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On knowing the value of everything and the price of nothing

At the latest Apple Summit in Los Angeles the question of Apple’s valuation was foremost on many minds. The illustration I used there to discuss valuation is shown below.

It shows the history of revenues (by reported segments) and gross margin for the five largest companies in the world by market capitalization. I have been publishing this illustration for five years[1] in order to contrast the growth and perception of value between companies that might be considered comparable with Apple. Thus the graphs show the top and (near) bottom lines of the companies over an epoch of about a decade.[2]

In contrast with the histories above, there is a price set on the equities today. These prices are captured by the market capitalizations as follows:

Current market cap (billion)  Peak market capitalization (Billion)
Apple

$918

$955

Amazon

$844

$856

Alphabet

$810

$825

Microsoft

$780

$789

Facebook

$584

$589

 

Market capitalizations are interesting because they show perceptions of value. The traders in the equity are negotiating with each other on what the shares are worth and, as a voting system in a liquid public asset, share pricing is very representative of the perceptions about that asset. Representative because there are literally millions of decisions being made on a daily basis which determine this price.

The sales and profit data in the illustration above is about the past. In contrast the market engine is voting about the future. Any student of finance knows: the value of a company is the net present value of all future discounted cash flows (plus any current assets.)

So what would history have to do with it? What use is the trajectory?

This goes to a deeper question: How does history inform the future? What is the value in knowing previous performance when thinking about future performance? The common caveat in mutual fund prospectuses is “Past performance is no guarantee of future results”. We are repeatedly warned of this because it is within our nature to look at history and recognize patterns. But beware! At least beware those whom you might entrust with your fortune.

But consider that it’s conventional wisdom to also say that culture and preparation are the best ways to ensure a prosperous future. Ask athletes or coaches and they will say that practice and dedication lead to success.  Sports fans know that a team or player with a record of success is more likely to succeed in the future. In this way sport is, in many ways, a simulation of reality. Which is why it’s so popular: a metaphor of life teaches as well as entertains.

Knowing how to read ability as well as conscientiousness are keys to scouting talent. Again, it’s not a guarantee, but in various fields of human endeavor the past does predict, with high accuracy, the future.

This relationship between past and future is what education is based on. We spend our lives preparing and training ourselves and our children and their children with the implicit hope that this leads to better outcomes for everyone. We establish a pattern of success because it is the best predictor of future success. Practice, learn, commit, defer satisfaction, trade time for knowledge, fight, lose and try again. These are the qualities we look for in the past of individuals when assessing their potential for the future. Culture is everything, we are told. Build a track record, we tell the young.

So what does this have to do with valuation?

We can’t easily measure the cultures of persistence and perseverance in companies. Grit, guts, stoicism, fortitude, courage, the Finnish “sisu“. These are not measurable in financial reports. Yet our language is as filled with words to describe character and our financial reports are empty of them.

It’s left to investors to work it out. The exercise of relating the future to the past is the calculation of the ratio between Price (future) and Earnings (past). A high P/E ratio suggests repeated success from past success. A low P/E is a disbelief in a future repeating the past.

The P/E ratio thus allows us to say to what degree recent past performance is repeatable. I.e. how many `last years’ can we expect in the future. A P/E of 1 means a company is worth what it earned last year. A P/E of 10 means it is worth ten years’ proceeds.[3]

This P/E ratio is shown for the five companies above as the overlaid bars in the graph above.

Sure, you say, but it depends on the industry and circumstances. A future divorced of the past is more likely in an environment where there is rapid, chaotic change. The more volatility in fundamentals, the more uncertainty. Technology is changing rapidly and therefore it’s quite possible that Apple’s low P/E reflects this disconnect.

If so then what about its peers? Why would Apple be subject to different technological risk than other technology companies? All of the top five companies are considered “tech”. Indeed, Apple is perhaps the least technologically oriented as it has a brand and consumer orientation. It operates hundreds of stores, and sells design as much as it sells algorithms. It fundamentally tries to deconstruct human needs and package those needs in products.

Alphabet, Microsoft and Facebook primarily don’t “sell” to end-users. The revenues come from businesses in the form of advertising or licensing. They don’t have support staff, interacting with people who buy what they use. They need to understand needs but they trade other things. And Amazon offers AWS to enterprises as its own unique product. Other than AWS it operates a marketplace, acting as an intermediary.

Apple is a consumer company depending on consumer tastes as a brand. This is more typical of a non-tech company in a boring business of consumer brands.

But it’s not valued as either a tech company or a consumer company. Both have typically higher P/E ratios. In fact, Apple’s P/E ratio is lower than the S&P 500 and has been below that level for almost the entire history of the iPhone, regardless of growth rate.

A track record of hit products and the stability of a brand seem to be of no value. Perseverance, consistency and stability are not valued. If it were an athlete with a track record of world-record performance and a spectacular reputation with the public, it would not be granted an above-average pay for its performance.

