perform new jobs. More importantly, I think, low app software prices make the risk to the user very low for *trying* to use the device for new jobs, which makes it easy for the hardware to migrate into new niches without Apple doing much at all.

If the services and software at least break even, and entice people to join the ecosystem, or at least stay there, then Apple can continue to make money on the hardware margin, which is the user’s entry cost into the value of the larger ecosystem. This is sort of the inverse of the Amazon model, which breaks even on the device at best, and makes money selling the services (content). Apple has also trashed the old desktop economic model, where the software on a machine was often worth significantly more than the machine’s hardware price, at least if the user had more than just the bundled software (and Microsoft made all the money off that part).

• http://twitter.com/JessiDarko Jessica Darko

Earnings not paid out in dividends, but retained by the company benefit shareholders because the cash-per-share ends up going up and up. Which means the shareholder can get that cash by simply selling the shares. (EG: if apple retains \$5 per share, then the price of the shares will go up \$5, and you will be able to sell the shares for \$5 more, and you get the \$5…. without there ever being a dividend.)

Assuming the PE stays the same, etc. But the risk of PE contraction is much less when it is so low that the cash per share is forcing the share price up dramatically all the time!

• Spock the Cow

@JessicaDarko
I get your point that, under the assumption that the P/E stays constant, retained earnings will drive up the share price. And Horace’s post about shareholder value relative to P/E assumes (I think) either a dividend payout or share appreciation.

I wonder how either of these assumptions are sound. Isn’t it a safe bet that we won’t be seeing a regular dividend from Apple anytime soon? And why should we assume P/E will remain near its present level?

I’m essentially questioning how a P/E analysis applies these days to a stock like AAPL. Or, to re-quote Horace, I don’t see how P/E really answers the “If earnings don’t change, how many years will I have to wait until I’m paid back for my share purchase with retained earnings.”

I apologize if I’m missing something basic here, as I am somewhat new to this world. But I have already asked one investment analyst about this and his answer was that P/E isn’t a great value metric for a business like AAPL.

• http://twitter.com/WalterMilliken Walter Milliken

Apple *is* paying a regular dividend now, as of August, I think it was.

P/E isn’t necessarily a good metric for *any* company, since it’s really just an emotionally-driven value divided by a fact-based business metric. To some extent, P/E is a “garbage in, garbage out” calculation. Though on the average, and especially for companies whose business is relatively stable (and therefore predictable), the P value can be semi-reasonable.

If you look at stable, boring businesses, Apple’s P/E is roughly comparable, which suggests that the emotionally-driven valuation completely discounts any growth possibility, and treats Apple like a company in a mature commodity market where growth only comes from stealing marketshare. This doesn’t seem to be a rational evaluation, at least to most of us who hang out here. And it certainly hasn’t been borne out in the recent past.

I think Apple and Amazon’s P/E values have one thing in common — they’re both based almost entirely on future expectations driven by factors other than actual data, i.e. sheer speculation about the future course of their business.

• Spock the Cow

@twitter-391777100:disqus
Aah, good point about the dividend. It’s so small that I forgot about it!

I think most people know that the AAPL dividend will never function in that blue-chip “pay back my investment” manner Horace is talking about. Well, to a new investor anyway. I guess if you bought in at under \$100, a mere 5 years ago, then the \$10.60 annual dividend is pretty nice.

• Sacto_Joe

Actually, as a retiree who no longer can risk or add to my holdings, the dividend is very welcome, since it represents income that I don’t need to acquire by selling to “make ends meet”. For my particular circumstance, the more I can hold, and the longer I can hold it, the better (at least until Apple stops growing), and even a small dividend helps me do that.

• http://twitter.com/JessiDarko Jessica Darko

I suggest you read Vick’s “Invest like Warren Buffett” boosk, or Mary Buffett’s “Buffetology” or “New Buffetology”.

Your questions are reasonable, but “debating” them with you will take more bandwidth than this kind of forum allows, but in those books are explanations that will make this clearer to you (And also, I suspect, open your eyes up to a lot of things)

• http://twitter.com/JessiDarko Jessica Darko

Spock, I think the best bet would be for you to go read some of Horace’s past articles about Apple’s PE compression.

In your response you said “If earnings don’t change”. But earnings are changing, and growing, but more to the point, so is cash. With the PE as low as it is (and has been) this forces up the stock price in a way that was ably demonstrated by Horace in past articles.

