I generally like your posts, but I am afraid this article parrots a great deal of mechanical 'wisdom' that Wall Street bandies about on the topic of valuation. Moreover, I disagree that the (long-run) value of Apple - or any other company - is a bet on the next year's earnings.
Danger! Danger! Be warned! The Capital Asset Pricing Model, the CAPM is CRAP. It will tell you what Asset A should be priced relative to Asset B but it doesn't have anything to say about what the absolute levels should be. And the problem, as anyone may have gleaned from recent stock market experience, is not mistakes in predicting the relative price of assets, it's the complete and utter failure in predicting the collapse in the absolute price levels of securities.
Look at the statement above, "assuming a specific market risk premium and a specific T-bond yield". It's a statement about relative prices! Does the quality of Apple's products not figure at all into its valuation? How about the effectiveness of its management? How about the mysterious ability to consistently come up with wildly successful new products? If you disregard factors such as these in your analysis, then you are in essence assuming that all companies are the same when it comes to these factors. That's not a smart thing to do.
It's as simple as this: Suppose I came to you and said,"tundraboy, will you invest $100 to get an equity stake in my business; I promise to give you back $107 one year from now," your sensible reaction would be "it depends." Depends on what? On what you can get from risk-equivalent investments elsewhere. If I - or Apple, or anyone else - can't meet or beat that test, then you'll (indeed, I hope you would) take your money elsewhere.
Whenever you invest money in an asset, you forego the opportunity to invest it elsewhere. There is thus an 'opportunity cost' associated with the use of your capital, whether you know it or not. That's all you need to know about why a cost of capital, or in this case, a 'cost of equity,' exists, and why people do indeed look at Asset A relative to (a risk-equivalent) Asset B. The CAPM is just a handy and simple way of concretizing that insight. More precisely, it says that I need to give you at least a relatively riskfree rate of return (e.g., the return on a T-bond) - for otherwise you would not invest in any risky asset - on top of which, I'd need to compensate you for a risk premium associated with the investors' perception of risk in that asset.
Is the CAPM perfect? Of course not. There are more complicated (and well-known) adjustments that one can make. Can markets have meltdowns and overreactions when everything - incl. CAPM - goes out the window? Of course it does. And, it can do so, both on the downside (e.g., when Apple went back to $80 in 2008) or the upside (say, if Apple gets to $500 per share tomorrow). Relative to evaluation of long-run value using fundamentals (which is also what Zaky is trying to do), that might represent a screaming 'buy' or a 'sell,' depending on your own evaluation.
It does not matter what model you use. I am suggesting there is a relevant expected return for Apple's (or any other) shareholders. Use your own 'model', whatever that is. Incidentally, when you use a P/E, there is a discount rate embedded in that number. Period. Whether you realize it or not, or believe it or not is somewhat irrelevant. As an investor, you need to be aware that, all else equal, if you're attaching a higher P/E to a stock, you're likely attaching a lower discount rate to (i.e., demanding a lower expected return from) it. That's really all I am saying.
If you think 12% - 14% is wrong for Apple, that's fine. We don't have to agree. You'd say Apple is a 'buy' at $250. Someone else might sell. Think about it: every time someone buys thinking Apple is undervalued, there is someone else on the other side of the transaction that is selling, thinking perhaps that it is overvalued. After all, when I bought Apple in the high 80s early last year (which I thought was a raging buy at that price), there was someone who thought the opposite. If there wasn't such disagreement, no one would buy or sell.
It's as simple as this: Suppose I came to you and said,"tundraboy, will you invest $100 to get an equity stake in my business; I promise to give you back $107 one year from now," your sensible reaction would be "it depends." Depends on what? On what you can get from risk-equivalent investments elsewhere. If I - or Apple, or anyone else - can't meet or beat that test, then you'll (indeed, I hope you would) take your money elsewhere.
I completely agree with the rest of your post, but the above assumes there are dozens of other 'sure thing' investments sitting around waiting to be snapped up. In reality, there are other investors who are also looking to make their 7%, especially in a market where your bank account might net you 1% or so. In a real life market situation, while he's pondering on 'it depends', the cost to entry to get the $107 is suddenly $102, because someone else already offered $100. I think the problem with trying to explain any of this is that the models have to be simplified to such an extent that they become almost irrelevant.
Thank you Andy Zaky for this series. It explains much of why APPL is undervalued and the metrics used by traditional analysts.