In the past I’ve argued anti-fragility as a cause. In the context of the other companies, Apple is at the center of perceived vulnerabilities and is thus perceived as vulnerable . The other four are at the center of no competition and perceived as invulnerable. And yet Apple, so far, has survived. So have the others, but apart from Microsoft, they are much younger. I argued that Apple exhibits anti-fragility and has unrecognized robustness. Perhaps Warren Buffet now agrees and this is encouraging to the thesis.

Yet, at an even deeper level, in Apple’s valuation we see how culture is not valued. How the idea of character assessment is not applied to businesses. How ethos is unquantifiable and thus discounted. How markets, accustomed to weighing things, reflective of collective human judgement, demonstrate that we are woefully incapable of valuing that which matters most.

Oscar Wilde famously said that the cynic knows the price of everything and the value of nothing. Here’s to the sentimentalist, because at the end of the day those who change the world know the value of everything and the price of nothing.

Notes:
  1. initially with Samsung rather than Facebook because it was originally a set of “challengers” to Apple. The fact that with only one substitution the illustration turned into a view of the five largest companies in the world was a welcome surprise. []
  2. This being the iPhone epoch []
  3. We could easily calculate P/E for more than one year but the default is one year. []
  • isitjustme

    There is no magic bullet but to the many analysts there is always one when they look at tech companies other than Apple, it is very frustrated to yell at these bizarros that one values a company by their profits and not their revenues or their moonshots but what do I know I am no accountant nor an anal-yst.

  • Claude Hénault

    To me it seems that Apple’s value is discounted because it is seen as vulnerable to various kinds of fickleness.

    The first of these was the idea that there was no ‘rational’ basis for the success of the product. The love of Apple was potentially fickle and could be fallen out of. Hence the stigmatizing allegations of Apple being a cult, not a product. Hence the articles probing whether various groups are becoming disenchanted: have teens or Americans or newbies or whatever turned their backs on Apple? It gradually percolated through to analysts that love of quality (customer sat) and capture by an interdependent ecosystem were adequate bulwarks against this kind of quick flip into Apple Doom.

    A second of these fickleness-related views was based on the idea that for Apple in particular volume size and price limitations were insuperable vulnerabilities. Size because of limits to growth. Growth stops when everyone that can have one has one. The solution of increasing the price of the product to make up for lack of sales growth has limits. Hence the ‘can Apple sell a $1000 phone’ stories. This view came under threat when a dim realization emerged that: 1. Apple did not mind a stable, repeated annually iPhone plateau. 2. Related devices (watches, AirPods) were continuing to provide new spending and pointing toward eventual new key products like AR glasses. And 3. Services were emerging as another major repeatable and growing revenue stream. All these factors led to realization Apple was not more subject to these factors than other producers of physical things.

    Lastly, though, is the perceived vulnerability of Apple to potential regulatory fickleness of the regime that runs China, where most of what Apple makes is produced. Apple has done what it can to reduce the risk of this fickleness. It has carved out a huge and enduring market for its products in China. It has deviated, but not bent, security rules to accodate some regime requirements. It has promoted stable and rules-based international trading regulations and practices. It is with this latter that Apple faces threat, and the threat is from the United States and the international trade wars it is fomenting. It remains to be seen what steps Apple has taken, or can take, to protect itself from the fickleness of President Donald Trump.

  • Sacto_Joe

    Actually, the reason AAPL has been so horribly undervalued for the last decade is simple: The market gave zero value to Apple’s cash.

    That particular worm has spectacularly started turning. Why? Because Apple has used it’s huge and growing cash stash to change the makeup of it’s investors towards buy and long term hold investors like Warren Buffett. Note that, if you had bought your shares just before Apple started buying back AAPL, and kept them, then you would now own 33% more of the company than you did originally. And if you continue to hold them until Apple buys back 50% of the shares from it’s peak issuance (it’s already bought back 25%), then your ownership of Apple will double. Meanwhile, Apple continues to grow.

    This is finally starting to sink in with even the dimmest bulb….

  • Robert Fischer

    To the contrary, I think the market has it right: Apple sells a pricey good that has a decent substitute (Android) and the culture has launched the Watch, AirPods, and the HomePod…late, later, and very late. In the tech industry, and even in the consumer industry, pricey things get undercut. Apple’s “lock-in” isn’t as strong as many thought; e.g. Spotify has nullified the thousands of $ spent on individual iTunes songs…and makes ppl question whether to spend more in ways that increase lock-in. Google monetizes curiosity with no real competition. Facebook’s products have no substitutes. Amazon’s scale and ubiquity create massive economies of scope and scale. With Google, they have proven that sometimes they buy YouTube for $1.65 billion. Apple bought…Beats headphones. So Apple gets valued more based on what they have done (and it’s wildly impressive) than what they can do…because everything new they do is generally delayed or full of problems. A great example is the HomePod and Siri are telling examples of what the market sees. With the HomePod, Apple’s “We enter markets late, but nail the product and reap all the profits” isn’t panning out at all. Before Siri, usually when they pioneer something they stay ahead with duration. And the market knows Alexa and Google have left Siri behind.