But think about it– if Apple’s valued at \$100B and it has \$105B in cash– then it is priced under its cash, right? Who cares what the PE is (in this hypothetical the PE could be 1,000 because Apple is making no money, or it could be 0.5 because it is making \$50B a year in profit.) As the cash goes up, if the price doesn’t go up, the proportion of the price that becomes cash goes up too.

Sometimes you see companies where they trade for less than the cash they have on hand– but these are usually companies that are bleeding money really fast and the investors are discounting that cash because they expect management is going to spend it before they could get it.

It is axiomatic that a stock with \$10 in cash is worth at least \$10 presuming the company is profitable…. In fact, it is probably worth much more than that… and even a conservative multiple of price-to-cash is forcing Apple’s stock up dramatically.

That’s part of the reason why it has gone from \$350 last year to \$700 this year.

• Spock the Cow

@Sacto_Joe:disqus @twitter-110885782:disqus

I certainly see how the dividend is welcome income, Sacto. I was just addressing the idea that it can be a way to cover the outlay for an investment in AAPL stock.

Jessica, you’re right to assume I haven’t read Horace’s articles on P/E compression yet. I just started listening to his podcast a couple weeks ago, and since I’m going chronologically starting with the first episode it will be a while before I get caught up. I just started reading the Asymco site a couple days ago.

I’m checking out the Buffett books now. Thanks for the recommendation!

• Sacto_Joe

“Given the fact that the YoY growth of aapl has been shrinking
dramatically in the last Q’s (now approaching 30% from the 95% of some
Qs ago)” does not appear to be a factual statement. The average growth during fy 2009 was 34%, during fy 2010 was 67%, and during fy 2011 was a remarkable 83%. Assuming that this quarter’s eps come in at about \$9.50/share, that would give us an average growth during fy 2012 of 63%, or more than twice the 30% figure you are quoting. You find these numbers by calculating the total earnings for each fiscal year, subtracting the year earlier’s earnings, and dividing the result by the year earlier’s earnings.

• mieswall

If aapl profit is 9 and 17 eps on Q4/12, Q1/13 (both numbers, very possible), the YoY growth will have shrinked to 36%. Then, to maintain that 36%, Q2/13 would have to be 20.45 eps (compared with the exceptionally good 12.30 of Q2/12). That would mean returning to 66% YoY growth that Q. Unlikely, although possible if ip5 and pad mini are huge successes.
In order to get that 17 eps, christmas Q sales of ip5 should exceed 50m. To keep the 66% YoY growth figure, the ip5 sales of that Q should be a number that Apple has proven it can’t produce right now. (that’s why they should use the cash to increase capex abroad).
I may be the bulliest Apple investor out there, but facts are facts. Even so, Apple should still be a good investment, since at that time the P/E shrink should stop, imho.
About commoditization: mp3 market is already s commodity. There is no question smart phones and tablets will also be there in the future; and Samsung/Google are doing all that they can to be it that way. That’s Google business; the cheaper the phones are, the larger its business is.

• Sacto_Joe

“If aapl profit is 9 and 17 eps on Q4/12, Q1/13 (both numbers, very possible), the YoY growth will have shrinked to 36%.”

“I may be the bulliest Apple investor out there, but facts are facts.”

Yes, facts are facts. You’re assuming both numbers. I can pull numbers out of the air as well. Doesn’t make them “facts”. The facts are what I’ve already quoted. Apple is likely to have a growth in EPS for fy 2012 of well over 60%. We’ll know exactly how much over in a couple of weeks. And forecasting next year’s earnings on the low growth of Apple’s 3rd and forth quarter this year is not intellectually honest. The reality is that Apple changed the equation in the 4th quarter of fy 2011 by moving the iPhone release date up by three full months. Consequently, fy quarter to fy quarter comparsions no longer make sense.

Re: commoditization: It’s way, way too soon since the disruption for commoditization to have taken place. Right now, Apple is struggling just to keep up with demand in spite of its best efforts to increase production of the highest quality devices in the market, for which it can, does, and should charge a premium price. Until it can get on top of production, it won’t even begin to worry about the commoditizers like Google and Samsung – nor should it.

• r.d

Horace,

Please do primer on Exponention Growth
and what happens to the pond when the pond
is half full on the 59th day.

• Lee Penick

The fish become rich?

• jawbroken

Which particular pond are you referring to?