Quote:
Originally Posted by AppleStud
Andy - its easy to make money on a company like apple. Got any success stories from some more challenging case studies?
Yes, please give links to any analysis of other companies.
Quote:
Originally Posted by anantksundaram
........
.... Think about it: every time someone buys thinking Apple is undervalued, there is someone else on the other side of the transaction that is selling, thinking perhaps that it is overvalued. After all, when I bought Apple in the high 80s early last year (which I thought was a raging buy at that price), there was someone who thought the opposite. If there wasn't such disagreement, no one would buy or sell.
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
An individual depserate for cash might do that, although it's not really the right thing to do.
If you buy 2 stocks, one share of company A and one share of Company B, each for $100.
After one year:
Company A stock rises to $110
Company B stock falls to $90
You don't sell stock A to cover for the loss of stock B, for more reasons than I can go into here. If you absolutely had to raise some cash (lets say you needed $80) with no other information at hand, it makes more sense to sell stock B (for tax reasons if nothing else). Regardless, in reality you'd sell the one that you thought was most likely to fall, which would in turn be the one you thought was over valued.
Huge mutual funds certainly don't sell high performing chunks of their portfolios to 'break even' and institutional traders generally don't either unless they're working for a company that has liquidity issues.
I completely agree with the rest of your post, but the above assumes there are dozens of other 'sure thing' investments sitting around waiting to be snapped up. In reality, there are other investors who are also looking to make their 7%, especially in a market where your bank account might net you 1% or so. In a real life market situation, while he's pondering on 'it depends', the cost to entry to get the $107 is suddenly $102, because someone else already offered $100. I think the problem with trying to explain any of this is that the models have to be simplified to such an extent that they become almost irrelevant.
Ah, notice I said 'risk-equivalent,' not risk-free (i.e., not 'sure thing').
I am simply saying that the price of stocks and bonds will be judged on the basis of what other similar objects are being sold/bought for in the financial marketplace.
This does not at all imply that we won't make mistakes or form poor judgments or be misled concerning what 'risk-equivalent' means for a particular stock (with bonds, it is far easier given credit ratings. Although, even there, we know that raters themselves can be wrong sometimes).
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
I have no idea what you mean. That is why I said '..... perhaps overvalued'. That is one of many reasons. For instance, liquidity needs might be another.
But the larger point is, ignoring market-maker positions, a fund can only 'sell' when there is someone on the other side who wants to 'buy.' And, people don't 'buy' if they think the stock is going to go down in value.
I have no idea what you mean. That is why I said '..... perhaps overvalued'. That is one of many reasons. For instance, liquidity needs might be another.
But the larger point is, ignoring market-maker positions, a fund can only 'sell' when there is someone on the other side who wants to 'buy.' And, people don't 'buy' if they think the stock is going to go down in value.
Unless I'm missing something, this statement is nothing more useful than a tautology. For every buyer in the market, a seller must exist, and vice-versa.
Unless I'm missing something, this statement is nothing more useful than a tautology. For every buyer in the market, a seller must exist, and vice-versa.
Then I've missed something, which perhaps you could explain. It is tautological to say that for every seller there must be a buyer, since the system of buying and selling is defined by this very transaction. It's very unclear to me what you believe to have added to this discussion of markets by restating the obvious using other words. Feel free to enlighten me.
Then I've missed something, which perhaps you could explain. It is tautological to say that for every seller there must be a buyer, since the system of buying and selling is defined by this very transaction. It's very unclear to me what you believe to have added to this discussion of markets by restating the obvious using other words. Feel free to enlighten me.
To say something happens and the obverse of that does not is indeed a tautology. The more important issue is why something happens, and whether the obverse happens for reasons that are different from or opposite to the event in question.
For instance, to say that the US$ depreciated against the Yen is tautologically equivalent to saying that the Yen appreciated against the US$. However, it may have been actions on the US part that led to the market lowering its value relative to the Yen, even though Japan may have done nothing to make the Yen appreciate. Thus, if we are trying to understand what led to the dollar depreciation (tautologically equivalent to a Yen appreciation) we would look to the US for an explanation.
Similarly, [E]*[P/E] is a tautology as I said before. But once we begin ask 'what does P/E mean' as a construct (it is simply the inverse of the growth-adjusted-cost-of-equity), it goes beyond the obvious.
A person selling will complete the transaction only when there is person buying. That is, indeed, a tautological statement if one goes no further.
