Originally Posted by jragosta
Similarly, if a company has negative growth, investors will be less likely to invest than on the simply return principle outlined in #1. So the P/E will be lower than the current earnings would suggest.
What does that mean for Apple? Simple. The market as a whole is trading at a P/E of 17 or 18. That means that if your company is growing as fast as the average Wall Street company, the shares should trade at around 17 or 18 times the earnings. That says that the market has determined that a 6% return is about right for stocks - on average, covering the evaluation in #1 above. If the market believes your stock is growing at faster than the average company, you should be able to add a component for #2, so your P/E should be greater than 17-18. If your stock is growing slower than the market average, you will subtract a 'growth premium' per #2 above and P/E will be lower than 17-18.
Apple is trading at around 13 (less after you back out the cash). Is it overvalued or undervalued? No one knows. The only way to know will be to project yourself into the future to see what Apple's future earnings are. However, the MARKET is saying that they expect Apple to grow at significantly slower than the average of the stocks on the exchange. Since most companies are growing at no better than inflation, that means that the market is predicting Apple will actually decline in profits over the coming years.
So, if you believe that Apple's profits will significantly decline relative to the market, then you would conclude that Apple is fairly priced.
If you believe that Apple will grow at roughly the same rate as the market (a few percent for inflation) over the next few years, then you should expect Apple to return to the market average P/E of 17-18, which means that Apple is a modest buy.
If you believe that Apple will grow faster than the market, then its P/E should be higher than 17-18, so it becomes a strong buy.
The market has made its position known. I happen to disagree - as does Zaky. I don't see anything that suggests that Apple's profits are going to decline in the near future. Even if you think that there's no 'next big thing' on the horizon, it seems to me that Apple's business model should allow them to grow at least as quickly as the rest of the market.
I don't even know where to begin.
First of all, with respect to 90% of the posters, I'm immediately reminded of Kramer and Jerry. And that's Cosmo Kramer, not Mad Money's Jim Cramer who is, in large part, single-handedly responsible for so many being armed with pithy sound bites that they don't know how, when, or where to correctly apply because the lack the fundamental, underlying expertise that someone like Jim Cramer has.
Back to Kramer and Jerry:
Jerry: So, we're going to make the post office pay for my new stereo now?
Kramer: It's a write-off for them.
Jerry: How is it a write-off?
Kramer: They just write it off.
Jerry: Write it off what?
Kramer: Jerry, all these big companies, they write off everything.
Jerry: You don't even know what a write-off is.
Kramer: Do you?
Jerry: No, I don't!
Kramer: But they do. And they're the ones writing it off.
Jerry: I wish I had the last twenty seconds of my life back.Seinfeld: The Package
First of all, there are many different reasons for trading in equities and different ways in doing so. The factors that you evaluate are different in each case, yet I see them being freely mixed in the discussion here.
Looking at how "The Market" prices a publicly held stock relative to the stock in other publicly held companies generally involves a short-term view of the collective market perception of how buying and selling opportunities in one specific equity compared to the marginal opportunities to invest a finite amount cash in one or more other equities. This analysis and investment decision is typically made with a specific time horizon in mind and it is one that is often of a relatively short-term nature. For example, "AAPL looks relatively undervalued compared to XYZ, therefore I'm going to buy 10,000 shares of AAPL and then sell when they're up $10 or in 2 weeks, whichever comes first." This is generally a view that may be formed based upon the available point-in-time information or from a basic extrapolation of recent trends.
(And before anyone jumps on my use of "margin," please make sure you first understand the difference between the economics concept of the margin with respect to the deployment of a specific, incremental amount of capital and the trading concept of using margin, or in other words, making a leveraged purchase of a traded instrument.)
This contrasts to fundamental analysis of expectations of future cash flows that a particular company will generate. These pro forma cash flows are modeled based upon scenario analysis of specific expectations regarding factors like market position, competitor analysis, pricing power, buying power, product pipeline, reputation, operating margins, liquidity, leverage, management, litigation, cost of capital, environmental risks, labor risks, market disruption, and so on. This is the type of in-depth analysis that is done by equity analysts at, for example, Wall Street firms such as Morgan, Citi, JPMC, Piper Jaffrey, Sterne Agee, etc.; as well as by the analysts at the bond rating firms such as Fitch and Moody's; by credit analysts at commercial and investment banks; and by M&A teams, VC firms, etc.
