Apple's "real" earnings grew a staggering 124.6% in Q4
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.
Just as impressive is Apple's 75.1% grow rate in sales. Apple's adjusted revenue grew from $6.673 billion in Q4 2007 to a whopping $11.682 billion in Q4 of 2008. Earnings per share grew 123.0% from $1.21 in Q4 2007 to $2.69 in Q4 2008. This begs the question? Where the hell are the analysts and why aren't they quick to point this out? Only on Wall Street can a company grow earnings 124.6%, sustain bouts of analyst downgrades and see its shares decline 55% (while boasting a 14 forward P/E on a GAAP-basis).
I was both shocked and very disappointed to see no analyst comment on the fact that Apple's business grew an astounding 124.6% on an adjusted (real) basis. What's even more troubling is that no one seems to emphasis the significance of the fact that Apple grew its cash hoard from approximately $21 billion in Q3 to $25 billion in Q4. That's a $5.00 increase in total cash per share from $23.45 in Q3 to $28.22 in Q4. At this pace, and assuming Apple makes no big acquisitions, Apple could very well have nearly $48 per share in cash and cash equivalents by the time we hit November 1, 2009.
The Obvious but Rarely Mentioned Problems with GAAP Accounting Measures
In many ways, the idea of GAAP accounting fails miserably at its intended purpose -- to give a "fairly stated" picture (as my accounting professor would often say) of a company's earnings results. Yet, under GAAP accounting measures, Apple is forced to use what is called the subscription method of accounting for sales of the iPhone by amortizing the revenue received from the device over a 730-day period (2 years). When Apple reports its GAAP earnings results, it only accounts for an infinitesimal portion of the revenue it actually receives from sales of the device in any given quarter. This is particularly troubling for Apple and its investors due to the fact that Apple draws nearly 44% of its revenue and an unbelievable 63% of its net income from iPhone sales! What is more realistic and fairly stated: an accounting measure that requires a company to leave out 63% of its net income or an accounting measure that forces a company to be transparent by including what it has actually earned in the quarter?
This should infuriate the informed investor because it means that Apple is quite literally trading on P/E ratios that do not reflect more than half of its business. When one compares Apple to Google, Research in Motion, Amazon and others similarly situated in the tech sector, one should notice that they all have very similar P/E ratios. All of their P/Es have contracted significantly as a result of the markets overblown fears of the United States entering the second great depression. Yet, Apple's stock has obviously been the hardest hit in this contraction because if one accounts for the 63% in EPS that Apple isn't reporting as a result of GAAP accounting measures, Apple's trailing P/E is probably closer to 11 and its forward P/E is closer to 7 (under the conservative assumption that Apple will earn $12 in adjusted EPS in 2009).
Moreover, such an accounting measure opens the door for bearish news reporters such as Eric Savitz at Barrons to continuously publish bearish analyst opinions by the likes of Kathryn Huberty, Travis McCourt, Toni Sacconaghi and Mike Abramsky who only tend to focus on less than half of Apple's business. Yesterday, Abramsky cut both his earnings outlook and price target on Apple despite the fact that Apple beat his EPS estimate by $0.11. I have yet to see one analyst or even one news reporter mention the fact that Apple is trading at a mere 3.4 times its cash position -- significantly lower than its counterparts: Google is trading at 7.8 times its cash, Microsoft is trading at 9.29 times its cash, Research in Motion at 17.8 times, Amazon at about 12 times, Cisco at about 4 times cash and IBM at about 11.5 times cash. Most of these companies have significant debt and thus net cash per share could be significantly lower.
This general sense of unjustified bearish surrounding Apple over the past 6 months is a directly result of GAAP accounting. If Apple were able to fully account for sales of the iPhone, almost no analyst would have any ammunition to justifiably downgrade the stock as they have over the past two months. While analysts were busy downgrading Apple in September, Apple was busy growing at 124%. Yet, due to the backwards accounting measures in place today, Apple could only boast a 23% growth rate in GAAP earnings. The table below compares Q4 2007 adjusted earnings to Q4 2008 adjusted earnings. Notice that Apple grew its operating income at a pace of 149.2%. This is a direct result of the revenue growth rate and gross margin percentage growth rate significantly outpacing the growth rate of operating expenses.