However, the person selling the asset might be doing it because (s)he thinks it is overvalued, while the person buying it, obversely, think the opposite. They might both be reasonable, intelligent investors who have looked at the same fundamentals and come to opposite conclusions regarding the value of the asset, based on their differing assumptions about the future course of events (e.g., cash flows, cost of capital, growth prospects) related to that asset.
The cash adds value to the company's stock only in the instance of figuring takeover value. Is anyone going to try to take Apple over? Not in your life. Cash in really only otherwise of use if it is capitalized. Apple is way beyond the point (IMO) where they can capitalize even a small fraction of the cash they have already hoarded, let alone the $15b they are adding at the current rate of accumulation. The bottom line is, profits drive stock valuation. Nobody but an arbitrager buys stocks for the company's cash on hand because unless you buy the entire company or they declare a dividend you see not penny of it.
I agree with you. However, the reality is still that cash is being accumulated at an ever-increasing rate. I'm simply trying to draw attention to this fact. It's the IMPLICATIONS of this, coupled with the seeming fact that Apple is acting more like a startup than a huge company, that I don't think has been sufficiently appreciated.
Yes, they can (1) buy back stock (which helps the stockholder but doesn't do much for Apple the company), (2) start giving out dividends (ditto to (1)), (3) sit on the cash, or (4) invest. Of these four, the best thing for Apple the company is (4), especially where such investing helps their core business.
Obviously, stock buybacks have the effect of reducing the market capitalization of the company. Since Mr. Zaky's major determiner of a future Apple being "over-valued" is tied into its future much higher market cap, then this would be a way to increase value. Also obviously, dividends increase the attractiveness of a stock in spite of a market cap making it "over-valued".
All I'm saying is that there appears to be a collision course at work here between the present value of Apple's stock and it's longer term value, in whatever ways one wishes to fram that value, and that this collision course is based on the apparantly exponential growth of profit that Apple is raking in.
BTW, if they ever get to the point where they can go beyond simply keeping up with demand, then that huge bundle of cash can be converted into a decrease in the price of Apple products, which in turn can increase its market share. Indeed, the mere potential of that ability may be one of the major reasons for Apple keeping such a large stash of cash.
To say something happens and the obverse of that does not is indeed a tautology. The more important issue is why something happens, and whether the obverse happens for reasons that are different from or opposite to the event in question.
For instance, to say that the US$ depreciated against the Yen is tautologically equivalent to saying that the Yen appreciated against the US$. However, it may have been actions on the US part that led to the market lowering its value relative to the Yen, even though Japan may have done nothing to make the Yen appreciate. Thus, if we are trying to understand what led to the dollar depreciation (tautologically equivalent to a Yen appreciation) we would look to the US for an explanation.
Similarly, [E]*[P/E] is a tautology as I said before. But once we begin ask 'what does P/E mean' as a construct (it is simply the inverse of the growth-adjusted-cost-of-equity), it goes beyond the obvious.
A person selling will complete the transaction only when there is person buying. That is, indeed, a tautological statement if one goes no further.
However, the person selling the asset might be doing it because (s)he thinks it is overvalued, while the person buying it, obversely, think the opposite. They might both be reasonable, intelligent investors who have looked at the same fundamentals and come to opposite conclusions regarding the value of the asset, based on their differing assumptions about the future course of events (e.g., cash flows, cost of capital, growth prospects) related to that asset.
How can you suggest that is tautological?
Well, rather easily, since I still think fundamentally you are restating the obvious. Perhaps we are talking right past each other, I'm not sure.
Whether a stock skyrockets or plummets, the numbers of buyers and sellers (as measured by shares traded) are always exactly equal. Everyone has their individual reasons for making a decision to be one or the other, and they do not by any means have to be based on opposite conclusions based on the same data. They can be based on reasons entirely external to any given stock, including the need to diversify, the length of time the investor has held the stock, the desire for further investing, or to generate cash to capitalize something else. The reasons are so many and varied, and the number of players so vast that trying to relate them to any one or even any several measures of value, seems like a futile exercise.
But then we have the markets, which don't care about individual buying or selling motivations. They exist only for the purpose of setting a price such that the numbers of buyers and sellers are always equal.
I agree with you. However, the reality is still that cash is being accumulated at an ever-increasing rate. I'm simply trying to draw attention to this fact. It's the IMPLICATIONS of this, coupled with the seeming fact that Apple is acting more like a startup than a huge company, that I don't think has been sufficiently appreciated.