    • art hackett

      You must be an analyst.

      • klahanas

        Bookies, players, all the same scene….:-)

    • Sacto_Joe

      Actually, there’s absolutely nothing wrong with HomePod, and quite a lot right, especially now with the stereo capability finally added. It’s a great product, it’s selling quite nicely, and it will continue to do so.

      What you’re really fixated on is Siri, or rather on Siri’s lack of “smarts” compared to the competition. You ignore, of course, the reason for those “smarts’; that is, the picking of people’s brains.

      To each his own. I’d rather not have my brain picked, and if it means my vocal assistant isn’t quite as “smart”, so be it.

      • klahanas

        The HomePod is an intentionally crippled product designed to support an ecosystem first and a compliant customer second. And ithat’s a pity. I would have bought one if only it had a line in port so I can use it with anything.

        This is not a question of whether Apple has the “right” to do so, it’s limitation effects the value proposition.

      • entertained

        Laughing at not including a niche feature being “intentionally crippled”. Entertaining as always.

      • klahanas

        Facts can be entertaining. Why would you not want to use it with non-Apple equipment? Hardly a niche feature, except to the loyalist perhaps.

      • Kizedek

        Why would you have bought one? Because it has pretty good sound, plus some other stuff like analyzing the room to improve its sound profile, it looks nice, or what?

        As Joe said, there’s nothing wrong with it. Certainly, the audio specs increase its value-proposition to those who use Siri and Apple Music on a daily basis. Certainly Apple had iOS users in mind, wanting to add value to users of the iOS ecosystem. So?

        Given the above, your question, “Why would you not want to use it with non-Apple equipment? “, is better framed this way: Why would you want to control your music with non-Apple equipment if you are already a happy iOS and Apple Music user?

        Don’t worry, when Apple’s Doom finally starts to materialize, Apple can choose to add hardware inputs and cater to users beyond Apple’s own “niche” of 1 Billion potential HomePod users. At that point, though, with everything already going wireless and digital, legacy analog ports like line-in certainly will be niche (Apple just likes to help make the inevitable happen sooner).

        At the moment, I suspect that Siri & Apple Music on the one side, and HomePod on the other, are like two tent poles that really require you to lean them against each other to get the best out of either, enhancing the value proposition of both as a result.

        As usual, Apple isn’t looking for compliance, it’s waiting for momentum based on the personal experiences and testimonials of those who have both tent poles working in harmony.

        Because Apple can afford to wait, and improve the value proposition of their ecosystem as they wait, critics seem to attribute that to arrogance on Apple’s part, and compliance on their customers’ parts. Others would just say its good business to think about your customers, even if there are only 1 Billion of them.

        Hey, you could petition Google and Amazon to give you a more expensive option of their home assistant, ones that include better audio, better room analysis, and all kinds of ports that cater to all Android users. You could then have a load of devices sitting on your table next to it — with them all eavesdropping on you at the same time, each device subscribed to a different service, and each asking you to repeat a different part of your request. You could have quite a party as they all try to comply with each other as well as with you.

      • klahanas

        Yes. It would it be for the sound. Why else?

        Why would I want to control my music with non-Apple equipment? Let me bulletpoint the most important reasons.

        – I already own non Apple equipment, and not just digital. Turntables, disk changers, receivers, and the like. Line in is a standard spec Apple is looking to remove. Self serving on their part. They could have offered broader latitude with a simple analog plug.

        – Why would I choose to get locked in to an ecosystem, not just music, but Homepod requires an iPhone as well. Sorry, no dice.

        – Apple can’t do everything.

      • Kizedek

        – Apple can’t do everything.

        Which is why it is a contradiction to say “The HomePod is an intentionally crippled product” when Apple doesn’t try to do everything.

        Maybe you think that when Apple famously says “No” to a feature, they are “intentionally crippling” the product. It’s that sense of decisiveness that really sticks in your craw, isn’t it? Hey, I kinda get it: one wonders how McDonalds got so popular around the world, when it was Burger King that said, “Have it your way.” Personally, I think its because McDonalds locks people in after they enter the restaurant.

      • klahanas

        Please stop. You’re being uncharacteristically disingenuous,.

        By not including a standard feature which most of its competitors have, the line in, it’s a diminished value proposition. It serves fewer people and devices. This is not a technical limitation.

      • klahanas

        My bulletpoints were in direct response to why I would want non Apple period. My original statement was on the diminished value proposition of not having a line in. I’m not already a happy iOS and Apple music user. I might have enjoyed a nice sounding speaker at this price point though.

        Who does not including a line in serve?

      • Sacto_Joe

        “This is a crippled product.”