Method for Arriving at Non-GAAP based Adjusted Earnings for Q4 2007
Since Apple didn't start releasing adjusted earnings results until this past Tuesday, I had to reconstruct Apple's fiscal Q4 2007 to account for iPhone sales in order to be able to more accurately compare Q4 2008 with Q4 of 2007. The two most difficult adjustments to determine were gross margins and total revenue. Both of these numbers required a small degree of guess work and so I was conservative in the guessing. It's quite likely that Apple would have reported a lower adjusted earnings number in Q4 2007 which suggests a larger growth in 2008 than indicated in the table above. Yet, the revenue number can at least be stated with a relatively high degree of precision.
Revenue Adjustments
In order to account for the full revenue Apple received from sales of the iPhone and Apple TV, one must reverse the current period's amortization of deferred revenue derived from the devices. At the end of Q3 2007, total deferred revenue (current and non-current) derived from sales of the iPhone and Apple TV was $180 million. Total deferred revenue derived from sales of the iPhone and Apple TV at the end of Q4 2007 was $636 million. In order to reverse Q4 2007's amortization of deferred revenue derived from the devices, one need only subtract Q3's total deferred iPhone and Apple TV revenue from Q4 2008. The difference between these numbers is what Apple actually added to the quarter's deferred revenue pile and is what Apple would have reported in adjusted earnings.
Notice, to get a full and accurate picture of revenue, one would also have to subtract any contribution of the previous quarter's deferred revenue that Apple added in its Q4 2007 GAAP-based results. This number is both quite small, likely $23 million, and quite difficult to determine with full accuracy. Thus, for the sake of conservatism, I simply left in the contribution which makes the growth rate in 2008 slightly better than stated in the table above. The offset between deferred revenue at the end of Q3 and at the end of Q4 results in a $456 million adjustment to Non-GAAP revenue. Thus, Apple would have earned about $456 million more in fiscal Q4 if it didn't employ the subscription method of accounting or if it provided adjusted revenue.
Gross Margins, COGS
Determining adjusted gross margins is a slightly subjective inquiry. Since there is no way to determine what the iPhone and Apple TV's gross margins were in fiscal Q4, and since we know they were better than overall gross margins, I bumped overall gross margin up 139 basis points. This more than adequately accounts for the better than overall gross margins enjoyed by the iPhone. Even if the gross margin percentage estimate is off by a 50 basis points, it would only account for a plus or minus one to two pennies in EPS. The 125% growth rate as stated above is a very realistic depiction of Apple's actual growth rate.
Operating Expenses & Operating Income
No adjustments are necessary for operating expenses as Apple fully recognizes any and all operating expenses when incurred without regard to any of its deferred revenue mechanism. If one takes a look at Apple's published adjusted earnings for Q4 2008, no adjustment is made to operating expenses in arriving at adjusted earnings. Since no adjustments needs to be made to operating expenses, operating income is simply the difference of subtracting operating expenses from gross margin.
OI&E
No adjustments are necessary for OI&E as Apple fully recognizes any and all OI&E without regard to any of its deferred revenue mechanism. See Apple Q4 2008 adjusted earnings results for example.
Tax Rate
No adjustments need to be made to the tax rate as a uniform rate is determined on a quarter by quarter basis. The effective tax rate in Q4 was approximately 26.5%. See Apple's Q4 2008 adjusted earnings for example.
EPS
As a result of the $181 million addition to net income based on the adjustments noted above, exactly $0.20 is added to EPS based on the published diluted share calculation of 895,666,000 shares. The table below is an unaudited reconciliation of Non-GAAP to GAAP results of operations for Apple's fiscal fourth quarter for the fiscal year ended in 2008.
Disclosure: Long Apple. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
Just as impressive is Apple's 75.1% grow rate in sales. Apple's adjusted revenue grew from $6.673 billion in Q4 2007 to a whopping $11.682 billion in Q4 of 2008. Earnings per share grew 123.0% from $1.21 in Q4 2007 to $2.69 in Q4 2008. This begs the question? Where the hell are the analysts and why aren't they quick to point this out? Only on Wall Street can a company grow earnings 124.6%, sustain bouts of analyst downgrades and see its shares decline 55% (while boasting a 14 forward P/E on a GAAP-basis).
