“When Apple’s (AAPL) shares responded to the news out of the company’s developers conference by closing the week at $325.90 — their lowest level since last December — I thought I’d take a look at how last Friday’s stock price compared with the 12-month price targets Wall Street’s analysts posted exactly one year earlier, after the conference that introduced the iPhone 4,” Philip Elmer-DeWitt reports for Fortune.
I dug out a dozen analyst’s reports issued on June 7 and 8, 2010, expecting to find numbers that were wildly off the mark,” P.E.D. reports. “To my surprise, the 12-month price targets neatly bracketed the stock’s current price. They ranged from a low of $287 to a high of $350, with a mean of $322.33 — just a few dollars off Friday’s close.”
“Where the analysts seem to have gone off the rails last year is in the price-to-earnings multiples on which they based their predictions. To calculate their price targets, they multiplied Apple’s estimated earnings by factors that ranged from 16 to 22.5,” P.E.D. reports. “When Apple more than delivered on those estimates — growing earnings 74.6%, 67.5%, 75.2% and 92.2%, respectively, over the next four quarters — two things happened: 1) the run on Apple’s stock price came to a halt, and 2) the analysts cut their multiples.”
P.E.D. reports, “When we asked these 12 analysts to explain the discrepancy, the four who responded all gave the same answer: ‘multiple compression.'”
Read more in the full article here.
[Thanks to MacDailyNews Reader “Dan K.” for the heads up.]
In a word, they are not confident that Apple growth can last. Apple is simply too big as a consumer product company. There is no precedent for such size company to maintain its growth. People are afraid. Therefore a risk insurance is built into stock price.
Apples biggest isssue is that the stock is over-owned. Its one of the most popular hedge fund holdings. Everyone I tell to buy the stock either already owns it or has as much of the stock as they want. I personally and more than 100% invested in Apple stock. Its hard to be any more bullish than that. But for most people its impossible for them to comprehend allowing one stock to dominate their portfolio. I remember the story of one mutual fund that was an early investor in WalMart. They said that as the stock appreciated it became over 5% of their portfolio so they sold it off to keep the portfolio diversified. The irony is that had they not sold it off nearly the stock would have appreciated so much that it would now be 50% of their portfolio. This is the problem with a stock that appreciates beyond expectations. For many people they just cannot justify letting one stock take up over half of their portfolio.
I’ve been saying this for quite some time now. The massive cash on hand, specifically the non-performance of it, puts downward pressure on the stock as reflected in the P/E ratio.
This says nothing about the overall performance of Apple, but you combine the non-performance of the massive cash on hand with the theory of large numbers, selective cashing out in a bear market, and the pain factor, and it’s no wonder Apple has such a low P/E ratio… lower still based on forward earnings.
So what?
At some point this will catch up, and there will be a huge pay off.
If they get rid of the cash, this effectively raises their P/E. How does that fit into your criticism of their strategy?
@macromancer,
I’m not criticizing their strategy. I’m merely pointing out that having the cash is weighing the company down *relative* to where it would be *fairly* *valuated* if investors weren’t calculating the cash in the Earnings part of the equation.
Think of it this way…
If you invest in Apple, 20% of every dollar goes and sits on a shelf (not literally, but it under performs against any conservative investment).
So you take 80 cents for every dollar and get the stellar return from Apple, but combine that with the lack of potential return from that 20 cents.
You could look at it this way…
Apple’s PE is currently 15.84, with 20% of that not performing, you’d get an adjust PE of 19, which in my opinion is still undervalued, especially compared to the competition, but it’s the way many investors are looking at it.
Apple doesn’t need to get rid of the cash. Apple doesn’t need to change a thing. However if, for some bizarre reason, having a PE ratio that was more fair was a priority for Jobs & Co. (which it’s not), then they’d want to do something with that cash like dividends, or investing it *anywhere* that yielded a higher return.
At some point, the poor performance of the cash is going to become an increasing concern, and Apple will face even more pressure to do something with it.
You are making a big assumption that Apple isn’t investing that money? When you listen to Apple quarterly conference calls they always refer to their cash holdings as ‘cash and short term investments’ I haven’t read their 10-K statements but pretty sure they do invest it.
And if you account for their cash, the price of the stock is actually MORE attractive, not less as far as P/E goes.
@macromancer,
Of course they invest it…The problem is that they invest it *poorly*. Yes I read their statements, and more importantly I read how analysts are reacting. Sure, analysts are off, but it explains how investors are taking the news. Here’s a really good article lifted off WSJ:
http://jerrytie.com/?p=413
“And if you account for their cash, the price of the stock is actually MORE attractive, not less as far as P/E goes.”
I think that’s where a lot of people get confused. Cash gets figured into the Price of the stock. However, Apple’s cash underperforms the market and even more significantly underperforms Apple in terms of Earnings.
Let’s say you have a lemonade stand and it cost you $10 to put it together and you sell $100 worth of lemonade each week with a 90% margin. For a kid, that’s a pretty good business. Now, lets say you still sell $100 worth of lemonade each week with a 90% margin, but the city requires you to put up a $100K bond for public safety for doing business on the sidewalk. That’s not a very good business because you could make much more money each week with that $100K.
So yes, if you took Apple today and added another $X billion to their cash pile, the stock would be more attractive. The Price goes up, but the Earnings don’t go up as much because there’s a low return on that $X billion in cash…significantly lower than the return on Apple’s business.
Let’s say you had a company that only earned nothing, but had $100 per share in cash. You’d end up with a ratio of 100:0. It would be worth something…$100 per share, but there would be no growth. If you bought a share, you’d have an opportunity loss on that $100. Investors know this, so instead of the stock being priced at $100 a share (the cash value), it would be priced below that.