Yes, they can (1) buy back stock (which helps the stockholder but doesn't do much for Apple the company), (2) start giving out dividends (ditto to (1)), (3) sit on the cash, or (4) invest. Of these four, the best thing for Apple the company is (4), especially where such investing helps their core business.
Obviously, stock buybacks have the effect of reducing the market capitalization of the company. Since Mr. Zaky's major determiner of a future Apple being "over-valued" is tied into its future much higher market cap, then this would be a way to increase value. Also obviously, dividends increase the attractiveness of a stock in spite of a market cap making it "over-valued".
All I'm saying is that there appears to be a collision course at work here between the present value of Apple's stock and it's longer term value, in whatever ways one wishes to fram that value, and that this collision course is based on the apparantly exponential growth of profit that Apple is raking in.
BTW, if they ever get to the point where they can go beyond simply keeping up with demand, then that huge bundle of cash can be converted into a decrease in the price of Apple products, which in turn can increase its market share. Indeed, the mere potential of that ability may be one of the major reasons for Apple keeping such a large stash of cash.
Your last statement is most alarming, so I will start with it. You are suggesting that Apple should subsidize their products with cash, in other words, to voluntarily cut their margins, maybe even lose money on every product but "make it up in volume." If you ever hope to see AAPL plummet, this scheme is the perfect way to make it happen.
The investment of cash returns very little, especially in the current interest rate environment. Either way, Apple is not a bank. They are not in the business of becoming an investment management company (hardly their core competence). Profits are supposed to be capitalized, used to grow the business they are in. Apple's ROI is so huge now that they cannot possibly reinvest even a tiny fraction of their cash reserves in this way, let alone the billion or more which pours in every month.
As problems go, it's a great one to have, but I do find myself constantly reminding people that Apple is NOT in the business of accumulating cash. It has little value to the company if it is not spent, and none to stockholders if it's not returned in the form of a dividend. (For the record, I'm not a fan of stock buybacks.)
Your last statement is most alarming, so I will start with it. You are suggesting that Apple should subsidize their products with cash, in other words, to voluntarily cut their margins, maybe even lose money on every product but "make it up in volume." If you ever hope to see AAPL plummet, this scheme is the perfect way to make it happen.
The investment of cash returns very little, especially in the current interest rate environment. Either way, Apple is not a bank. They are not in the business of becoming an investment management company (hardly their core competence). Profits are supposed to be capitalized, used to grow the business they are in. Apple's ROI is so huge now that they cannot possibly reinvest even a tiny fraction of their cash reserves in this way, let alone the billion or more which pours in every month.
As problems go, it's a great one to have, but I do find myself constantly reminding people that Apple is NOT in the business of accumulating cash. It has little value to the company if it is not spent, and none to stockholders if it's not returned in the form of a dividend. (For the record, I'm not a fan of stock buybacks.)
Again, I'm in basic agreement. And I'm not suggesting that Apple "subsicize their products with cash", I'm simply saying that it's an option. Not for me to say what Apple chooses to do! I'm just a lowly stockholder.
My whole purpose is to spotlight the growing snowball nature of Apple's cash situation (and indeed of Apple products in general), and to suggest that there will inevitably be a positive effect of that underappreciated phenomenon on Apple's stock price.
Again, I'm in basic agreement. And I'm not suggesting that Apple "subsicize their products with cash", I'm simply saying that it's an option. Not for me to say what Apple chooses to do! I'm just a lowly stockholder.
My whole purpose is to spotlight the growing snowball nature of Apple's cash situation (and indeed of Apple products in general), and to suggest that there will inevitably be a positive effect of that underappreciated phenomenon on Apple's stock price.
Essentially that is what you suggested. Using cash to lower the cost of products is a subsidy no matter how you cut it. One of the reasons Apple is so profitable, and we have done well as investors, is their margins. If Apple ever decided to try to use cash to "buy" market share, you as an investor can expect to get hammered. (Essentially this is what Microsoft has been attempting with products such as Zune and Xbox. How's that working out for them?)
Again, investors don't buy a company's cash position. Without a dividend, they see not of cent of it. It's about as relevant as the dark side of the moon. Cash does not improve earnings unless it is reinvested in growth.
Essentially that is what you suggested. Using cash to lower the cost of products is a subsidy no matter how you cut it. One of the reasons Apple is so profitable, and we have done well as investors, is their margins. If Apple ever decided to try to use cash to "buy" market share, you as an investor can expect to get hammered. (Essentially this is what Microsoft has been attempting with products such as Zune and Xbox. How's that working out for them?)