I was both shocked and very disappointed to see no analyst comment on the fact that Apple's business grew an astounding 124.6% on an adjusted (real) basis. What's even more troubling is that no one seems to emphasis the significance of the fact that Apple grew its cash hoard from approximately $21 billion in Q3 to $25 billion in Q4. That's a $5.00 increase in total cash per share from $23.45 in Q3 to $28.22 in Q4. At this pace, and assuming Apple makes no big acquisitions, Apple could very well have nearly $48 per share in cash and cash equivalents by the time we hit November 1, 2009.
The Obvious but Rarely Mentioned Problems with GAAP Accounting Measures
In many ways, the idea of GAAP accounting fails miserably at its intended purpose -- to give a "fairly stated" picture (as my accounting professor would often say) of a company's earnings results. Yet, under GAAP accounting measures, Apple is forced to use what is called the subscription method of accounting for sales of the iPhone by amortizing the revenue received from the device over a 730-day period (2 years). When Apple reports its GAAP earnings results, it only accounts for an infinitesimal portion of the revenue it actually receives from sales of the device in any given quarter. This is particularly troubling for Apple and its investors due to the fact that Apple draws nearly 44% of its revenue and an unbelievable 63% of its net income from iPhone sales! What is more realistic and fairly stated: an accounting measure that requires a company to leave out 63% of its net income or an accounting measure that forces a company to be transparent by including what it has actually earned in the quarter?
This should infuriate the informed investor because it means that Apple is quite literally trading on P/E ratios that do not reflect more than half of its business. When one compares Apple to Google, Research in Motion, Amazon and others similarly situated in the tech sector, one should notice that they all have very similar P/E ratios. All of their P/Es have contracted significantly as a result of the markets overblown fears of the United States entering the second great depression. Yet, Apple's stock has obviously been the hardest hit in this contraction because if one accounts for the 63% in EPS that Apple isn't reporting as a result of GAAP accounting measures, Apple's trailing P/E is probably closer to 11 and its forward P/E is closer to 7 (under the conservative assumption that Apple will earn $12 in adjusted EPS in 2009).
Moreover, such an accounting measure opens the door for bearish news reporters such as Eric Savitz at Barrons to continuously publish bearish analyst opinions by the likes of Kathryn Huberty, Travis McCourt, Toni Sacconaghi and Mike Abramsky who only tend to focus on less than half of Apple's business. Yesterday, Abramsky cut both his earnings outlook and price target on Apple despite the fact that Apple beat his EPS estimate by $0.11. I have yet to see one analyst or even one news reporter mention the fact that Apple is trading at a mere 3.4 times its cash position -- significantly lower than its counterparts: Google is trading at 7.8 times its cash, Microsoft is trading at 9.29 times its cash, Research in Motion at 17.8 times, Amazon at about 12 times, Cisco at about 4 times cash and IBM at about 11.5 times cash. Most of these companies have significant debt and thus net cash per share could be significantly lower.
This general sense of unjustified bearish surrounding Apple over the past 6 months is a directly result of GAAP accounting. If Apple were able to fully account for sales of the iPhone, almost no analyst would have any ammunition to justifiably downgrade the stock as they have over the past two months. While analysts were busy downgrading Apple in September, Apple was busy growing at 124%. Yet, due to the backwards accounting measures in place today, Apple could only boast a 23% growth rate in GAAP earnings. The table below compares Q4 2007 adjusted earnings to Q4 2008 adjusted earnings. Notice that Apple grew its operating income at a pace of 149.2%. This is a direct result of the revenue growth rate and gross margin percentage growth rate significantly outpacing the growth rate of operating expenses.
Method for Arriving at Non-GAAP based Adjusted Earnings for Q4 2007
Since Apple didn't start releasing adjusted earnings results until this past Tuesday, I had to reconstruct Apple's fiscal Q4 2007 to account for iPhone sales in order to be able to more accurately compare Q4 2008 with Q4 of 2007. The two most difficult adjustments to determine were gross margins and total revenue. Both of these numbers required a small degree of guess work and so I was conservative in the guessing. It's quite likely that Apple would have reported a lower adjusted earnings number in Q4 2007 which suggests a larger growth in 2008 than indicated in the table above. Yet, the revenue number can at least be stated with a relatively high degree of precision.