• http://twitter.com/JessiDarko Jessica Darko

He’s deliberately not referring to a specific pond, because he’s exercising a belief that requires he keep himself carefully ignorant of certain information… like the fact that Apple’s share of the total phone market is %5, or of the total computer market is %10, or that while the iPad is %80 of the “tablet” market, the pond isn’t really “tablets”, but portable computing….where the iPad has a lot of room to grow.

It is this kind of careful ignorance that has people believing Apple cannot grow much and thus only merits a 15 PE.

• Walt French

@r.d., I am assuming you’re talking about the notion of a container doubling its contents daily, starting from 0.5^60 of the container. Yes, a constant 100% growth per day, 50% full on the 59th day, and no possibility of continuing the growth rate after day 60.

I guess. You might have been a bit less obtuse. As @Jessica Darko notes below, the analogy is to a rather different situation, where Apple’s two most significant products decidedly DO have room to grow. I guess I’d say that when Apple sells 3 billion iPhones and 3 billion iPads per day, it will have reached saturation, and your point about a breakdown of growth will be real.
I’ll guess that something else is more important first.

Horace has noted two things: first, Apple has learned Disruption Theory pretty damn well, and has shown at least *some* signs of even being able to disrupt itself. Just 5 years ago, Apple was a computer company with “ordinary” computers, no phones or tablets. Who knows what products they will offer five years from now?

Second, and somewhat related, Horace has noted Apple “skimming” the high-margin phone business, not trying to meet the needs of people whose income and/or needs doesn’t support buying a \$400–\$800 device. This cannot be unconscious, so the question is whether they expect the overall market to grow into their price range, demolishing the cheapo smartphones at about the same rate that feature phones are being replaced, whether they have some strategy for a lower-cost lineup based on Siri but with a minimal screen, or …

Whatever, unlike the relatively static Microsoft of the last two decades (making minor, mostly unsuccessful forays into growth markets), or Google, which mostly doubled down on advertising even as it promotes out-there ideas such as cars, all companies are kinda committed to prospering in a very different tech and business climate in 5 years’ time. Linear, or log-linear extrapolation will be a decent projection until it is utterly not.

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

“I guess I’d say that when Apple sells 3 billion iPhones and 3 billion iPads per year (a 2-year replacement cycle for the planet), it will have reached saturation, and your point about a breakdown of growth will be real.”

Considering that Android is growing rapidly and MS will be coming on strong with Windows Phone 8 / Windows 8, that’s a pretty big if.

“Horace has noted at least two: first, Apple has learned Disruption Theory pretty damn well….”

It would more correct to say that Steve Jobs learned Disruption Theory very well, plus the fact that he had vision to “see” years down the road and take steps to manifest that vision. As for the rest of the executive team, we don’t know if they have that IT factor yet.

• aaarrrgggh

Remember that big jump in 08 was the result of abandoning the subscription earnings for the iPhone though…

• http://www.asymco.com Horace Dediu

The data shown includes restatements of previous years’ earnings.

• commoncents

To the comments regarding dividends: there seems to be some confusion about retained cash/earnings, dividends, and investor returns. Earnings which are retained and REINVESTED at attractive return-on-invested-capital enhance shareholder wealth. Examples would be investments in profitable new products, or repurchase of shares at a price below intrinsic value. Earnings which are retained and used for low-return ventures squander shareholder wealth. Examples are poor-profitability acquisitions, or sitting on huge hoards of cash earning less than the rate of inflation. This is where Apple is now…letting the value of their previous earnings slip away like sand in an hour-glass as the return does not keep pace with inflation. Hopefully someone in management gets a clue. The final use of capital is giving back some of the profits to the owners of the company; how that turns out financially is then up to each individual investor and how well they deploy that capital.

• Walt French

@commoncents wrote, “Hopefully someone in management gets a clue.”

While *I* hope that they take their cues from somebody better versed in running real-world businesses for the long term.

Apple has done a splendid job of internal, organic growth, reportedly *only* spending \$150 million on iPhone/iOS. Committing that amount to an utterly unproven, impossible market in 2005, rather than paying dividends, would’ve scared many investors blind, very likely including you, had you known.

I have no inside track on what Apple’s plans are for its \$100 billion of cash, but I’m quite happy to have it in the hands of people who have shown themselves genius-level experts on timing new products and new markets. The “poor-profitability acquisitions” you cite are non-existent, and instead they are buying and building expertise in silicon, manufacturing, retailing and other core areas.

