Wall Street is still missing AAPL’s boat, but investors don’t have to

By Ken Cheng

Another quarter, another earnings report; however, this quarter’s earnings report was a bit special. How so? Well, Steve Jobs deigned to give us his state of the union address. While others have different theories on why Steve made an appearance it seems to me that there is only one reason.

I wrote back in April about how analysts were just “not getting” Apple’s earnings. They were having a difficult time interpreting Apple’s deferred revenues. Here’s the link to what I wrote in April:

Wall Street is missing important aspects of Apple’s story – April 25, 2008

Since then, analysts, and by inference investors, have continued to get it wrong, punishing Apple’s stock price. As a long-term Apple shareholder, I was frustrated. Steve was frustrated, too. How do I know?

He answered Jim Goldman of CNBC in an interview after a recent product launch about why he thought the stock was going down. He blamed the short-selling hedgefunds. If Steve wasn’t frustrated, he could just have said, it wasn’t any concern of his and dismissed the question, but no, Steve answered it. The shorts have had their way with Apple stock, and it bothered Steve because there is no fundamental reason for the stock to have reacted so negatively since January.

So, what can Steve do?

He can give a gift to analysts and investors alike, by revealing how much iPhone and ATV revenue and income Apple is deferring due to subscription accounting. Apple uses subscription accounting due to Sarbanes-Oxley rules. They file earnings with reports using GAAP (Generally Accepted Accounting Principals). Reporting financials the old-way, without deferring revenues, they call non-GAAP.

For the most part, as we all know, Apple is deliberately vague and conservative when talking about their financials, so revealing this info, is rather extraordinary. Analysts and pundits have constantly criticized Apple for poor corporate governance by not breaking out their revenue streams more clearly. For example, can anyone tell me how many Mac Pros Apple sells? No, they don’t break it out. No one knows, and Apple won’t tell. Then why so much info on iPhone deferred sales and income? I mean, over the next 7 quarters, Apple will recognize all of those deferred sales, won’t it? Yes. It’s there. Sitting in the bank, collecting interest, and just waiting to be counted by GAAP rules.

Steve decided to spill the beans because analysts and investors were underestimating the true sales of Apple. While sales and profits were still growing nicely, you had pundits saying that sales and profits were actually slowing! This allowed the shorts to push the stock down, as slower growth merits lower price multipes. And, down it went. From over $201 at the beginning of the year into the $80s, this year.

Long story aside, the facts are these:

I had written a few sentences describing the above chart, but you know what, Steve Jobs said it better in the conference call. This is what he said:

As you can see, the non-GAAP financial results are truly stunning. By eliminating subscription accounting, adjusted sales for the quarter were $11.68 billion, 48% higher than the reported revenue of $7.9 billion, while adjusted income was $2.44 billion, 115% higher than the reported income; if this isn;t stunning, I don;t know what is — all due to the incredible success of the iPhone 3G.

Truly stunning! Not too many companies make $2.4B in a quarter. The ones that do, have names like Walmart, Berkshire Hathaway, Proctor&Gamble, Johnson&Johnson, AT&T, IBM, Pfizer, Google, Coke. Here’s a list of the biggest US-based companies sorted by market cap, excluding banks, oil companies and GE:

Look at last quarter’s earnings. You can see, for the most part, the more you make, the more your company is worth. Fast growing companies, generally are rewarded with higher multiples to earnings, though when you are one of the top-30 companies or so in the world, you tend not to grow too fast. Ask MS. Of course, Apple is growing very quickly in this group, and would normally be rewarded with a higher earnings multiple. But look. Apple made $2.4B last quarter, that would put it between Pfizer and IBM both worth about $113B, but Apple would justify a higher multiple because of its growth rate, and yet, Apple is trailing this pack of behemoths at $86B.