Again, investors don't buy a company's cash position. Without a dividend, they see not of cent of it. It's about as relevant as the dark side of the moon. Cash does not improve earnings unless it is reinvested in growth.
(Sigh) No, I didn't suggest it, essentially or otherwise. I posited it. However, since you seem disinclined to let this go, let me hypothesize a situation where such an action might make good business sense.
At one time my sister and her husband owned a small mailer in the small town she lived in. It was free, paid for by the ads my sister gathered to run in it. A few years in, the main newspaper in town decided to give their ads away for free, thus putting my sister's paper, the only competition for ads in town, out of business. Afterwards, their prices returned to normal.
Needless to say, if my sister had had sufficient reserves, this wouldn't have worked. And such is the case on any scale one might wish to mention. Thus, if one assumes parity is achieved between the products of, say, Microsoft and Apple, and Apple didn't have a sufficient cash reserve, Microsoft could use a similar approach to choke Apple to death, much as my sister's business was.
Now, I admit this is far-fetched, and it is not to be taken as a "suggestion" on my part. It is merely an example of how, in some circumstances, having a good sized bank roll is a good idea.
(Sigh) No, I didn't suggest it, essentially or otherwise. I posited it. However, since you seem disinclined to let this go, let me hypothesize a situation where such an action might make good business sense.
At one time my sister and her husband owned a small mailer in the small town she lived in. It was free, paid for by the ads my sister gathered to run in it. A few years in, the main newspaper in town decided to give their ads away for free, thus putting my sister's paper, the only competition for ads in town, out of business. Afterwards, their prices returned to normal.
Needless to say, if my sister had had sufficient reserves, this wouldn't have worked. And such is the case on any scale one might wish to mention. Thus, if one assumes parity is achieved between the products of, say, Microsoft and Apple, and Apple didn't have a sufficient cash reserve, Microsoft could use a similar approach to choke Apple to death, much as my sister's business was.
Now, I admit this is far-fetched, and it is not to be taken as a "suggestion" on my part. It is merely an example of how, in some circumstances, having a good sized bank roll is a good idea.
We both seem disinclined to let it go, so don't put it all on me. All I am telling you is, that from a stockholder's standpoint, you'd find out in a big hurry how bad an idea it would be if it ever happened. The markets get freaky whenever margins slip by even a few percentage points, since margins are one of the major determinants of earnings, which is what investors really care about. It also needs to be pointed out that for Apple to dip into their cash reserves means that they are unable to pay for something out of current cash flow. Which, with few exceptions, translates into losing money.
Bottom line: Apple doesn't need cash reserves of this magnitude to do anything short of staving off Armageddon, and since they will never have enough for that eventuality...
Bottom line: Apple doesn't need cash reserves of this magnitude to do anything short of staving off Armageddon, and since they will never have enough for that eventuality...
I think it's just a question of degree, but the huge cash pile might come into play at some point if some new technology is discovered that can only be produced in relatively small quantities and Apple could buy up or pre-order with cash, a few years' supply to get ahead of the competition. They did this to a very limited extend with Nand Flash memory a few years back.
Lets say some scroll up screen can be built with some new rare metal... $10bn in cash buys you exclusive rights for 5 years; that's a helluva market head start.
Other than that, from an investor's point of view, $15bn in dividends per year would be nice...
Comments
I generally like your posts, but I am afraid this article parrots a great deal of mechanical 'wisdom' that Wall Street bandies about on the topic of valuation. Moreover, I disagree that the (long-run) value of Apple - or any other company - is a bet on the next year's earnings.
/snip
Great post.
Danger! Danger! Be warned! The Capital Asset Pricing Model, the CAPM is CRAP. It will tell you what Asset A should be priced relative to Asset B but it doesn't have anything to say about what the absolute levels should be. And the problem, as anyone may have gleaned from recent stock market experience, is not mistakes in predicting the relative price of assets, it's the complete and utter failure in predicting the collapse in the absolute price levels of securities.
Look at the statement above, "assuming a specific market risk premium and a specific T-bond yield". It's a statement about relative prices! Does the quality of Apple's products not figure at all into its valuation? How about the effectiveness of its management? How about the mysterious ability to consistently come up with wildly successful new products? If you disregard factors such as these in your analysis, then you are in essence assuming that all companies are the same when it comes to these factors. That's not a smart thing to do.