Some day in the next couple of years, I expect to see Apple either pay out half of its mountain of cash (which many investors will piss away on Facebooks, Groupons or other hot deals), or else move into a business where they can bring substantially new value-added. I’m willing to be patient.

• commoncents

This idea that they should hold on to what is now roughly \$120,000,000,000 so that they can develop new lines of business simply doesn’t hold water. How much cash did it take for them to develop the iPhone? The iPad? I’d guess about 0.1% of that. So why in the world would one expect that the next big thing would somehow require 1000X as much? And it’s not like there isn’t going to be a continuing tsunami of cash coming in. Frankly, if they for some bizarre reason they get to where there isn’t a gusher of new cash continually pouring in, as an investor you’d be quite happy that some of the cash was returned to you during the good ole days.

• http://twitter.com/JessiDarko Jessica Darko

Dude, it is their cash, not yours. You can’t have it. Sorry. If you don’t like the way Apple is being run, you can resolve the problem very simply: Sell your shares and exit the stock.

Then you’ll never have to worry about it again.

As for those of us who remain long, we believe you are completely wrong, and you’ve been giving several reasonable arguments for why.

Since you’re still arguing it, the only correct solution is for you to sell your shares.

• http://twitter.com/endsofinvention Ends

Sorry Jess, but the business is owned by the shareholders not the managers. The cash belongs to the shareholders. That’s why its called share holder because you OWN a share in the company; not because you own some abstract financial instrument. Holding a share gives you the right to say what, how or where a company does what it does. Sure a single share gives you a very small voice but a 1 share shareholder has no fewer rights than someone with a million shares. Well that’s how it works in the first-world.; not sure about the US.

• http://twitter.com/WalterMilliken Walter Milliken

You are making the presumption that Apple can do something with all that cash that actually earns more than keeping pace with inflation. That is a *very* questionable assumption. Horace has analyzed this several times in the past, and the options boil down to:

1) Give the cash to the stockholders (resulting in an immediate -30% return on that money as it gets taxed going back into the US). No thanks. They seem to be returning a large part of the US cash flow now, which has already been taxed, increasing the dividends beyond that will simply transfer shareholder-owned cash to the US government.

2) Buy something worth several 10s of billions of dollars — of which there are very few examples, and none that appear to add significant value to the company. In fact, most giant corporate acquisitions in recent years seem to have had negative returns for shareholders. Look at Microsoft’s giant ad arm writedown this year, or Google’s \$12B acquisition of a money-losing phone company with no obvious route to return to profitability. I’m *glad” as a stockholder that Apple isn’t doing this kind of typical mega-corp “buy into new lines of business” nonsense.

3) Invest it in R&D to expand into new areas of business (or increase sales and profits in old ones). But spending that kind of money on more R&D is almost *certain* to be wasted. Look at how successful Google and Microsoft are at throwing money into R&D…. I worked in R&D for many years, and there are limits to how much growth into new areas you can constructively absorb. Apple simply has too much cash to invest this way.

You are also overlooking that they *are* investing some part of their cash flow in one of the highest-return businesses in the world — Apple. The put some of it to work pre-buying components to get better prices and lock in supplies. Some goes to production equipment that keeps their cutting edge designs ahead of competitors. And some goes into R&D.

Ultimately, their *overall* return on investor assets is still excellent, you’re only looking at the part that doesn’t generate these astronomical increases in value. As a stockholder, I’m not at all worried about how they’re using their cash — they seem to be doing much better than just about any other cash-rich company has done, overall. So some of their assets aren’t making any significant profit. But they’re not pouring that money down ratholes, either. I’m very happy with that.

• commoncents

The idea that somehow the Apple and its shareholders can benefit by not paying tax on repatriating overseas funds is flawed. Unless somehow those taxes are eliminated (not very likely; we’ll know in a few weeks whether there is even a chance on reductions), you either have to pay the tax at some point, or NEVER see that cash. And look what opportunities Apple has squandered in the meantime. With their EXCESS cash (that which is not reasonably foreseen to be needed for operations) two years ago, even after paying the repatriation taxes, they would have been able to buyback shares around \$300; so that money would have basically doubled, even with the taxes. Same thing is likely happening now. While they sit on far, far more money the could reasonably use for expanding Apple’s business, they miss the opportunity to buy shares at today’s low prices. When they finally start getting serious about buy backs, they won’t even be able to buyback half as many shares for any given amount of cash.