That’s what’s happening to Apple. It has $65 billion in cash that’s figured into the the value of the company, but it’s not getting earnings, or growth in that $65 billion. If Apple were to shut down all operations and just hold on to that $65 billion, it would be valued at less than $65 billion (assuming all other assets disappeared), since there would be little earnings that underperformed the market.
What justifies Apple’s low trailing P/E, MrEd? Even if Apple cannot sustain its recent incredible growth (and it cannot in the long term, or it would soon own the entire world), why is Apple valued (in terms of P/E) at so much less than other companies that are not growing as fast or producing such massive cash flow and profits?
In addition, Apple is a company with an incredibly dominant market position (iOS), no long term debt, and a huge cash hoard to spend on R&D and strategic acquisitions.
You say that Apple’s cash is not performing, and you are correct that it is obviously not returning 20% or more. But Apple can get almost $3.5B per year out of that cash at 5% return. That’s better than wasting it like Microsoft, and it is certainly not a big negative when those liquid assets go hand-in-hand with massive growth and market dominance.
Your explanation for Apple’s low P/E does not adequately explain the P/Es for other companies. Therefore, it has little merit in my book.
My explanation – sometimes people just refuse to admit the truth even when it is slapping them in the face. Buy and hold AAPL – that’s my strategy.
@kingmel,
“Buy and hold AAPL – that’s my strategy.”
And that’s a good strategy. I’m not knocking it, and have absolutely no argument I can think of against it unless you have loan sharks holding your family hostage…though it’s worth first asking how much you love your family 😉
However…
Apple will have an unfair valuation based on an unfairly considered P/E ratio for a couple of reasons…
1) Since it’s not a start up, as the second largest corporation in the world, it will be judged on a TTM basis. However, it’s performing like a start up, so the earnings being calculated in the first few of those twelve months are going to be roughly half what Apple’s actual earning are today. Apple should really be evaluated on current and future earnings, but that’s where the “unfair” comes in.
2) The cash *really* under performs, but compared to Apple’s business it’s even worse. Do you think Apple has a good business, or that it sucks? I think Apple has a great business, so as an investor, I want to invest every dollar I have in Apple’s *business*. Unfortunately, I can’t. When you buy Apple stock, it’s an 80% investment in the business and a 20% “opportunity loss tax”, which is the cash.
Which would you rather invest in: Apple stock with a 307.43B valuation and 65B in cash, or 277.43B valuation and 35B in cash? Assuming Apple is going to sit on this cash as it has been and not account for a need in an amount in excess of 35B for operating expenses, the latter is going to yield a better return on your investment.
Again, there are many reasons for Apple to continue doing exactly what it’s doing, but don’t expect Apple to be fairly valuated as a result even if it does outperform and continue to climb long term.
Apple has never adopted the wisdom of the Wallstreeters. When Wallstreet preached that it was not prudent for a company to conserve cash but to borrow heavily for growth, it only served the interests of Wallstreet. Wallstreet is composed of the investment banks, fund managers and all manner of sharks and predators who are giving wrong advice to companies so that they can manipulate and control their stock prices. It just like the banks luring consumers to take up easy credit cards and encourage them not to save anymore. Thus, millions of consumers are just working for the banks for the rest of their lives.
One of my rare fores into the blogosphere to respond to this. Apple’s cash build is not surprising given yesterday’s report that they are spending up to $1.3 b per year on iTunes. At that rate, they can ill afford to make a mistake giving dividends and/or buying and integrating companies that cost billions of dollars (ie. Adobe, Sony).
They are cautious and I am very pleased to see how they are handling this. The naysayers are consistently comparing this company to others and coming up with silly suggestions to satisfy the whims of Wall Street. Apple is a tech company that barely survived the 90’s, Thank goodness they have not forgotten that. If the company does well with its execution, the stock price will follow….. Just my 2 cents.
Damn straight.
The best investment anyone can make is in themselves.
Independence.
Ya they spend 1.3 billion, but they claim to break even, so they really spend zero. I don’t follow your argument
You break even AFTER returns prove to be positive…so counting your chicken before they hatch is not very smart.
Maybe im not understanding your reply, but I doubt Apple started spending 1.3 billion a year on iTunes from day one. Certainly they ramped up into this expense and certainly part of that has to be in capital investments like hardware and infrastructure that does not need to be replaced every year.
@theiphonedoc,
“Apple’s cash build is not surprising given yesterday’s report that they are spending up to $1.3 b per year on iTunes. At that rate, they can ill afford to make a mistake”
At that rate, they can go on indefinitely. They’re spending $1.3B but bringing in more than that. They make a profit on iTunes. It’s unknown how much, but it doesn’t take much of a margin now to bring in millions/billions.
“They can ill afford to make a mistake giving dividends and/or buying and integrating companies that cost billions of dollars (ie. Adobe, Sony). ”
Apple could buy Adobe and not do anything with it, and still make far more profit each year than sitting on the cash they would use to buy it. Of course, if Apple bought Adobe, there are many things they could do to leverage it as an asset or influence the industry in ways that are beneficial to Apple. But just holding it as an asset would be beneficial in terms of higher profit.
Sony, not so much. They’d lose money that they put in Sony unless they could turn it around, which they shouldn’t attempt. There’s really nothing in it for Apple.
However, besides the loser that is Sony, there are other companies Apple could consider where the purchase would simply mean more profit and they could get as involved or not as they saw benefit.