It's as simple as this: Suppose I came to you and said,"tundraboy, will you invest $100 to get an equity stake in my business; I promise to give you back $107 one year from now," your sensible reaction would be "it depends." Depends on what? On what you can get from risk-equivalent investments elsewhere. If I - or Apple, or anyone else - can't meet or beat that test, then you'll (indeed, I hope you would) take your money elsewhere.
Whenever you invest money in an asset, you forego the opportunity to invest it elsewhere. There is thus an 'opportunity cost' associated with the use of your capital, whether you know it or not. That's all you need to know about why a cost of capital, or in this case, a 'cost of equity,' exists, and why people do indeed look at Asset A relative to (a risk-equivalent) Asset B. The CAPM is just a handy and simple way of concretizing that insight. More precisely, it says that I need to give you at least a relatively riskfree rate of return (e.g., the return on a T-bond) - for otherwise you would not invest in any risky asset - on top of which, I'd need to compensate you for a risk premium associated with the investors' perception of risk in that asset.
Is the CAPM perfect? Of course not. There are more complicated (and well-known) adjustments that one can make. Can markets have meltdowns and overreactions when everything - incl. CAPM - goes out the window? Of course it does. And, it can do so, both on the downside (e.g., when Apple went back to $80 in 2008) or the upside (say, if Apple gets to $500 per share tomorrow). Relative to evaluation of long-run value using fundamentals (which is also what Zaky is trying to do), that might represent a screaming 'buy' or a 'sell,' depending on your own evaluation.
It does not matter what model you use. I am suggesting there is a relevant expected return for Apple's (or any other) shareholders. Use your own 'model', whatever that is. Incidentally, when you use a P/E, there is a discount rate embedded in that number. Period. Whether you realize it or not, or believe it or not is somewhat irrelevant. As an investor, you need to be aware that, all else equal, if you're attaching a higher P/E to a stock, you're likely attaching a lower discount rate to (i.e., demanding a lower expected return from) it. That's really all I am saying.
If you think 12% - 14% is wrong for Apple, that's fine. We don't have to agree. You'd say Apple is a 'buy' at $250. Someone else might sell. Think about it: every time someone buys thinking Apple is undervalued, there is someone else on the other side of the transaction that is selling, thinking perhaps that it is overvalued. After all, when I bought Apple in the high 80s early last year (which I thought was a raging buy at that price), there was someone who thought the opposite. If there wasn't such disagreement, no one would buy or sell.
It's as simple as this: Suppose I came to you and said,"tundraboy, will you invest $100 to get an equity stake in my business; I promise to give you back $107 one year from now," your sensible reaction would be "it depends." Depends on what? On what you can get from risk-equivalent investments elsewhere. If I - or Apple, or anyone else - can't meet or beat that test, then you'll (indeed, I hope you would) take your money elsewhere.
I completely agree with the rest of your post, but the above assumes there are dozens of other 'sure thing' investments sitting around waiting to be snapped up. In reality, there are other investors who are also looking to make their 7%, especially in a market where your bank account might net you 1% or so. In a real life market situation, while he's pondering on 'it depends', the cost to entry to get the $107 is suddenly $102, because someone else already offered $100. I think the problem with trying to explain any of this is that the models have to be simplified to such an extent that they become almost irrelevant.
Andy - its easy to make money on a company like apple. Got any success stories from some more challenging case studies?
Yes, please give links to any analysis of other companies.
........
.... Think about it: every time someone buys thinking Apple is undervalued, there is someone else on the other side of the transaction that is selling, thinking perhaps that it is overvalued. After all, when I bought Apple in the high 80s early last year (which I thought was a raging buy at that price), there was someone who thought the opposite. If there wasn't such disagreement, no one would buy or sell.
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
An individual depserate for cash might do that, although it's not really the right thing to do.
If you buy 2 stocks, one share of company A and one share of Company B, each for $100.
After one year:
Company A stock rises to $110
Company B stock falls to $90
You don't sell stock A to cover for the loss of stock B, for more reasons than I can go into here. If you absolutely had to raise some cash (lets say you needed $80) with no other information at hand, it makes more sense to sell stock B (for tax reasons if nothing else). Regardless, in reality you'd sell the one that you thought was most likely to fall, which would in turn be the one you thought was over valued.