Revenue Adjustments
In order to account for the full revenue Apple received from sales of the iPhone and Apple TV, one must reverse the current period's amortization of deferred revenue derived from the devices. At the end of Q3 2007, total deferred revenue (current and non-current) derived from sales of the iPhone and Apple TV was $180 million. Total deferred revenue derived from sales of the iPhone and Apple TV at the end of Q4 2007 was $636 million. In order to reverse Q4 2007's amortization of deferred revenue derived from the devices, one need only subtract Q3's total deferred iPhone and Apple TV revenue from Q4 2008. The difference between these numbers is what Apple actually added to the quarter's deferred revenue pile and is what Apple would have reported in adjusted earnings.
Notice, to get a full and accurate picture of revenue, one would also have to subtract any contribution of the previous quarter's deferred revenue that Apple added in its Q4 2007 GAAP-based results. This number is both quite small, likely $23 million, and quite difficult to determine with full accuracy. Thus, for the sake of conservatism, I simply left in the contribution which makes the growth rate in 2008 slightly better than stated in the table above. The offset between deferred revenue at the end of Q3 and at the end of Q4 results in a $456 million adjustment to Non-GAAP revenue. Thus, Apple would have earned about $456 million more in fiscal Q4 if it didn't employ the subscription method of accounting or if it provided adjusted revenue.
Gross Margins, COGS
Determining adjusted gross margins is a slightly subjective inquiry. Since there is no way to determine what the iPhone and Apple TV's gross margins were in fiscal Q4, and since we know they were better than overall gross margins, I bumped overall gross margin up 139 basis points. This more than adequately accounts for the better than overall gross margins enjoyed by the iPhone. Even if the gross margin percentage estimate is off by a 50 basis points, it would only account for a plus or minus one to two pennies in EPS. The 125% growth rate as stated above is a very realistic depiction of Apple's actual growth rate.
Operating Expenses & Operating Income
No adjustments are necessary for operating expenses as Apple fully recognizes any and all operating expenses when incurred without regard to any of its deferred revenue mechanism. If one takes a look at Apple's published adjusted earnings for Q4 2008, no adjustment is made to operating expenses in arriving at adjusted earnings. Since no adjustments needs to be made to operating expenses, operating income is simply the difference of subtracting operating expenses from gross margin.
OI&E
No adjustments are necessary for OI&E as Apple fully recognizes any and all OI&E without regard to any of its deferred revenue mechanism. See Apple Q4 2008 adjusted earnings results for example.
Tax Rate
No adjustments need to be made to the tax rate as a uniform rate is determined on a quarter by quarter basis. The effective tax rate in Q4 was approximately 26.5%. See Apple's Q4 2008 adjusted earnings for example.
EPS
As a result of the $181 million addition to net income based on the adjustments noted above, exactly $0.20 is added to EPS based on the published diluted share calculation of 895,666,000 shares. The table below is an unaudited reconciliation of Non-GAAP to GAAP results of operations for Apple's fiscal fourth quarter for the fiscal year ended in 2008.
Disclosure: Long Apple. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
Comments
Fact is that even though I am convinced that Apple will do very well in the future, the next two quarters might well see a decline in revenue because of the economic situation, plus macbooks are rather expensive plus Apple sells a lot of iphones but having only one product is still very risky and they might see a decline in a not too distant future if they don't offer more choice. Also, one new iPhone a year wont be enough.
At the moment, there is nothing really exciting which could drive the business and there are a lot of risks. Even though a share for under 80 will look like a bargain in one or two years, it might still look expensive in two months.
Fact is that even though I am convinced that Apple will do very well in the future, the next two quarters might well see a decline in revenue because of the economic situation, plus macbooks are rather expensive plus Apple sells a lot of iphones but having only one product is still very risky and they might see a decline in a not too distant future if they don't offer more choice. Also, one new iPhone a year wont be enough.
says who? Seems to be working a treat right now. Apple achieved world domination of the Mp3 player market with only a few product variations. Part of Apples appeal is that there is NOT a huge variety of products. Otherwise the 'experience' gets messy. Though I'm sure Apple will branch out when the time is right (with the iphone).