As to your last comment, I don’t think it is too much to ask them to walk and chew gum at the same time. Fact One: buy producing the best-quality, innovative computing devices, Apple has hit a grandslam home run with their products and ecosystem. Fact Two; buy being ridiculously conservative with the EXCESS cash, they have squandered to opportunity to serve their shareholders even better. Whether you can appreciate this truth or not, let’s leave it at that…so as to not pollute what is generally an excellent places for comments.

• Sacto_Joe

@ commoncents, I understand your point. I even agree with it to a limited degree (see my statement below). However, as the old saying goes, hindsight is always 20/20. It was, and remains, literally impossible to predict with absolute certainty when Apple’s earnings growth will level off. I can practically guarantee you that even Steve Jobs was surprised by the enormity of Apple’s success, especially with a history like Apple’s in the rear view mirror. And perhaps you are right, and in a few years we’ll look back on this as a missed opportunity to add value by dramatically decreasing Apple’s outstanding stock (or, looked at differently, investing in their own stock). But there’s also the possibility that earnings growth will start to flatline sooner than you or I expect it to. And as an Apple shareholder, that burgeoning cash pile represents the ultimate rainy day fund that will underpin my investment for years to come.

Now, I’ve already spoken elsewhere of our being on fixed income, with little hope of adding to our savings and every indication that we will now be “burning” savings to make ends meet. So for me, a dividend is a wonderful thing. It means I can afford to sell less AAPL and hold it longer. Heck, if the dividend got big enough fast enough, I would even be able to add to my AAPL holdings! At the same time, I need AAPL to be stable for the long haul, preferably another twenty years or more. And so I’m not in favor of overdoing stock buybacks at this level of cash. If we get to \$200 billion, I would be more inclined to agree that stock buybacks and dividends need to be amplified dramatically, holding cash at that level.

Just my 2 cent’s worth….

• commoncents

One more thing…
…given that AAPL stock is trading at such attractive levels already, and assuming further P/E compression (due to general anxiety that the party must end, Steve Jobs is gone, people freaking out when the share price surpasses \$1000/share, etc), if Apple finally gets a clue and starts buying back their shares aggressively, the shareholders could see even far greater profits than they’ve seen to date. Hopefully the next group in the U.S. government makes this decision easier for Apple management by lowering the repatriation taxes on their foreign-held cash; it’s certainly not doing the U.S. any good over there.

• Walt French

Share buy-backs are essentially—mathematically identical to—reverse fractional splits plus a one-time dividend. Fewer shares out, money out of the corporate coffers and into investors’ hands.

Say, a 5:6 split ratio, resulting in 5 shares for every 6 you hold today, but at the same ~ \$660 price because each of the now 5/6ths of a billion shares no longer has \$110 of cash each.

Except that Apple no longer has an easy way to weather a surprise initiative from Google, Microsoft, Samsung, Lenovo or ???. No way to pick up a major global network over which to distribute content, nor a way to guarantee revenues to producers so as to wean them from the cable companies.

They’d be substantially more stuck in their current business, one that @r.d. and others are worried are already closer to saturation. In an industry that’s undergoing such sharp changes, that’d seem the pinnacle of stupidity.

• unhinged

This strikes a chord. I’ve recently been reading “Great by Choice” (Collins and Hansen, Random House Business Books) where the data shows that the best results come from sticking to a steady pace through good times and bad. Collins also wrote “Good to Great”, another excellent read.

• Walt French

I liked “Good to Great” at the time, but I think it would’ve been better had it been written post-Christensen.

Horace has occasionally described how a group of very smart businesspeople all suddenly turned “stupid” simultaneously with the introduction of a new, unexpected technology. I think it’s very helpful to understand companies by breaking up their success into macro, industry and firm effects; G2G mostly talks up the latter.

Unquestionably important, especially as it talks about resilience in the face of exogenous changes, but maybe not recognizing how a firm (like Apple) disrupts an industry, even an entire economy.

Thanks for the note, tho. I’m sure “Great by Choice” will reflect those factors more.

• http://twitter.com/JessiDarko Jessica Darko

Share buybacks have not helped Microsoft or Intel, despite plowing billions of dollars into these programs, their share prices have not appreciated anywhere close to the amount of money spent.

Apple has much better places to deploy its cash.

The problem is, people think that Apple’s cash is just going to waste– it is not. It is a strategic asset, and at the level they are playing at, havin \$100B in cash is extremely valuable.

