asymco

As the chart below shows, the last quarter (third calendar, fourth fiscal 2011) was slow with only 52% earnings growth. The discussion centered on the (surprisingly) disruptive effect of the iPhone transition. Surprising since most analysts, myself included, were lulled into thinking that the portfolio of iPhones and their wider distribution would create a smoother sales pattern vis-a-vis the more cyclical pattern seen in the first three years of production.

The second quarter was surprisingly strong and the third was surprisingly weak. So how do we estimate the fourth?

In last week’s discussion of Apple’s (historically low) valuation, comments arose that perhaps the company’s discount is not unique. Can we look at comparable companies and determine whether the relationship between growth, size and valuation are consistent?

The challenge is in finding “comparable” companies. Apple is characterized by being large in terms of market capitalization, highly profitable, in the technology sector and growing relatively quickly. One can find a cohort of companies with each of these characteristics but not all.

Here is an attempt at looking at the largest companies by Market Capitalization (the so-called Mega-caps) to spot patterns of valuation. Some of the companies in the top 20 mega-caps were technology companies so I thought I’d highlight them. I then also added a few of the top 20 technology companies by capitalization to create a larger sample.

The group I settled on is shown in the list below ranked by market cap.

Companies below $130 Billion in market cap (i.e. below Novartis) are in the top 20 technology list but not in the top 20 overall list.

I then plotted the P/E rate vs. 5 year Growth Rate for these companies, separating the tech sector by color (Red):

The pattern is not encouraging. It appears that there is no correlation. Perhaps the technology companies are, as a group, further up and to the right, but overall they are equally unobservant of growth.

For example, SAP has grown less than 5% in five years and yet enjoys a P/E of 20 whereas Microsoft has grown 18% and has a P/E of less than 10. The non-technology sector companies are similarly broken. Berkshire Hathaway, a conglomerate, is rewarded for slow growth and China Mobile is punished for relative high growth.

But you’ll notice that some companies are not on this chart. That’s because they are outliers. Their growth or P/E are so far out of this cluster that the would make it impossible to discern individual performance. The complete “top 20″ picture is shown in the following chart which will require either a large display or a lot of scrolling (1300×1364 pixels):

Andy Zaky at Bullish Cross wrote a great post on Apple’s valuation, showing the deep discount of Apple’s earnings vs. an average company. It essentially states that Apple’s money is not green.

Felix Salmon took it forward by enumerating a few explanations that might be used for the despondent valuation. None are successful arguments, but that should not be a surprise.

To understand the phenomenon a bit more precisely, I maintain and think about these charts:

This shows Apple’s share price (“P” in blue) and its earnings per share (“E” in green). In addition

Warning: This requires Flash.

This is a data set that shows Apple’s product-level performance according to Units sold, Average Selling Prices, Cost of Sales, Gross Margin, Unit Growth, Revenues, Revenue Growth and Gross Margin contribution. It, along with all the other data sets are available under the Products menu at the top of this page.

Default settings:

• Line Chart
• Y-Axis set to Revenues.
• Color set to GM (Gross Margin percent).

Every quarter Apple’s management issues a “guidance” or forecast of their own earnings in the following quarter. Over the years, this figure has been nearly useless because not only is it not accurate, the error itself has been wildly variable. I plotted what I call the Earnings Guidance Deficit for Apple based on the formula (Actual EPS diluted – Guidance)/Guidance.

The higher the value in the bars above, the more the company underestimated

This is the cascading view of Apple’s financial performance in the third calendar quarter. It only includes information that is already in the income statement but shows the relative growth of the individual product lines, their cost structures and the relationship between fixed (Operating) expenses and their variable (cost of sales) expenses at a glance.

In the past I would publish current and year-ago data, but in this quarter’s summary I present three years’ history of quarterly data. Note that the full view is quite large (2,220 x 886 pixels).

Here are some handy tips on how to read the chart:

• The “top line” is the size of the first column in each quarter’s chart.
• The “bottom line” is the size of the last column.
• The blank areas are what Apple pays suppliers.
• The red area is what Apple pays to the government.
• The Pink and pale blue area is what Apple pays its “exempt” employees. (Other Income and Expense is also included but is nearly invisible).
• The Green area is what is declared as earned and becomes the “E” as part of the P/E ratio. (Note that not all of this goes to the Cash account as the cash flow statement will reveal).
• The colored areas in the first column labeled with product name and “GM” (for gross margin) represent what Apple keeps from the sale of each product after paying expenses tied to producing that product.
• The ratio of sold areas to the corresponding white areas below in the first column represent the margin (as a percent) per product line
• You can observe the trend over three years by tracking each of these quantities from left to right.

The scale of the chart is shown by the line near the top representing $30 billion.