        Only for those outside of the ecosystem. Maybe it’s time to join ‘em since you can’t beat ‘em. It’s a very warm and welcoming ecosystem. You can take my word for it.

        Oh, and about “expense”: Apple has since forever given it’s users back on the software and quality fronts what it costs them on the hardware front. Note thaf Steve Jobs always considered Apple primarily a software company.

      • klahanas

        Sorry, I don’t get locked on if I can help it. Fortunately, I can currently help it.
        The ecosystem should be a benefit, not a requirement.

        One persons warm and welcoming is another’s censored and controlled. No thanks. I would say that you personally might be warm and welcoming. Companies are not people.

        Btw I own Apple gear.

      • Sacto_Joe

        As I’ve said, the Apple ecosystem is a blend of software and hardware. It’s distinct from other ecosystems in that you pay more for hardware but are rewarded by extreme interoperability and device longevity.

        You are literally choosing to inhabit a different, less interoperable ecosystem with the availability of less expensive hardware (and a lower resale price). Nobody’s forcing you to choose one “lock-in”’over another.

        Don’t worry; be happy….

      • klahanas

        As I’ve said as well, this isn’t about Apple’s “right”. The Apple ecosystem has severely limited the value proposition of the device.

        Including a Line in and Bluetooth would not have hampered the benefits you tout in any way. Zilch, nada.

        It would hurt the lock in though, and you’re a stockholder….
        I’m on the other side of the table, I’m a customer.

      • entertained

        Most people only play music from their phone, most potential Homepod buyers are iPhone users. Straightforward.

      • klahanas

        Don’t care what most people do. That’s not my concern. Why should it be?

      • entertained

        Why would anyone care about your concern…? Do you think this is a customer service complaints page for you to post on?

      • klahanas

        Why, do you think this is a customer praise page for the cheerleaders?
        I commented directly on topic, in response to Sancto Joe.

        Do have a glorious day.

      • Sacto_Joe

        “I would have bought one if only….”

        Apple will try to survive the loss of your custom, klahanas….

      • klahanas

        You know Saint Joe…

        The New Horizons spacecraft was reawakened to explore the Kuiper Belt.

        “But is that good for Apple?”

        I can understand your interest in stocks, and Apple’s survival.
        Product development does not seem to suit you.

        If Apple really thinks the way you just reacted, I’m right.

      • Sacto_Joe

        “The New Horizons spacecraft was reawakened to explore the Kuiper Belt.”

        …and the Opportunity is clinging to life in the middle of an epic dust storm. So? Rather off topic, isn’t this?

        I suppose we could exchange barbs, but that really never gets anywhere and eventually just bores me, so I’ll try a more reasoned approach. For now.

        What you fail to bring into your calculations is the sheer massiveness of Apple’s installed base, Apple’s laser-like focus on building quality products, and the resulting inability for them to even come close to matching demand as it is.

        As Kizdek already pointed out to you, Apple can always choose to expand it’s base to non-Apple users when they get to the point that their installed base becomes saturated.

        Also, wireless speakers are the future. It behooves Apple to move in that direction.

        An example: Some of us are old enough to remember the 3 1/2″ hard floppy which Apple used in the first Mac and that everyone dissed because it wasn’t “standard”.

        Except, of course, when it was, a few years later….

      • klahanas

        When Apple does decide to play nicely with others that does change the calculation.

        My barb was to poke fun at the narrow stockholder view of “the business” above all. I don’t care about the business past the warranty period. I’m a customer.

        Kizedek is wrong, you are wrong, not opinion, it’s math. Not offering line-in or even Bluetooth interoperability is limiting even to iOS users who happen to own other equipment. It is self serving to Apple to have it that way. The device is already wireless.

        Removing is not being innovative. The 3.5 floppy died through old age, when everyone was ready, and you can even still use one if you need to.

      • Sacto_Joe

        So for you, the HomePod is all about Apple not “playing nicely” with it’s competitors? Seriously? Well, I guess it’s “self-serving” if Apple doesn’t “play nice” with those who, in the same position, have not “played nice”’with it. But that’s just business, isn’t it?

        As regards your “math”, anything declaring itself “math” needs something far more substantive than what you’ve offered, which boils down to an opinion. Still, if you want to come across as pompous, that’s your business….

        BTW, offering interoperability makes zero sense for the HomePod without a considerable effort being expended between manufacturers. They’re more than just another set of speakers. These are tuned speakers, and tuning in an accompanying speaker set would not be a simple matter of plugging in a cable.

        Finally, not sure why “innovative” is being bandied about (I certainly didn’t bring it up), but many seemngly simple things can in fact be considered innovative. Innovation is all about shifting the paradigm. Period. Doesn’t matter how little it takes to accomplish that shift.

        And I wasn’t talking about the death of the 3 1/2” floppy, I was talking about it’s genesis. Wrong end of the stick there….