It means they can buy any company they need, should they need to.

Thus, Sharp, TSMC, etc, know that Apple could buy a competitor if the don’t play ball… so they play ball.

That \$100B is earning a return, you just don’t see it. (and of course at the same time, it is also earning returns itself… )

Being able to write a check for \$10B for a new manufacturing plant is really, profoundly, strategic.

• Walt French

@Jessica Darko wrote, “Share buybacks have not helped Microsoft or Intel…”

Of course, the purpose is to help the investors of the companies, who get their money subject only to cap gains tax, and can reinvest it however they see fit.

There are all sorts of little “but…”s with this, but every investor can roll his/her own buyback: it’s called a share sale. If you want the stock, but without it holding all the cash, you can make your own synthetic shares by borrowing cash in proportion to the cash that come with the shares.

The claim always comes down to the notion that the individual can make better investment decisions than Management. In some cases, this is true. With Apple, it’s really hard to understand the claim.

• http://twitter.com/JessiDarko Jessica Darko

Share buybacks have not helped investors. The buybacks do not drive up the share price, as you seem to be proposing, in the case of the two companies I mentioned– intel and microsoft– they’ve been flat to down, despite tens of billions of buybacks.

In theory they may work as expected, causing a boost to the price and thus more money for the investors– but I don’t think they really work, in practice, consistently enough to recommend one for Apple.

But at the end of the day, this is a quibble, we don’t seem to disagree on the real issues.

• iphoned

“Share buybacks have not helped investors.” That’s not a smart statement. Or a correct statement. Or one that reflects well on the poster’s investment knowledge.

• Walt French

I’m sure you’d be happy to share your wisdom. Why post it as an empty challenge?

I myself haven’t evaluated whether the share buybacks helped or hurt investors; I merely go from the notion that investors may be fooled by short-term cosmetics, but what really matters is the actual business success the firm can have, plus their financial decisions, which mostly —in a Modigliani-Miller sort of sense—don’t affect the real risk/reward tradeoffs much at all.

So please, share the justification for your claims that “That’s not a smart statement. Or a correct statement.” Seems it’s incumbent on you to raise the ante if you raise the contradiction level.

• http://twitter.com/JessiDarko Jessica Darko

I gave examples to support my statement. You have nothing but derogatory characterizations of me, along with a dishonest representation of what I was saying.

I consider that a conclusion of the debate with the point in my favor.

I don’t see how you thought you could win by refusing to play!

• Sacto_Joe

I think the discussion on Apple’s cash is appropriate. I would caution all sides to keep it civil. It is quite possible to have a legitimate difference of opinion. For myself, I’ve been puzzling over this issue of Apple’s growing stash for some time. A few things to keep in mind:
1. Apple stock is not being valued properly even if it had no cash. Its future earning capability is not being priced in.
2. One can think of the excess cash being generated as a by-product of an unbelievably successful business plan.
3. That business plan is still in effect, and there is every reason to believe that Apple’s cash stash is going to be getting much, much larger.
4. To paraphrase an old saying, if money isn’t used to fertilize green and growning things, then like fertilizer its just so much sh!t.
5. Even as say, a U.S. bond, it’s doing some good.
6. I don’t see money going to taxes as a waste. I may be alone on this forum with that opinion….
7. I see a legitimate argument in any excess cash (however that should be defined) being distributed back to the investors.
8. Improving the value of the stock by “drying up” shares via a buyback is a means for Apple to invest in themselves. And improving the value of the stock gives more “punch” to stock options, which helps them attract and retain the best available talent. It also “signals” the investment community that they think their stock is worth the price.

I probably can think of others, but that should get the ball rolling….

• Sacto_Joe

I also suspect strongly that P/E compression is ending. Andy Zaky made this case in his last blog. Discounting future earnings is behind a lot of the compression to date, but there was no ignoring last Holiday Season, just as there’s no ignoring the upcoming Holiday Season. January’s earnings report is going to be mammoth, and everyone knows it, and April’s will be as well, and everybody knows that too. Indeed, the present “selloff” is like the tide receding just before the tidal wave. I’m expecting the P/E to come close to 20 just before earnings in January. And, of course, I’m expecting the P/E to instantaneously drop three or more points when the E part gets posted. By May or June, we’ll see a “compression” again as profit taking rips through.

Again, my 2 cent’s worth….