If you back out Apple’s cash of $25B, that leaves you an operating business value of about $63B. If you annualize Apple’s earnings. Let’s take that $2.4B, and estimate going forward. Let’s say the first 3 quarters of ’09, Apple makes triple what it made this past quarter, or about $7.2B. Add in that Xmas quarter, which is usually about 50% better than the other 3 quarters, and you get $3.6B, for a total of $10.8B in annual earnings. That would make the P/E ratio less than 6 (63/10.8 = 5.8), when you net out cash. That’s tiny.

I’m not going to do the price projections that Apple’s earnings can support, but just note that historical P/E’s for the whole S&P500 are in the 15x range, and high-growth companies often sport multiples of 30x. You can do the math and see that Apple’s future earnings can support a much higher price.

If you are a fundamental investor and not a technical trader. If you have a long time horizon, at least a year, then Steve has just done you a huge favor. He’s let you peek into the crystal ball into the future of Apple’s earnings.

Right now, Apple reports $1.26 a share in earnings, this past quarter, but in the near future, in about a year, those GAAP numbers will approach the current non-GAAP numbers of $2.69 a share, and exceed them. Analysts and investors will look up and be surprised. You won’t be, because Steve just gave you a peek into his crystal ball.

Apple has become a free-cash flow machine, on par with the biggest companies in the world. That’s what Steve wants you to know.

Well, I wanted to end there, but I can’t help myself. Take a look at what Apple itself said in a press release:

Management believes that these non-GAAP financial measures, when taken together with the corresponding consolidated GAAP measures and related segment information, provide incremental insight into the underlying factors and trends affecting both the Company’s performance and its cash generating potential. Management believes these non-GAAP measures increase the transparency of the Company’s current results and enable investors to more fully understand trends in its current and future performance.

That’s Steve talking to you, the investor. Take a look at the non-GAAP numbers. That’s Apple’s TRUE performance this past quarter. The rest of the market will know that in a year’s time. You know it now.

P.S. I’ve seen a number of analysts downgrade Apple’s price target. Feel free to ignore them, for they know not what they just heard.

[Thanks to MacDailyNews Reader “Ken Cheng” for this submission.]


  1. You know, investors, should listen to the conference call, which should be available thru apple.com or iTunes.


    They should also carefully read the press release, with the non-GAAP figures.


    There’s lots of juicy info in there. Here’s one:

    Did you know that the Gross Margins on the iPhone 3G were 47.8%? They are, just look at the first table, just divide $1812 into $3787. That’s way above Apple’s total Gross Margins of 34.7% last quarter.

    That’s another reason why Apple is compelling. As the iPhone 3G deferred revs start to hit the books, Gross Margins will go UP! Analysts love that, and investors should too. Of course, if you buy an iPhone 3G, you might not like it, but do what I did. I bought Apple stock, a week after Steve announced the iPhone back at MWSF07. The share price runup, paid for the iPhone and then some.

  2. Apple’s “real” earnings grew a staggering 124.6% in Q4


    By Andy M. Zaky, Bullish Cross, Special to AppleInsider

    In its recently reported fiscal fourth quarter, Apple’s adjusted net income grew approximately 124.6% from $1.085 billion in Q4 2007 to $2.437 billion in Q4 2008 — an extraordinary number when fully accounting for iPhone sales in both periods. ” width=”19″ height=”19″ alt=”cheese” style=”border:0;” />

  3. Because of Sarbanes-Oxley and accounting rules, Apple is obligated to account for iPhone sales as they do. That the Wall Street analysts aren’t more up-to-date on either SOX or accounting rules is astonishing, as understanding these are essential to their work in assessing the valuations of the companies they follow.

    One advantage of how Apple accounts for the revenues for the iPhone has to do with recurring revenue. Those two magic words mean a lot to any business, and especially to Wall Street. Recurring revenue means you won’t just have one rockin’ quarter, but it shows that your revenues are sustainable. And Wall Street (should) value(s) companies with sustainable and predictable earnings growth.

    Do I think most analysts are lazy frigtards? Absolutely. But if you are a Warren Buffet-type investor, this is good news. The lame assessments by Wall Street of Apple and its prospects could help to undervalue the company’s stock, and as a result, create a pretty damned good buying opportunity. Add to the relatively low P/E currently with Apple, and a mountain of $25 billion in cash, and you have one helluva good buy in my opinion.

