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.]