Huge mutual funds certainly don't sell high performing chunks of their portfolios to 'break even' and institutional traders generally don't either unless they're working for a company that has liquidity issues.
I completely agree with the rest of your post, but the above assumes there are dozens of other 'sure thing' investments sitting around waiting to be snapped up. In reality, there are other investors who are also looking to make their 7%, especially in a market where your bank account might net you 1% or so. In a real life market situation, while he's pondering on 'it depends', the cost to entry to get the $107 is suddenly $102, because someone else already offered $100. I think the problem with trying to explain any of this is that the models have to be simplified to such an extent that they become almost irrelevant.
Ah, notice I said 'risk-equivalent,' not risk-free (i.e., not 'sure thing').
I am simply saying that the price of stocks and bonds will be judged on the basis of what other similar objects are being sold/bought for in the financial marketplace.
This does not at all imply that we won't make mistakes or form poor judgments or be misled concerning what 'risk-equivalent' means for a particular stock (with bonds, it is far easier given credit ratings. Although, even there, we know that raters themselves can be wrong sometimes).
Not necessarily true. I don't know the %, but funds do sell stock for profit taking to cover their losses in other stocks and investments. With the recent economic woes, I suspect there are quite a few funds that did this / are doing this with APPL. As I am not a stock expert, I believe there are probably numerous reasons people / funds sell stock other than the straightforward belief the stock is over valued.
I have no idea what you mean. That is why I said '..... perhaps overvalued'. That is one of many reasons. For instance, liquidity needs might be another.
But the larger point is, ignoring market-maker positions, a fund can only 'sell' when there is someone on the other side who wants to 'buy.' And, people don't 'buy' if they think the stock is going to go down in value.
I have no idea what you mean. That is why I said '..... perhaps overvalued'. That is one of many reasons. For instance, liquidity needs might be another.
But the larger point is, ignoring market-maker positions, a fund can only 'sell' when there is someone on the other side who wants to 'buy.' And, people don't 'buy' if they think the stock is going to go down in value.
Unless I'm missing something, this statement is nothing more useful than a tautology. For every buyer in the market, a seller must exist, and vice-versa.
Unless I'm missing something, this statement is nothing more useful than a tautology. For every buyer in the market, a seller must exist, and vice-versa.
No, it's not. I am surprised you'd think that.
No, it's not. I am surprised you'd think that.
Then I've missed something, which perhaps you could explain. It is tautological to say that for every seller there must be a buyer, since the system of buying and selling is defined by this very transaction. It's very unclear to me what you believe to have added to this discussion of markets by restating the obvious using other words. Feel free to enlighten me.
Then I've missed something, which perhaps you could explain. It is tautological to say that for every seller there must be a buyer, since the system of buying and selling is defined by this very transaction. It's very unclear to me what you believe to have added to this discussion of markets by restating the obvious using other words. Feel free to enlighten me.
To say something happens and the obverse of that does not is indeed a tautology. The more important issue is why something happens, and whether the obverse happens for reasons that are different from or opposite to the event in question.
For instance, to say that the US$ depreciated against the Yen is tautologically equivalent to saying that the Yen appreciated against the US$. However, it may have been actions on the US part that led to the market lowering its value relative to the Yen, even though Japan may have done nothing to make the Yen appreciate. Thus, if we are trying to understand what led to the dollar depreciation (tautologically equivalent to a Yen appreciation) we would look to the US for an explanation.
Similarly, [E]*[P/E] is a tautology as I said before. But once we begin ask 'what does P/E mean' as a construct (it is simply the inverse of the growth-adjusted-cost-of-equity), it goes beyond the obvious.
A person selling will complete the transaction only when there is person buying. That is, indeed, a tautological statement if one goes no further.
However, the person selling the asset might be doing it because (s)he thinks it is overvalued, while the person buying it, obversely, think the opposite. They might both be reasonable, intelligent investors who have looked at the same fundamentals and come to opposite conclusions regarding the value of the asset, based on their differing assumptions about the future course of events (e.g., cash flows, cost of capital, growth prospects) related to that asset.
How can you suggest that is tautological?
The cash adds value to the company's stock only in the instance of figuring takeover value. Is anyone going to try to take Apple over? Not in your life. Cash in really only otherwise of use if it is capitalized. Apple is way beyond the point (IMO) where they can capitalize even a small fraction of the cash they have already hoarded, let alone the $15b they are adding at the current rate of accumulation. The bottom line is, profits drive stock valuation. Nobody but an arbitrager buys stocks for the company's cash on hand because unless you buy the entire company or they declare a dividend you see not penny of it.