    Apple’s current trailing PE is 17.83. But if you factor in its cash horde of $24.49 Billion, the PE is more like 12.72. For a tech stock with the earnings growth experienced by Apple, that is a very good value. Its PEG (price to earnings growth ratio is already .88), and factoring in cash, it’s even lower. Unless consumer and enterprise spending on cell phones and computers totally crater, Apple is a very good investment indeed.

    If you are a long-term investor, the short-sightedness and lazy habits of frigtard analysts might make for a great buying opportunity.

  4. My comment is not meant to show any dislike of Apple or it’s products. It’s only to say that Apple isn’t all that special as certain people make it to be.

    This is all very interesting, no doubt, to somebody, somewhere. But in the real world, the world where WS and investors live and breathe, nobody gives a crap. WS doesn’t give a crap about the need for computers, iPhones or iPods. Apple is still the same as any other stock be it RIM or Google or Amazon.

    How are they the same? They’ve all lost on or about 50% of their value since earlier in the year. The supposedly recession proof Apple, the grand maker of beloved computers, handsets and PMP players with all of it’s packed retail stores, cash reserves and global carriers was smacked down faster than any of the other tech companies.

    I’m not sure what the real point of pointing out this special accounting method is supposed to change. Do you think that one day a light bulb is going to go on in all the WS analysts and investors heads? Heck no. You think anyone is going to look at this deferred accounting method and boost Apple back up before every other tech stock? I don’t think so. It might mean everything in the world to Apple the company, but means absolutely nothing to the real world of investors out there.

    Apple still remains as basically upper-middle-class high-tech toy company that caters to fanboys that don’t have enough sense to tell they can buy decent computers for less money if there’s no Apple logo on it.

    WS doesn’t know squat about OSX or unibody CNC machining. Apple is just another stock to pull money from when the stock goes up a fraction. Nothing more, nothing less. Apple’s deferred accounting method has been explained for well over a year. Nobody on WS gets it, nobody on WS cares.

  5. I am continually amazed at the lack of understanding that is displayed by the investor analysts. Several years ago I was evaluating a privately held company that was up for sale. _All_ of the information that I could find at the time indicated that the profitability of the company was not a measure of its value. Value is measured entirely on the cash flow of the company. Obviously for a publicly held company there is an independent valuation in terms of its market cap, but the two should be somewhat in sync. The failure to recognize that Apple has created a cash-cow with the iPhone is effectively criminal. The deferred revenue from this last quarter is equivalent to 40 percent of Apple’s operating expenses. In a year, the deferred revenue will easily be greater than their operating expenses.

  6. iphonerulez, it’s my personal belief, and you are welcome to disagree, that because many people think and act as you described above, that people like Warren Buffett are able to make superior returns.

    People, hedge funds, mutual funds have been forced to sell to meet redemptions, margin call, etc. and there has been panic selling.

    The stock price of Apple has suffered in the process. However, Apple has the cash to weather this storm better than most companies. They don’t have to lay off 10-25% of the team, or sell or close down factories. When the fear dwindles and the sanity returns, there may well be some explosive growth in the share price as earnings once again matter.

    And if Windoz doesn’t get it right in the 7th round, the game may be over for them, leaving the mid and high value computer market to Apple.

    Linux can have the machines that make $10 profit.
    ” width=”19″ height=”19″ alt=”grin” style=”border:0;” />

  7. Apple’s stock has shown good strength relative to the NASDAQ in the past week. If this continues, shorts will close out their positions and the stock will rise.

    Also, here is an analyst just quoted in Barrons who is positive on AAPL:

    Dan Chung, of Fred Alger Management … sees Apple (AAPL), trading around $96, as a potential bargain. “You don’t get many [affordable] opportunities to buy a large-cap, highly liquid leader in its field with such a pristine balance sheet,” he says, predicting a 22% rise in 2009 earnings to $6.25/share. The shares should trade between $150-$180 on strong cashflow from the iPhone.

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