AAPL of Investors’ i?

Despite continuing to unhappily take the “under” both for the U. S. economic consensus (e.g. Ben Benanke’s positive growth forecast) and thus for the stock averages, I can make a multi-year case for AAPL stock as having a favorable risk-reward ratio.  Here’s why.  Full disclosure:  I am long AAPL.

The major argument against AAPL has been that it has only produced a stream of hit products similar to the output of Andrew Lloyd Webber or Kid Rock, or a movie studio, etc., but that when you live from hit to hit, you can flame out fast.  So, how do you put a valuation on that sort of company?  In days of more fearful (i.e., conservative = attractive to the investor) valuations of stocks, one way was for the stock to sell around or even below the value of its tangible assets.  Of course, profitable companies with strong market positions were not expected to keep as much in cash and cash equivalents as Apple does; the expectation was that stocks had to provide income as bonds did, plus the reasonable possibility of capital gains.  Thus, the inherent greater riskiness of stocks vs. bonds was to be made up by a margin of safety for stockholders.  If one looks back to the two major secular bull markets that involved outperformance of stocks vs. bonds since World War I, one can look at 1921-1929, and (pick your preferred starting and ending points, and your preferred index) 1932-1979 (or, 1940-65).  In those cases, stocks started out as undervalued vs. bonds by multiple metrics, such as:  dividend yield, implied earnings yield (= reciprocal of the P/E), and relative to tangible book value. 

Don’t look now, but those days of conservative stock valuations have begun to return.  For some months now, the DJIA has outyielded the 10-year T-bond, and for some of that time, outyielded the 30-year as well.  This is the first time outside of the panic in late 2008-early 2009 that this has been seen since about 1960.

I mention the above because AAPL is one of the few large companies with the tangible assets, valuation and growth possibilities to actually qualify as having highly positive present value even under conservative valuations.  Long-established names such as MCD and IBM have been busily returning almost all their free cash flow back to shareholders via dividends and stock buybacks, but however commendable such activities are, all that cash has left the companies’ coffers and cannot be double-counted in the stock’s valuations.  So one is buying the future of those companies, whereas soon enough Apple will have $120/share in cash or near-cash (short-ish term assets) with no debt.  Thus one can adjust the current $422 stock price down to about $320 without much of a leap in earnings projections, and thus make AAPL stock more comparable to MCD and IBM.  On that basis, it is cheap compared to them, and has the home-run upside possibility in the next few years that could yield further big gains on top of the astounding run it has already has. 

Given the clear risks to AAPL’s stock price, is the above-hypothesized upside adequate for long-term investors?

Has Apple moved into the category of great companies that are great because of their corporate capabilities and identity (e.g. MCD and IBM), rather than because of the leadership of one or two people, the loss of whom would likely lead to the corporate ship foundering on the rocks one of these days?

With Siri potentially representing a meaningful step up above the competition, the answer to the above questions increasingly may be “Yes”.  Siri has even impressed someone at the Harvard Business School, as discussed in Apple’s Siri is as Revolutionary as the Mac:

Siri, the new iPhone’s voice-control software, is going to have as big an impact as that first iPhone did. It’s going to fundamentally change our relationship with computers. . .

Jobs described the original Mac as a bicycle for your mind. Siri deserves some equivalent description — I think it’s going to take devices and turn them into assistants for our minds. It seems crazy right now, but I don’t think it will be long before we view this technology in the same light as we view the iPhone: we won’t quite be able imagine life without it.

Techie bloggers w/o portfolio are one thing, Harvard Business School another.  As a modern-day Edgar might have said (King Lear), in marketing, the buzz is all.

Concomitant with high praise for iCloud from such people as David Pogue, tech blogger for the NYT, it appears that Apple continues to have the rare combination of real innovation and execution.  The iCloud is an important achievement for AAPL given the problems it had with its prior iteration, MobileMe.  Apple has already apparently spent close to $1 B on its new center in N. Carolina.  There will be more such centers worldwide.  Not many companies have the funds and capabilities to have a great, large-scale cloud capacity.  With the cloud comes really, really knowing your customer, with the many business benefits that entails. 

