Predictably Profitable, Unpredictably Valuable

Predicting Apple’s yearly revenues has been fairly easy. The following graph shows the relationship between budgeted spending on Machinery, Equipment, Internal-use software, Land & Buildings and the shipment of iOS device revenues.

The company conveniently publishes a full-year forecast of these expenditures every fiscal year so by October we know roughly how sales will be during the following year. This pattern has held for 10 years so there is little uncertainty about the 11th year of iOS devices.

Although the two are not very tightly coupled, there is a causal link between them: spending on machinery and equipment for production leads to more production which leads to more sales (assuming prices are stable–which they are).

We are, as of the time of writing, half-way through a fiscal year and the quarterly spending can be inspected for any surprises. None are evident as the second fiscal year (first calendar quarter of 2017) shows a new high in capital spending at nearly $3 billion, placing us on track for the surge into the production of the new iPhone (and iPads.)

The quarterly relationship between sales and spending is less precise as equipment buying is “front-loaded” into a production cycle but there is a strong correlation nonetheless.

When looking through the data, quarter after quarter, year after year, there is a consistency and reliability to the spending/revenue relationship which implies, to me at least, a high degree of certainty.

This predictability, however, has not detracted from the volatility in Apple’s share price–an instrument designed to embody precisely this prediction.

Apple’s share price continues to see swings of more than 70% in any given 52 week period. In the latest 52 week period the shares traded between $89.47 and $154.88, a 73% swing.100% is not unheard of. Incidentally, S&P 500 volatility ranges around 45%. Apple is by far the largest company in the world and fairly old by large company standards. It should attract a certain premium of stability.

And yet it doesn’t. Skepticism around the company is continuously evident. It’s in the headlines written every day which concoct convoluted reasons to doubt future performance. It’s in the conversations I have with investors who question the tiniest of details in the design of a product (like headphone jack or home butto) in order to gauge their impact on the survival of the firm. It’s in the continuous parade of “disruptive entrants” or “established giants” ready to knock the company off its perch by virtue of simply existing.

Perhaps the panic it induces in investors with its reliable profits is Apple’s most predictable attribute.

  • Frank Ichel

    Thank you, Horace! Very interesting charts!

    1) Question on everyone’s mind, then: What sales value would this correlation output for next year?

    2) As always with correlation studies, there could be a third variable we are overlooking that explains both revenue and planned expenditure. That third variable could be something related to management’s perceived success or health of the business and industry. Therefore, could planned expenditures could be more useful as a lens into management’s perception of the health of their business, rather than suggesting a causal or predictive relationship to sales?

    • Kizedek

      The common perception among analysts and easily panicked investors, is that Apple is out of touch with reality and carries on blithely, doing their own thing, regardless of the concerns and warnings of “intelligent” folk. It even has a name: “Reality Distortion Field”

      I would suggest that the “third variable” is Apple’s own deep understanding of its own business, their superior understanding of what works and what doesn’t, and their understanding of the reasons for their own successes.

      Perhaps their deep understanding of their business, and the strategic decisions they routinely make (even years in advance) to continue doing and improving on “what works”, has some real proven connection to reality that most analysists and panicked investors (and competitors) don’t fully appreciate.

      For example (and here I am just spitballing a few of the things that come to mind out of all the Asymco articles) :

      –how Apple controls its supply chain and invests up the line of production;

      –how Apple is taking more of its “destiny” in its own hands by achieving new capabilities, such as chip and silicon design and manufacturing.

      –how Apple’s product line is simple and each model continues for a couple of years so that margin on each actually increases as time goes on (because there is time for fixed costs to be completely paid off);

      –how Apple retains its ASP on all products, even older ones, by constantly adding value to purchased products through continued updates, exemplary support, and ecosystem synergies;

      –how Apple creates a moat against competition wherever possible by innovating around materials and production methods;

      –how Apple is careful to not launch an idea until it is ready and the foundations have been set in place (often years ahead), and there is immediate, practical application for the new technologies and software;

      –how Apple is patient and plays the “long-game”;

      • Space Gorilla

        Spot on.

      • Childermass

        You are right. I’d go further on the ‘deep understanding’.

