Apple's P/E compression illustrated

The reason we look at valuation is that it offers insight into how innovation is perceived. If a company is a successful innovator it usually creates vast wealth for its owners. However, the timing of that wealth creation depends greatly on its recognition by others. In other words, valuation lets you determine how recognizable innovation is. If your analysis tells you that a company is supremely innovative but nobody else recognizes this then you have an investable opportunity.

So with that in mind we like to compare industry and innovation analysis with what “the market” thinks about Apple.

The latest method we had in mind was to compare P/E (a measure of valuation) and Growth. We’ve shown before that they seem to be moving in different directions. That’s not been news for over a year. What we will try to do now is to see if there is discernible change in the relationship before and after the financial crisis.

The following chart is a simple representation of P/E (line chart with left scale) with Net Income growth super-imposed (bar chart with right scale.) We chose a time period of 22 quarters. 11 quarters after the crisis (i.e. quarters after the one ending in Sept. 2008) and 11 quarters before the crisis (quarter ending 12/20/05 through the one ending 6/30/08).

We then plotted a scatter of all these pairs (P/E vs. Net Income Growth).


The R-squared value simply shows that there is no correlation between these two variables, but this is not a surprise.

The next step would be to compare the pre-and post-crisis data sets. The idea being to see if, and to what degree, there was influence from conditions beyond the control of the company.


What seems to be happening is that the cluster of values did indeed move from the right (high P/E) to the left (low P/E) without much change in the growth.

We can get an even better feel for this by measuring the “center of gravity” of the clusters and plotting how they shifted.

This chart illustrates succinctly the phenomenon of “P/E compression” where P/E drops while growth continues.

In the case of Apple, average growth actually increased slightly between the two sampling periods (from 68% to 71%) while the average P/E dropped from 32.8 to 17.5.

What will follow over the next few weeks will be pair-wise comparisons of Apple and comparable companies along these metrics of P/E and Growth.