      • klahanas

        Not playing nicely for its customers…
        Or does Apple make turntables, TVs, receivers.
        What if I want to connect and original iPod or a Zune….

        It’s a speaker, it shouldn’t require a marriage certificate. Compete on being a good speaker, or not….
        Get Outlook for iOS

    • Gandhi

      How’s Google’s acquisition of Motorola work out for them? Google+ was a huge hit wasnt it? I see people walking around everywhere wearing Google Glass. Those Google Pixel phone sure are burning up the top selling cellphone charts aren’t they? i know these are all hit products because my GoogleTV told me so!

  • Childermass

    Five years is not a long time.
    Companies are a bit like people. As they mature they get more settled. A ‘fair’ p/e for a company is a bit like a character assessment for a person, it takes a while. In time Apple’s p/e will be around 15 or so.
    Markets struggle to understand eccentric companies like we struggle to understand eccentric people. Whether Apple is ‘tech’ or ‘white goods’ is beside the point. It is niche.
    Horace says culture is not valued. On the contrary it IS valued, but negatively. Companies with strong cultures are undervalued because they are hard to understand. They are not just numbers. They are attitudes. Some may like the attitudes, others may hate them. ‘Likers’ see nothing but good, ‘haters’ nothing but bad. The market, led as it is (by unhappy circumstance) by ‘tech’ analysts, get Apple doubly wrong. It isn’t a ‘tech’ company and it does have attitude, and, on the whole, ‘Mr Market’ likes ‘tech’ and does not like attitude.
    What is this attitude Apple has? It is the attitude of a niche company. ‘Niche’ does not mean small, it means it appeals to a certain type of person and not to others. Niche companies put quality over price. They put long term over short term. They put profit (sanity) over sales (vanity) and cash above both (reality). They could not care less about ‘market’ share (because they have 100% of the market they want). They lead, they do not follow. They use good ideas without shame (because they are humble), and they resent others stealing theirs (because they are proud).
    Complex and contradictory they march to the beat of their own drummer. Not Wall Street’s, not yours, not anyone’s. Their own. One day they will be fairly valued. Until then, buy. Then hold.
    Five years is not a long time.

    • Kizedek

      I’m not sure about your idea of Niche, or Apple’s being a Niche company. Even by your own definition — “appeals to a certain type of person and not to others.”

      Apple products appeal to, and enjoy loyalty from, a whole cross-section of people. It really is intended to be “the computer for the rest of us”. By your definition or characterization of Apple as Niche, Nike would be a niche company. Yes, Nike do 60-dollar shoes, and they do 260-dollar shoes; but I would say at least some of their shoes appeal to just about everyone on the planet, even to those who aim to spend only 30 dollars and do so.

      Niche would be the likes of Birkenstock, not Nike. With Birkenstock, you think of brown leather for hipsters. That’s it, that’s all I can conjure up. That’s “appealing to a certain type of person and not to others”.

      You also said that, “They put long term over short term”. I would hope any company does that. Certainly, any person with discipline does, as Horace points out. That’s the crux of what Horace is getting at. Wallstreet is not valuing Apple’s long term. It is not valuing Apple’s great performance year in year out, quarter after quarter. Wallstreet doesn’t think that Apple’s track record and discipline adds up to beans, and it is not willing to bet on a continued solid performance from Apple, let alone success, next quarter or next year. Hence the low P/E.

      • hannahjs

        Apple was dismissed as a niche player for as long as I can remember. There was always something “wrong” with this company in the alleged minds of investors and analysts, whose sour attitude permanently infected the news media and poisoned the stock market. It remains a tainted stock despite having recently earned the confidence of Warren Buffet.

        There exists a politics of culture, a semiotic realm of ideas and impressions that influences markets and irrationally brands brands with the scarlet letter. This politics undervalues a strong brand like Apple, who ought to be celebrated as the unique success story they are, just like Pixar. The hits keep on coming, but investors have been hornswoggled into believing they’re a one-hit wonder.

    • Sacto_Joe

      “Horace says culture is not valued. On the contrary it IS valued, but negatively.”

      Thanks for agreeing that Apple is undervalued. That’s something.

    • Sacto_Joe

      The more I think about your posting, Childermass, the more I think you are agreeing with Horace. But Horace is focusing on the failure of the market to realize value, where you are focused on the element of Apple that you see as responsible for the disconnect.

      One could easily, and at first I did, see your post as a kind of criticism of Apple. But really, it’s just an acknowledgement.

      None of which really addresses the issue raised by Horace: Short of Apple not being true to itself, what solution is there for the undervaluation issue? The “wait five years” approach hasn’t worked particularly well. I’ve waited more than twice that long already.

      The only alternative I can come up with is to educate the market. And that’s where Apple’s newly acquired cash freedom comes into play. Sometimes it takes a mighty whack to wake the dumb beast up to reality.