        Apple have always said that their desire is to make ‘insanely great’ products. Never to be the biggest, or the most profitable, or even the most popular, but to make things they themselves love and would want to own. To do that requires an immense investment in talent, care, wastage and time. To be able to make that investment year after year means their business model has to have wide margins. Therefore the business must source at the best price possible and charge as much as it can. It’s not a unique model. Many of they world’s great companies do just this. They tend to be called ‘niche market’ companies because they address the tastes of a niche rather than the price competitiveness of the mass market.

        They know that quality is more important to their customers than price

        They value profit above market share

        They have a focussed, narrow product range

        Their market is worldwide

        They are driven, difficult to work with and obsessed, they know best

        They take their own privacy very seriously

        These are qualities all niche companies share.

        As it happens Apple makes computers (iPhones are pocket computers that can be used to make phone calls), and software for their computers and provides services run by that software on their computers. That doesn’t mean they are a ‘computer company’. Or an industrial conglomerate (Samsung). Or an OEM (Dell). Or an advertising agency (Google). Or a discount, government-supported e-tailer (Amazon). Or a business services software house (Microsoft). And the fact they are huge does not mean they are not ‘niche’. ‘Niche’ does not mean small.

        Apple is disruptive because it applies a different set of values to what it does. It is why it cannot be copied (only mimicked). It is also why Wall Street and its followers will never understand.

      • art hackett

        I would love to know when Apple/Jobs realized that they hadn’t just made a new, better iPod/phone, but a new computing paradigm that was disrupting the world in a way that hadn’t been seen since the industrial revolution, and when Microsoft realized there would be a computer in every pocket (that wasn’t Microsoft). Also Google, especially since they were initially targeting the Blackberry/Microsoft dominance, notwithstanding their extremely fortuitous position witnessing the gestation of said revolution. No doubt one of Steve’s biggest regrets.

      • demodave

        “They value profit above market share”

        I don’t think this is correct. Tim Cook has said, even if paraphrased “we don’t think about the bloody ROI”.

        I do think that these are a correct counterbalance, though:

        “They know that quality is more important to their customers than price

        They are driven, difficult to work with and obsessed, they know best”

      • Childermass

        Thank you for replying.

        I think Tim Cook is being cute. It may well be that when they start a project there is no imperative to design to a price or to a ROI. They want to make insanely great products. However, when it comes to selling them, then they price them with good margins. Not always, but nearly always. A business like Apple knows that it needs these big margins to ensure they can afford the levels of investment that are needed for ‘insanely great’.

        I believe they price to design, rather than design to price.

        And they certainly don’t pursue market share.

  • Funniest thing to me is that many competitors focus their strategies on those tiny product details seen as major points of attack. It shows correlation between their vision of products and external opinions, like pundits of focus groups or past experiences, while Apple continues to be successful being true to the products they make.

    Examples: lack of flash compatibility lead to many products proud of having a cumbersome flash compatible browser, lack of keyboard …, lack of headphone jack …, lack of copy & paste … but also the “problems” caused by touch bar (mac record quarter), lack of curved display, …

  • Luis Alejandro Masanti

    I think that the difference in ‘value’ (Apple) and ‘valuation’ (analysts) comes from the fact that Apple has a ‘long vision’ —Make the world a better place— and analysts has a ‘short vision’ —gime me a quick earn—.

    I hope that —as during Steve Jobs’ era— Apple do not give too much attention to analysts and Wall Street demands.

  • Sacto_Joe

    So depending on which year you start measuring from, Apple iOS is adding between $1.5 B and 2 B a year in revenue as it expands it’s capex. Note that, because of the enormous enterprise size Apple has reached, the percentage growth per year decreases more and more rapidly. Wall Street fastens on this as the reason to shun AAPL, presumably because there are companies with better growth possibilities out there.

    But when you look at those “better growth possibilities”, you see a lot of companies whose stocks have substantially higher P/E ratios than AAPL. And a few of those companies, like Microsoft, are only promising growth, which makes stockholders tantamount to gamblers.

    As a person who once lost a considerable sum on GTAT, I can guarantee you there is risk associated with gambling….

  • fstein

    Thanks. This predicts not only next year, but long term iOS. Apple can, and will, continue these investment.
    Once again, Apple defies convention and wins. Everyone else in consumer retail pivots to virtual, robotic, on-line. Apple’s stores now are all in, on the customer experience.