• ptmmac

The majority of posters on this board believe Apple to be uniquely prepared to meet the challenges of the smart phone market. Horace did produce a graph a few months ago that showed how many companies have dropped by the way side trying to compete in the smart phone and personal computer market. There were literally dozens of companies that have fallen on hard times. Wall Street is not unreasonably discounting Apples share price after watching this blood bath over the last 30 years. Perhaps that graph is all the explanation as to why Apples PE remains so stubbornly

• Sacto_Joe

You could say that about any company. Apple has a far better likelihood of future success than most. Ergo, that ‘s not the reason.

• unhinged

But is that likelihood of success obvious to the wider market? If the expectation continues to be that someone else will come along and take Apple’s lunch a la Microsoft in the 90s AND that it’s difficult to make money in the mobile arena AND that tech stocks are too risky anyway, then it’s entirely reasonable to assume such expectations are a major cause of the low P/E.

We all know that investing is as much about psychology as it is about the numbers being reported.

• http://www.asymco.com Horace Dediu

This makes sense to me. The tech industry overall is discounted deeply and has been so since the crash of 2000. The hangover from the 90s is still felt because the PC industry and IT in general overshot their markets. Devices have also not been a great story so far with notable exceptions. But painting Apple with the same broad brush is assuming a lot.

• Walt French

We should have another data point at the end of the quarter: how difficult is it for a competitor to come into the market (which it previously got driven out of), after spending many billions in R&D, marketing and a deal with the previous giant of manufacturing?

Certainly, the early anecdotes are that well-funded, well-scaled, well-experienced and well-managed Microsoft/Nokia are NOT endangering Apple in any significant way. At this point, Apple can even be said to enjoy a head start in corporations’ development of proprietary apps for “mobile” use, at least as long as “mobile” apps are different from what the Enterprise’s desktops need. I’m frankly astonished that Microsoft hasn’t pulled out all the stops to utterly dominate the business arena, and to make it at least a tossup in the consumer space (where so many devices are now sold).

My own guess about the rising concern is whether at- or below-cost Android tablets can squeeze the profit margin out of iPads, or relegate Apple to “skimming” the high-margin, top decile of customer needs.

• ptmmac

Another possibility is that mutual funds and retirement vehicles have reached the limit of how much Apple stock they can hold. Once these highly regulated companies have 5% in one company they are forced to sell to maintain a low exposure to any one company.

• Sacto_Joe

As an investor, that’s a good reason to abandon mutual funds, which is exactly what, and why, I did.

• Bernard Baruch

This is oversimplified, but I thought I would share an opinion.

One of the assumptions that I always hear about Apple is that smartphone consumers will get a new phone every 2 years. Historically, this is wrong—look at the demand curve for televisions, phones, cars, laptops etc…. One of 2 things will happen to the smartphone space: pricing will collapse, or the upgrade cycle will slow by 50%, because each new iPhone sans Steve Jobs has been mildly better, but given that most are new to iOS, they won’t notice at first purchase. They will on the second, which is where you will flatten the curve. I don’t pretend to know that date but it is probably evident sometime next year.

Assuming you reach the total addressable market, if you slow down that 24 months to 30 months you effectively cut the sales by 25% on a unit basis, or the company will have to eat into the margin, to keep the upgrade cycle going. Previous consumer product messaging upgrade cycles were driven by huge disruptive changes in features: pagers, the original cell phones, Palm Pilot and contacts, the beautiful hardware of the RAZR vs other feature phones, RIMM and messaging/security adoption driven by government and finance, . Then, the market provided the general consumer access to all that iOS could offer-music, an internet browser, applications, photo and video sharing accelerated through superior Data networks, and arguably SIRI (or not, if you have ever used Google NOW). What is next? Many people, Steve Wozniak included, think that the much larger screens were an improvement on that scale; one only need look at the S3 sales to see that as a differentiator. NFC is clearly another feature not included (like LTE last year) that may be included next year, if it fits Tim Cook’s gross margin requirements. We can argue about Android share and China all day long, but personally I think Apple is so bad at the cloud (mobile me, calendar sync issues, maps, etc) in contrast with Google that I feel comfortable saying it is not in their DNA.

The slowdown/flatlining will come; its just a question of when. That may not be happening yet, but portfolio managers will look out 1 year and if they can see it happening, you have no more buyers for the stock unless Tim Cook miraculously discovers a new market on a different planet. I think the maps disaster was such an unforced error that most managers said “Hey, if the guy does that, there will be more unforced errors on crucial decisions going forward, and there are no huge features coming, I think the party is over here.” And given that Apple’s market cap is so large that finding other risk/reward opportunities around them is easier, you will have a hard time locating the incremental next buyer of the shares.