The objective in this fundamental analysis is to build a baseline scenario of 3-year cash flow projections, which are based on proprietary P&E and balance sheet models. This cash flow is then used as a basis to formulate buy/sell recommendations and target stock prices; credit ratings and default probabilities; valuations for mergers, acquisitions, and VC-type investments; etc.
Specific factors that might be relevant with respect to formulating a cash-flow forecast for Apple Inc might include:
- Impact of management change, most obviously with respect to Steve Jobs/Tim Cook, but also the possible impacts from Ron Johnson's departure, a scenario where Jony Ive might leave Apple, and so on
- Apple's use of it's massive cash position, whether for acquisitions, or supply-chain management with significant forward purchases to lock in prices for key components such as flash memory
- Apple's ability to continue innovating, gain/maintain/lose market share, overcome competitive challenges such as the most obvious ones of Google/Android and Samsung, perpetuate the brand image as cool and aspirational, etc.
- Maintaining margins on products as a function of pricing power and buying power
- and so on...
There are additional considerations as well. jragosta's reference to "the market as a whole" and implications regarding growth rates, earnings, share price, etc. is off-base. There is no "market as a whole," or at least not in any way that has any bearing or analytical value with respect to the market price of Apple's common stock. What is relevant is market or industry sectors, not to mention geography, listing exchange, etc. This is the reason why there are utilities indexes, transportation indexes, etc. so as to facilitate comparison of like stocks because that's where comparison of growth rates, margins and so on are actually relevant. Is there any meaning in comparing Apple to, let's say, Nike or Coca-Cola, or a major pharmaceutical company? The short answer is no. The longer answer is that if an investor is looking for the best return/reward on the investment of their marginal dollar and is not taking anything else into consideration such as diversification, growth vs. dividend, and so on, and they expect a better return on a short-term investment in Apple than in Berkshire Hathaway, they may choose to invest that marginal dollar in AAPL. But that is completely contrary to the long-term view of an investment such as Warren Buffet's moderately successful (sarcasm) approach at Berkshire Hathaway. He has done amazingly well by identifying investments based upon developing a long-term view of the unique fundaementals of a specific company.
Another factor that is uniquely relevant to Apple is that no company has, or ever has had, composed such a significant component of the total market cap across an industry, an exchange, an index, all publicly held large-cap stocks, or what have you. Apple being such a Goliath has very significant consequences in terms of it's ability to move market indices such as the S&P 500. It is the most widely held equity and is a significant component in many, if not most, mutual funds. That affects the buying decision of fund managers, especially those managing index funds where they need to continue rebalancing their holdings. AAPL, I would believe but am not certain, is a very liquid stock but the ability to sell-off or buy a large block of shares will be constrained by both availability and the market impact of a large number of shares changing hands.
Further, the law of large numbers, which has been mentioned previously in this thread, is very relevant to Apple. The larger something is, the harder it is to make signficant changes in its size; and this is particularly true for companies with sizable revenues, earnings, market share, and/or market cap. If a company has 2% market share, it is far easier to double that than a company that has 20% market share. And obviously extrapolating from that, a company with an extremely large market share would be essentially constrained by its ability to actually influence the overall growth of the entire market rather than simply its abillity to capture a larger portion of market share from its competitors.
I quoted jragosta at the top because I was motivated to comment specifically regarding his referring to a comparison of Apple to some mythological "average" publicly held company, but obviously my post is directed at most all of the preceding posts in this thread.
Let the attacks begin...
BTW, if you want to make personal attacks, don't -- I can respond better than you can heckle. If you're not sure what you're talking about, please remember Abraham Lincoln's famous words, "It is better to remain silent and be thought a fool, than to speak and remove all doubt." If you know what you're talking about and can frame a reasonable and well articulated counter-argument, then bring it on ;-)
(Full disclosure: I don't have any direct position in AAPL, nor do I intend to make one in the forseeable future. I don't work for Apple or any of its competitors. I haven't been a banker for a very long time and I don't hold any type of analyst position.)Edited by tmhisey - 5/18/12 at 8:27am