At the moment, there is nothing really exciting which could drive the business and there are a lot of risks. Even though a share for under 80 will look like a bargain in one or two years, it might still look expensive in two months.
I absolutely guarantee this quarter will be staggering. "nothing really exciting" ? other than possibly the most exciting and innovative product lineups ever.
Apple has only just lit the fuse on numerous fronts, and Jan will bring even more new toys no doubt.
I don't see why this should be of any importance. Investors know about the model, and they take it into account when they think of how much they are ready to pay for the shares.
Except that they aren't taking it into account - which is obvious by the stock price. Apple is currently priced like it isn't experiencing any earnings growth at all.
I think that the worse the recession, the better it is for Apple. A recession will hurt Dell, HP and other competitors which don't have the cash horde, cash flow or margins. Apple can survive four years with *ZERO REVENUE, NO LAYOFFS and NO NEW DEBT* while their competitors can't do any such thing.
The credit markets are screwed, and Apple has no need to use their credit markets while competitors do (and have to pay through the nose or risk bankruptcy if they can't roll over debt that expires). Apple has high morale because Steve told the employees no layoffs during the recession, while the others will be laying off left and right if the recession is severe (and I have lived through that, very little R&D gets done while you are commiserating over the water cooler, Apple will be kicking ass with new products over all that time).
The cash horde can be used to buy out nice small companies at good prices during the recession.
The deferred earnings are dragging things down now, but they will be artificially inflating earnings this time next year.
etc. etc. I am 100% in Apple stock and April '09 Apple calls. I just don't see any other investment with this combination of safety and potential. Everything is a risk, I even lost money in a money market fund that went bust just last month, and cash will get eaten away by inflation - Apple is by far the best investment I can find anywhere.
I absolutely guarantee this quarter will be staggering. "nothing really exciting" ? other than possibly the most exciting and innovative product lineups ever.
Apple has only just lit the fuse on numerous fronts, and Jan will bring new toys no doubt.
Didn't want to offend anybody, I think the Macbook/Pros are breathtakingly cool (even though they clearly lack some software to take advantage of the GPUs). But Apples stock price is based on incredible growth, which they could deliver for a long time now and they will be able to do it again.
Just now, for the next quarters, I am not so sure.
Also, for the iphone: Let's not fool ourselves. Others are playing catchup and there are some potentially potent competitors. The iPhone is still the real deal, but this might change...
I just understand everybody who is prudent at the moment, and EPS of 15 don't look so cool anymore if the E gets cut by a third, which just could happen, even though I really hope it won't.
Thank you very much
? iPhone out sells RIM this past Qtr
? Apple continues to innovate (as Jobs said was THE key way forward after the dot.com bust)
? Dell is selling mfg plants
? Vista is, well, enough said
?Large numbers (sorry - recent AI article this week) of Apple retail stores are to people converting to Macs from PC
? Apple has 0 debt and $25B in cash
anyone else see a pattern here?
Believe the stock price is more reflective of increased global risk in fin markets and that it will bounce back well once the craziness settles down. Way to go Jobs and Co. for living up to your promise to out-innovate the competition. Believe they (RIM, PC makers) are still wondering what hit them.
Let's not fool ourselves. Others are playing catchup and there are some potentially potent competitors. The iPhone is still the real deal, but this might change...
Highly doubtful, an OS of OSX proportions , + developers + userbase is not something that grows overnight. (It's taken apple 20 or so years!)
At least the next 4 years is apples for the taking on all fronts.
I'm sure android and others way well have a decent stab, they may even overtake in sheer numbers one day, but apple will take the cream, and thats where the profit is. Same position apple is in today with computers, except for phones(which are really computers, just small
Fact is that even though I am convinced that Apple will do very well in the future, the next two quarters might well see a decline in revenue because of the economic situation
The last month have been unusually rough, but we've been in recession or a decline for at least the past year or so. Remember when Apple's stock was at $200 in December 2007 to $120 in February 2008. It mad it back up to $175 and is now at $95, yet throughout it all, Apple sales are still beating estimates. I see no reason why this holiday will be any different for Apple.