Apple appears to have the chance to be a GM in its heyday (say, post-WW II up till the first oil shock), and IBM in its first computer heyday (say, 1950s and especially 1960s into the 1980s):  to be a, or even the leader in a transformation of the way we live and do business.  It could be the master of the screen.  What consumer screen remains for Apple to conquer?

The TV.

It is said that SJ hated TV.  Perhaps Tim Cook doesn’t.  Within the past year, Apple was assigned a patent for goggle-free 3D TV viewing that allowed multiple TV watchers to all be individually tracked.  But it’s better than that:  the viewers could each move around in their chairs or on the couch, and the system would be tracking them and would adjust the images to maintain the 3D capabilities.  With an Apple TV that is a whole TV rather than simply a micro-mini computer hooked up to a TV, a major chunk of the non-movie theater world of screens could arguably then belong to Apple.  Tying that possibility with an i-enabled product line with an improving Siri and descendants/relatives/friends of Siri set of functionalities, Apple could then be a great company qua company rather than only a Jobsian vision brought to fruition.

There could be much more to the AAPL stock story.  Think further diversification. 

Apple is already a very large retailer, both online and in physical stores.  Imagine the possibilities.  Amazon grew rapidly to sell much more than books.  Apple has retailing possibilities that go well beyond Apple products.  Just as Amazon grew into selling much more than books and the into developing products, so might Apple grow to be a major retailer of . .  . whatever.  TBD.

Moving on, let’s discuss the earnings in light of the above optimistic discussion.  Here is a link to an AAPL-oriented blogger who reports that the AAPL blogosphere is looking for Tuesday’s Q4 earnings to approximate $9/share (the Street is in the $7+ range).  Given my downbeat macro economic view, I would suggest that Siri-enabled “i”-devices will roll out this and next year and that calendar 2012 AAPL earnings could be roughly in the range of $50/share and calendar 2012 earnings could be $70+.  Cash on the books, if there is no share buyback, large acquisition, or large dividend payout could be $200/share, or two hundred billion dollars, in a few years. 

Let’s turn to the intangibles at Apple post-SJ.  Again, while I have no idea of what the Apple mood is at Cupertino and globally, the “vibes” from the stock action suggest positivity.  Perhaps the team is inspired by a dying Steve Jobs working as long as he could.  So perhaps they want to “win the future” for him.  Perhaps more relevant, the new management team has a lot to prove.  If I were part of the new leadership at Apple, already with more personal wealth than I would need, my professional goal would be to show that Apple was not a one-man show.  So we may have a double-barreled set of internal factors at  the company that favor shareholders.  In contrast, by the time that GM and U. S. Steel (picked randomly), were slowly dying, many years from their dynamic growth phases, complacency was prevalent in upper management. 

What about competition?  Of course, it will be intense.  The important big picture point is that AAPL is in a leadership position in one of the key growth industries for years to come.  All the company has to do is maintain its smart-phone lead and keep a large market-share of tablets as the worldwide market grows (I know, easier said than done).  Apple did not bother with a conventional, slow-/no-growth cellphone, so the market is coming quickly to it; soon enough, will anyone even market a non-smart phone?  Will a non-smart phone be like a Yugo?  Where’s NOK stock price now?   

Meanwhile, you can’t beat something real- such as Siri- with nothing but talk (pun intended).  I recall Mr. Softee (MSFT) boasting in the 1990s how much money it was spending  on – what was it . . . is my memory slipping? . . . oh that’s it– voice recognition for computers!  It was going to make the mouse obsolete.  Wha happened?  So what’s going on now at Mr. Softee?  Oh yes, it took some cellphone Viagra.  But the effect didn’t last four hours.  So what has happened to the critically well-received Windows phone in the marketplace?  Here’s an August 2011 report: 

Whoops! 