      Take yesterday’s close at under $185/share. That clearly indicates that the market still doesn’t “get” Apple. So Apple needs to lower the cash boom, buy a ton of this cheap AAPL, and squeeze even more of the short term investors out of the AAPL market. That’s money well spent, since, as I pointed out below, the longer the market keeps AAPL undervalued, the more stock Apple will remove from the market, and the higher the percentage ownership of Apple for long term holders.

      That kind of underpinning of value will inevitably attract even more buy and hold investors, displacing even more short term investors and options players, and slowly driving the valuation of Apple up where it belongs.

      Then, when the AAPL float is largely made up of long term investors, Apple slows the buybacks and increases the dividends, attracting even more Apple longs, and flushing away the power of short term investors and the options market to hamstring AAPL’s valuation. Permanently.

      Result: A stable yet fully valued stock. And the joke is that the short term players will have brought it on themselves by undervaluing the stock in the first place….

      • Space Gorilla

        Hey, you’ll give away the plan! 🙂 Let the trolls and doomsayers and the market continue to fail at understanding Apple. Better for those of us who do understand, in the long term.

      • Sacto_Joe

        In my own little way, I’m trying to educate the market….

      • Space Gorilla

        You do a very good job. I’m just kidding about giving away the plan of course. There’s no danger of the trolls, doomsayers, haters, and poor analysts learning anything. People believe what they’ve chosen to believe. All the better for me as a long term Apple investor.

      • klahanas

        Please take this as an inquiring comment, with a smattering of sincere criticism.

        You already know that I don’t pretend to know jack about stocks and gambling, I have never purchased a stock with my own money, and I sell granted or otherwise earned stocks as soon as is practical. I just don’t have the mindset or temperament for it.

        I like that you make a great effort to explain, rather than to simply proclaim. Here’s my question.

        It seems that you’re looking to violate the law of reciprocal risk/reward, and are stating that Apple somehow has achieved that. Any comment?
        Either the “law” is BS, or Apple has not achieved it’s violation.

        Also, you seem to be basing the valuation on existing corporate equities and assets. Isn’t that already reflected in the stock price? You seem to be saying it’s not. So a one time correction up would be expected.

        Again, I don’t know much about such matters, but I do seem to be under the distinct impression that Wall Street rewards or punishes change, real or perceived. Can it be that after a possible correction for undervaluation, Apple is simply a stable stock?

      • Sacto_Joe

        Not sure about the “law”;’more of a postulate?

        AAPL is a comparatively odd stock because Apple is a comparatively odd company. Yes, that oddness impacts it’s valuation, which, importantly, is separate from it’s value. And it is the variance between those two that basically answers your question: There is a great deal of “hidden” value in AAPL.

        My guess about the prime factor behind this failure to see AAPL’s value is that the market is mistakenly catagorizing Apple as a hardware company when it is at base a software company. Consider Microsoft, with an extremely high net income. Why? Because it’s roots are grounded in being a “pure”’software company. The hardware was left to others, and quickly became a low margin “commodity”.

        Microsoft almost destroyed Apple back when it appropriated the Mac’s software “crown jewels”, and churned out Windows. Then Steve Jobs returned, and flipped the Windows dynamic on it’s head: He commoditized Apple’s software! An odd thing for a software company to do, but Apple was in the unique position of being a software company that manufactured it’s own hardware.

        But the market is “trained” to think that hardware will eventually commoditize – which is the case when there isn’t any extra value assciated with a particular piece of hardware. What Apple did is add value to their hardware in two ways: They created high quality hardware that they coupled with user-friendly software specific to that hardware. Result: Hardware that was impervious to commoditization. With this dynamic, Apple was able to survive as a niche company.

        Enter the Steve Jobs paradigm shift which led to the first truly useful cell-based pocket computer, which from the get-go inculcated this different approach to software “sales”, and which also “piggy-backed” on the immense in-place world-wide cell phone structure. That in turn began generating huge amounts of cash for what the market continued to see as a hardware company doomed to commoditization, and thus the market continued to overlook Apple’s hidden value proposition. So much so that, six years ago, Apple came to the conclusion that it could literally use it’s burgeoning cash to purchase back it’s own stock at fire sale prices, both putting that cash to work for it’s owners and supporting it’s stock, which was under serious assault.

        Cut forward to today, and Apple has now literally bought back over 25% of it’s stock, still has a quarter of a trillion dollars in it’s cash stash, about half of that in very low interest debt, and over $50 B/year more coming in, which could grow to $75 B/ year in five years or so.

        But that’s not all: The recent Republican tax bill has been extremely good to Apple. It now has both an appreciably lower tax bill and access to all it’s foreign cash income. For the first time, it has truly massive amounts of cash to put behind it’s stock repurchases, not just this year, but going forward potentially indefinitely.

        And most important of all, it still shows zero signs of being commoditized.