I believe people are really quite frightened to speak too highly of Apple simply because they are likely to be chastised for creating 'yet more Apple hype' or 'being a fanboy' and under some spell from Uncle Steve.
All I know is that APPL at sub-100 (27 of that is cash) is the investment opportunity of the century. But then I said that when I bought over two years ago!
All told, AAPL is likely 10-15% lower than it should be right now given the broader economic picture.
But here is my real curiosity: Why is it that AAPL earns revenue over 24 months, but T takes the subsidy in one quarter rather than amortizing it into the contract?
Except that they aren't taking it into account - which is obvious by the stock price. Apple is currently priced like it isn't experiencing any earnings growth at all.
No, Apple is priced like it's a tech/consumer discretionary company in a recession that the market fears could turn into worse. It has nothing to do with analysts, and everything to do with the fear in the market. If you're right, then hopefully the economy will turn around in time for your calls to not expire worthless. When the market is full of fear, that's the best time to buy. Thank your lucky stars you're getting such an obvious sale, don't complain.
RIMM is at a 20% discount relative to AAPL on GAAP P/E numbers.
Assuming RIMM's market share is not gobbled up by Apple.
I dont see RIMM surviving long (unless heaven forbid MSFT buys the company, which IMO would be a great move for microsoft and would certainly prolong its demise)
I believe RIMM has always been overvalued due to investors basing the company on numbers alone and without any prophetic thinking.
No, Apple is priced like it's a tech/consumer discretionary company in a recession that the market fears could turn into worse. It has nothing to do with analysts, and everything to do with the fear in the market. If you're right, then hopefully the economy will turn around in time for your calls to not expire worthless. When the market is full of fear, that's the best time to buy. Thank your lucky stars you're getting such an obvious sale, don't complain.
Give an example of another company that was priced this cheaply when it was still growing like this, with this much cash per share and no debt.
Give an example of another company that was priced this cheaply when it was still growing like this, with this much cash per share and no debt.
There's no reason to give another company, what you're suggesting is that the very foundation for market is false - that the market does not assimilate all available information. It's you that must prove the outrageous claim.
There's no reason to give another company, what you're suggesting is that the very foundation for market is false - that the market does not assimilate all available information. It's you that must prove the outrageous claim.
The market has never understood apple, and never will. To truly understand apple takes much vision and knowledge which 95% of humans lack.
To be blunt! And thats being kind.
The market has never understood apple, and never will. To truly understand apple takes much vision and knowledge which 95% of humans lack.
You can believe that if you want. Clearly a lot of people around here do. But it's hogwash - the market understands Apple just fine - other participants in the market simply don't agree with the extraordinarily bullish outlook that many here do. That's what makes a market - the tug of war between the bulls and the bears. As a bull, you should be glad that the bears currently have it.
How many people here were complaining that the market "didn't understand Apple" when it was at $200? Nobody. People are just bitter that Apple has fallen just as much as everyone else has in this ugly market. Live with it, get over it.
There's no reason to give another company, what you're suggesting is that the very foundation for market is false - that the market does not assimilate all available information. It's you that must prove the outrageous claim.
You said it is priced like a tech company going into a recession, give another example - you must have one or you would not have been able to make the original claim (that Apple was fairly priced, because other tech companies are priced like that - I say that there are no examples, because I have never seen a deal this good based on valuation).
The efficient market argument is a cop out, did you think think that Nortel was really worth $87/share during the telecom bubble? The market did, and that was pricing in "all available information", blah blah blah.
There are irrational moves way above and way below realistic values based on expected future cash flows. Apples discounted future is way better than the current stock price, just as Nortel's was way worse than $87. Nortel alone proves that efficient markets are a load of crap, there you go - I have "proved my outrageous claim"... Now what is your other example that shows Apple is fairly priced.
If you ever need anyone to write an article about Apple from a medical standpoint, just give me a call! (Nothing on Steve-O's health though, please)
WOO-HOO!!!