MSFT missed the search engine gold-mine and has (wow !/sarcasm on) Bing.  It keeps playing catch-up.  Meanwhile, just how much profit does GOOG get from the Android platform?  Oh yes . . . once again memory fails . . . now I remember:  zero.  Android is just so great and wonderful, GOOG gets a premium price for licensing it out.   Nothing.  (Yes, I know there’s another way to look at the Android freebie, but the business rationale therein has plenty of warts, as well.)  And then there’s Amazon and its fiery line.  These may be good e-readers, but they also may ultimately flame out (pun again intended).  And AMZN is grossly overvalued.  And the Street can’t help making excuses for its repeated failings to invest in its planned needs (or worse, but I’ll keep my E-mouth shut now).  For example, here’s Value Line on AMZN: 

Amazon.com’s bottom line is apt to compare poorly in the coming quarters.  Every couple of years or so, the company has had to make substantial investments in physical and technological infrastructure, much of it running through the income statement and hurting profits.  The time for this has returned once again . . .

Bottom line on competition:  the above snark aside, all Apple’s obvious competitors have their own issues.  And given that it has limited legacy businesses (iPod), perhaps it does not deserve the same low P/E that MSFT deserves in view of MSFT’s revenue stream still coming very heavily from the 20th century stuff of an operating system (? to become obsolete other than as a free, bundled service) and Office (? same fate).

Why might AAPL be undervalued?  Must not the market price be highly efficient for such a highly valued company?

My answer:  AAPL could be inefficiently (under)priced for the opposite reason that CSCO traded at 150X earnings in 1999.  Was that an efficient price?  LOL.  CSCO did lots (and I mean lots) of deals for stock back then (and it’s been doing more lately).  So the Street “needed” a high stock price to allow it to do the deals so that investment bankers could have great vacations and even villas in France and Italy, or at least the equivalents in the Hamptons.  So they invented all sorts of fake valuation reasons to “justify” 150X earnings. OTOH, AAPL does few deals, and I don’t know if they need Wall Street middlemen at all for the few they do.  Plus, unlike MSFT, which is again boasting of how great its future will be, AAPL is famously secretive.  It simply wants to win, and it defines winning as putting cash in the bank.  Maybe MSFT will indeed have a great future, but even if that is so, it won’t mean that it won’t be Pepsi while AAPL could be Coke.  Or, Ford and GM back in the day.  After all, we’re taking long-term global growth markets, where there will be multiple winners. 

Not that there’s any guarantee, but Value Line gives the “value line” (fair value) for AAPL at 17.5X cash flow.  In Apple’s case, cash flow is more or less equal to earnings.  Discounting that by 20% to 14X earnings, and assuming $50/share earnings sooner rather than later, one gets a $700 share price.  Even if it takes two years to get there, that sounds pretty good to me.

If one day, Apple announced that it was going to pay out $150/share with a recapitalization, including taking on some debt while disbursing all its cash, consider what that would do to earnings estimates and the stock price.  There’s your immediate stock upside in addition to earnings surprises and major new product releases.      

Putting it all together, AAPL stock strikes me as well positioned to potentially be a big enough long-term winner to justify the risks, even at its current stock price.  It has a seasoned, motivated management team; a potentially hot product feature to roll out throughout its major product line in Siri, with years of improvements in that technology ahead; unbeatable financial strength; loyal and even super-loyal users;  a focus on secular growth fields; and a low price-earnings ratio based on reasonable earnings estimates.  All this is being said by a blogger who is bearish on the stock market as a whole and bearish on the U. S. economy; but AAPL is about as far from the central control of the economy exerted by Washington as can be; it is highly international; and periods such as this recent period of high correlation between stocks have always given way to periods of differentiation.  Looking out to mid-decade or so, I thus perceive a significant chance that AAPL can achieve the bifecta of much higher earnings and a nicely higher P/E.  This might yield the world’s first trillion dollar market cap company.  If so, some might want to sing:

Yes, Siri, that’s my baby; No, sirree, don’t mean maybe; Yes, Siri, that’s my baby now.  (Apologies to Donaldson/Kahn)

Next stop on the AAPL express:  earnings Tuesday after the close.  Plus holiday season guidance, which will be way low, IMHO.

Staying tuned.   

 Of course, as always, nothing in this post represents investment advice.  Rather, it represents my current thinking, which itself may change for any number of reasons, and no one can expect any changes, large or small, in my viewpoint to necessarily make their way into the public domain.