        Will this finally be reflected in a “stable” stock price? That’s a good question. What is stable is Apple’s ability to counter the market’s tendency to undervalue AAPL. Over time, that should reflect itself in a new market reality for AAPL in the form of a higher P/E.

        Of course, nothing insulates Apple, or any company, from macroeconomic issues, such as the impact of a “trade war”. But Apple’s enormous cash stash will allow it more ability to protect it’s underlying value than many other companies.

        That is why, oddly, many owners of AAPL are actually welcoming the present pull-back in the price of AAPL: It gives both them and Apple a chance to buy even more seriously discounted AAPL…..

      • klahanas

        Thank you for the thoughtful response. I appreciate it.

        Let me delineate where we agree first…

        a) Apple is not a commodity. That much is obvious, though I prefer standardization (if not commodity) if for no other reason than a larger ecosystem with multiple suppliers of the pieces gives the most freedom to the user in control over their device, as well as better price tiers.

        b) The recent Republican Tax bill favors companies. Though I think it amounts to corporate welfare, which I adamantly oppose.

        c) Piggy backing the cell phone structure was very opportune, and only a new player (disruptor) could do it. They had nothing to lose in doing so, and competitors got what they deserved.

        d) Apple may indeed be undervalued if hidden assets are not reflected in the stock price, but I still see that as a one time correction.

        Now where I remain doubtful…

        a) If the inverse relationship of risk/reward is not a law, there certainly can be no law regarding a correct P/E.

        b) I agree MS stole, but they did not steal from Apple, if anything, they stole from Xerox. Apple licensed the PARC tech, which means they paid Xerox for the right to use it. MS didn’t.

        Then what about X-Windows, GEM, GEOS, Deskmate, and so many others. Did they steal from Apple too?

        d) “Apple came to the conclusion that it could literally use it’s burgeoning cash to purchase back it’s own stock at fire sale prices, both putting that cash to work for it’s owners and supporting it’s stock, which was under serious assault.”
        How in the world that’s not insider trading is beyond me. You could say that they are basing on public information. If so, why aren’t they competing for those shares raising the stock price from fire sale to competitive?
        As a humorous aside, that reminds me from “Grumpy Old Men”… “Why don’t you pull your lip over your head and swallow!”
        Anyway, thanks again.

      • Sacto_Joe

        I appreciate your openness to cordial discourse as well.

        1a) There is one other aspect of Apple that keeps it away from commoditization; they aren’t resting on their laurels (in a way, that’s what happened to Microsoft). That means “standardization” keeps getting pushed off into the future.

        For that matter, there’s another aspect; Apple started out with near-zero production capacity for it’s high-quality devices. That production capacity has since grown by leaps and bounds – but even so, it’s not nearly as large as I expect it will eventually be. This “growth in quality production” is also operating “under the radar”. Yes, there are other high quality smartphones. But none with close to Apple’s production capacity.

        1b) As an Apple stockholder, and one who is far from wealthy, I feel double-taxed. First, Apple pays a tax. Then, when I receive a dividend, Apple’s earnings are taxed yet again. My preference would be for Apple to pay no tax and the dividend tax to be much more progressive than it presently is.

        1c) Totally agree.

        1d) The problem is that the “one time correction” continually recedes, such as it is presently. Per Google Finance, Apple’s P/E is now down to about 16+ (note that Yahoo Finance has the P/E at 17+). At this level, any “correction” has pretty much evaporated. (However, as I say, many long term Apple holders see this as more opportunity than negative….)

        Personally, I’d be looking at the stock from Apple’s POV: What will Apple consider to be the “correct” level for the stock, at which time they would shift from buybacks to increased dividends? IMHO, it’s a ways over the 20 P/E that the market seems to think should be the “corrected” level. Apple might slow buybacks at a permanent 20 P/E, but I personally don’t see them stopping buybacks for much less than a permanent 25-30 P/E or so.

        2a) You’re right: There’s no law regarding a “correct” P/E. But it’s safe to say that Apple is clearly signaling that the present P/E is way, way too low. And I agree.

        2b) I hate the word “steal”, but I think that’s an interesting point. Of course, you must recall that what Apple licensed from Xerox was subjected to considerable added value by Apple. And talk about stupid: Xerox was given a goodly chunk of AAPL (much as Microsoft was later). What they wouldn’t give to have that stock now!

        As for the rest, businesses are always trying to ride on the coat-tails of other businesses. Google found a nifty way to do that with Android (no “profit”, so no infringement). So did Microsoft with Windows. Fortunately, Apple survived. And grew stronger.

        2d) It’s not “insider trading” because, at the time, Apple bought at the price the market was saying it was worth. Apple was no different than we were when we bought our AAPL with no assurance of what the future would hold. People like me were saying AAPL was a steal years ago, but nobody believed us. They still don’t, for that matter.