Ultimately, if AAPL misses on numbers this time (because of all the tailwinds), the stock will be at 500 so fast it will make everyone’s heads spin. You may get the mini and the iTV, but that is in every buyer’s script, so the units are priced in. Getting beyond a 10x multiple in a flagrantly disruptive sector is going to be tough and risky.

• http://www.asymco.com Horace Dediu

This is wrong on every point raised.

Regarding upgrade cycle time: Phones have had 18 mo. to 2 year cycles for decades. The reason is because they wear out physically and because they break. The iPhone has fewer moving parts than phones used to have but they are still prone to breakage and ports, home buttons and audio jacks wear out. Batteries are another point. I don’t have figures, but battery life does decrease over time and iPhone batteries have a finite rated life. The better analogy would be the difference between “mature” desktops and “mature” notebook computers. Notebooks are replaced far more frequently even if they can still operate reasonably well with existing software. This is also due to the increased wear and tear. A cursory glance at the budgets of corporate IT departments can confirm this.
Pricing has historically eroded for phones for decades. That did not affect the ability of innovations to be priced at a premium. Pricing reflects value and has always done so. Your mistake is in assuming that there can be no increase in value because there can no longer be any innovation. The iPhone launched into a commoditized smartphone market and it was perceived as a ridiculous bauble by incumbents. The people who had the sharpest visibility into roadmaps of components, software trends and laboratories full of prototypes could not conceive of what value an iPhone could bring, even when they saw it.

• Walt French

Horace, I would be cautious about your reasoning these two points.

First, reliability. Good design attacks weak points; that’s where a dollar of engineering usually delivers the best bang-for-the-buck. Five or ten years ago, failure points were spinning disk drives (they’re gone), laptop hinges and wires that go through them (ditto), batteries (hugely improved), assembly failures such as omitted screws or poor solder joints (tackled through better design, materials and processes) and many others that don’t leap to mind.

As a kid, I got a parts box of electronics when our console radio caught fire due to some electrical failure; by 25 years ago stereos essentially stopped failing. Today’s devices have benefit of understanding almost a half-century of failure modes, so I no longer have my heart go into my throat when I drop my phone onto a carpeted floor. And I’ve estimated it might add less than \$1 to a phone to make it water-resistant, meaning that spilling a beer onto it, or seeing it slip into the sink or lake could/should soon be non-failures, too. Reliability is a small, decreasing concern in products of Apple’s quality.

Second, pricing of premium ideas. You’ve commented about Apple’s “skimming” strategy; can lower-priced, maybe more job-focussed devices be far behind? This should provide a long horizon for Apple. But at some point, the industry will have created products & institutions that serve people’s needs well; the market for devices will shift to a zero-sum game of Apple vs Googlarola. I have no doubt that Apple would compete very well in that world, but it’s still a low-replacement, relatively static market.

If there’s one thing I find most fascinating about Apple, it’s their ability to detect emerging megatrends, and to shape and ride the waves that result. Was this more than exceptionally good luck or individuals’ unique skills? Is that special something somehow pervasive in the company? Apple may have to move to entirely different areas to deliver the type of premium ideas for which they’re famous. This talent is exceptionally difficult to observe, either from the inside (too many biases to cite), or the outside (too little data; too much noise). Here’s where your models help separate trends from disruptions. And I think this is the whole crux of the matter of Apple’s future.

• iphoned

the multiple was 2x now prior to 2008. Things were just a “flagrantly disruptive” back then, if not more so.

• http://www.facebook.com/people/Chris-Greene/620255997 Chris Greene

3 months later and the stock opened @ 504. Looks like we have a winner.

• applefan

the problem is that his 2012 number is way too aggressive (as proved by apple’s earnings, and 60% growth of 2013 is very high. This is a good analysis, but he should used more conservative numbers going forward. I believe the volatility of apple stock has a lot to do with anylysists. They pump up the stock by giving too high an estimate and then when apple misses, the stock drops like a dead stone. I also believe that apple has a low p/e ratio because of the risk associated with the huge swing of the stock. If apple does not have such huge swings daily, the stock price would be higher since it would attact more investors. Currently it way things are, one need to have iron nerve to invest in apple.