        Put another way, It’s not “insider trading” when the market discards nuggets of gold and Apple picks them up out of the dirt. If Apple had manipulated the price lower, that would be different. But that wasn’t, and isn’t, the case.

        Flip the argument over: Amazon is increasing it’s float, and selling that new stock into a market that gives the company a P/E of well over 200. Is that “insider trading” because people are valuing Amazon that highly? Nope.

        But it sure helps Jeff Bezos fund Blue Origin!

      • Space Gorilla

        “People like me were saying AAPL was a steal years ago, but nobody believed us. They still don’t, for that matter.”

        That’s the nut of it right there. I predicted Apple would have a billion customers a little more than a decade ago. I was laughed at.

      • klahanas

        To play devils advocate… there would be inside knowledge, for any company, on whether to pull the “buy” trigger. This knowledge is not publicly available. A company which buys its own stock has a measure of certainty an outsider does not.

      • Kizedek

        “b) I agree MS stole, but they did not steal from Apple, if anything, they stole from Xerox. Apple licensed the PARC tech, which means they paid Xerox for the right to use it. MS didn’t.”

        As Joe mentioned, Apple’s work went way beyond Xerox Parc. Wikipedia mentions: “the Apple work extended PARC’s considerably, adding manipulatable icons, and drag and drop manipulation of objects in the file system (see Macintosh Finder) for example.”

        This is the kind of thing people have in mind when they say MS stole from Apple. Also, we are talking about timing and MS access to Apple’s work: Apple released the Lisa in ’83 and the Mac in ’84. MS didn’t have a good, comparable GUI for some years …probably Windows 3.11in 1993! At which point, Gates had direct access to Apple GUI code in order to create Word for Mac OS. (Incidentally, it seems Jobs’ trusting nature or naivety in giving free access made it hard to win a suit against MS, not because there was no merit; and Jobs was determined to never again make it that easy)

      • klahanas

        Apple may have gone beyond PARC, but other than interface elements Windows did not behave like System whatever. The interface elements were PARC’s design. And you still don’t address all the other Windowing environments.

      • Walt French

        Since Markowitz’s 1952 “Portfolio Selection,” investors have a well-reasoned and empirically very successful description of investing risks and reward. Sharpe & Lintner’s 1964 CAPM expanded on it and showed that for ☞well-diversified☜ investors, the stock’s beta is all that matters for valuation. (Its TOTAL volatility is the only risk that matters for pricing options or to totally UN-diversified investors.)

        I saw a recent assessment of Apple’s beta as 1.15, slightly above the market portfolio’s. The market perception (beta calculations inherently drive off market prices as Horace describes) is that Apple has somewhat higher risk than the market in the way that counts.

        Normally, above-market-beta stocks ALSO have above-market P/Es.

        If Apple were MORE stable than the average US stock, it wouldn’t have a higher beta, because it wouldn’t depend so much on the future growth of the US economy (returns to the market).

        I’m a quant, but a retired one, without access to my favored tools. But Horace’s identification of the anomaly seems consistent with the more detailed numerical studies: investors have a deep fear that its success cannot continue, in his & my minds because most cannot understand how applicable his simple metaphor of culture, talent and team scouts is, to Apple.

      • klahanas

        Thank you very much. Especially for the background references on risk/reward. Like I said, I don’t know squat about these stock matters.

        So I looked up beta. It’s a metric of risk, as you say. What it really is, statistically, is a running measure of volatility over baseline. Baseline, as you also say, being dependent on the prospects of the economy. In my admittedly ignorant opinion, it’s an oversimplification, it averages, but it is but one way of looking at things.

        The problem with averages, from evolutionary biology, is that it can be the smallest of random differences that determine survival over extinction.

        This is all a critique of finance, not you. Do people get stuck into economic models that become so widely believed, that they become self-fulfilling prophesies? I ask this because economics is not natural law, and by necessity the mathematical models rely on assumptions that are not indisputable.

        To my passive knowledge, the closest thing economics and finance have to natural law are the laws of Supply and Demand, Buyer/Seller, and Risk/Reward. Thank you for shining light on the risk/reward aspects.

        Don’t worry about me ever becoming an economist of any sort, and almost certainly a terrible one. The world is safe.

        To Apple stockholders… I wish you well, as people, but as a customer we’re adversaries if your stock interests impede on my customer interests. That’s just fundamental for any company, not just Apple.

  • Simon_Hibbs

    It’s also interesting to look at Apple’s P/E ratio history, and how the launch of the iPhone caused it to plummet.

    http://www.macrotrends.net/stocks/charts/AAPL/pe-ratio/apple-pe-ratio-history

    It bottomed out at about 10 several times since then, and now at ~18 is about as high as it’s got in the iPhone era. I’m not entirely sure that the current level is irrational though. 18 years is a long time, and it really does seem likely that iPhone gold mine production is likely to reach steady state soon. The main period of undervaluation of Apple was probably in the 2007-2014 period when their profits were massively ramping up.

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