I agree with you. However, the reality is still that cash is being accumulated at an ever-increasing rate. I'm simply trying to draw attention to this fact. It's the IMPLICATIONS of this, coupled with the seeming fact that Apple is acting more like a startup than a huge company, that I don't think has been sufficiently appreciated.
Yes, they can (1) buy back stock (which helps the stockholder but doesn't do much for Apple the company), (2) start giving out dividends (ditto to (1)), (3) sit on the cash, or (4) invest. Of these four, the best thing for Apple the company is (4), especially where such investing helps their core business.
Obviously, stock buybacks have the effect of reducing the market capitalization of the company. Since Mr. Zaky's major determiner of a future Apple being "over-valued" is tied into its future much higher market cap, then this would be a way to increase value. Also obviously, dividends increase the attractiveness of a stock in spite of a market cap making it "over-valued".
All I'm saying is that there appears to be a collision course at work here between the present value of Apple's stock and it's longer term value, in whatever ways one wishes to fram that value, and that this collision course is based on the apparantly exponential growth of profit that Apple is raking in.
BTW, if they ever get to the point where they can go beyond simply keeping up with demand, then that huge bundle of cash can be converted into a decrease in the price of Apple products, which in turn can increase its market share. Indeed, the mere potential of that ability may be one of the major reasons for Apple keeping such a large stash of cash.
To say something happens and the obverse of that does not is indeed a tautology. The more important issue is why something happens, and whether the obverse happens for reasons that are different from or opposite to the event in question.
For instance, to say that the US$ depreciated against the Yen is tautologically equivalent to saying that the Yen appreciated against the US$. However, it may have been actions on the US part that led to the market lowering its value relative to the Yen, even though Japan may have done nothing to make the Yen appreciate. Thus, if we are trying to understand what led to the dollar depreciation (tautologically equivalent to a Yen appreciation) we would look to the US for an explanation.
Similarly, [E]*[P/E] is a tautology as I said before. But once we begin ask 'what does P/E mean' as a construct (it is simply the inverse of the growth-adjusted-cost-of-equity), it goes beyond the obvious.
A person selling will complete the transaction only when there is person buying. That is, indeed, a tautological statement if one goes no further.
However, the person selling the asset might be doing it because (s)he thinks it is overvalued, while the person buying it, obversely, think the opposite. They might both be reasonable, intelligent investors who have looked at the same fundamentals and come to opposite conclusions regarding the value of the asset, based on their differing assumptions about the future course of events (e.g., cash flows, cost of capital, growth prospects) related to that asset.
How can you suggest that is tautological?
Well, rather easily, since I still think fundamentally you are restating the obvious. Perhaps we are talking right past each other, I'm not sure.
Whether a stock skyrockets or plummets, the numbers of buyers and sellers (as measured by shares traded) are always exactly equal. Everyone has their individual reasons for making a decision to be one or the other, and they do not by any means have to be based on opposite conclusions based on the same data. They can be based on reasons entirely external to any given stock, including the need to diversify, the length of time the investor has held the stock, the desire for further investing, or to generate cash to capitalize something else. The reasons are so many and varied, and the number of players so vast that trying to relate them to any one or even any several measures of value, seems like a futile exercise.
But then we have the markets, which don't care about individual buying or selling motivations. They exist only for the purpose of setting a price such that the numbers of buyers and sellers are always equal.
I agree with you. However, the reality is still that cash is being accumulated at an ever-increasing rate. I'm simply trying to draw attention to this fact. It's the IMPLICATIONS of this, coupled with the seeming fact that Apple is acting more like a startup than a huge company, that I don't think has been sufficiently appreciated.
Yes, they can (1) buy back stock (which helps the stockholder but doesn't do much for Apple the company), (2) start giving out dividends (ditto to (1)), (3) sit on the cash, or (4) invest. Of these four, the best thing for Apple the company is (4), especially where such investing helps their core business.
Obviously, stock buybacks have the effect of reducing the market capitalization of the company. Since Mr. Zaky's major determiner of a future Apple being "over-valued" is tied into its future much higher market cap, then this would be a way to increase value. Also obviously, dividends increase the attractiveness of a stock in spite of a market cap making it "over-valued".
All I'm saying is that there appears to be a collision course at work here between the present value of Apple's stock and it's longer term value, in whatever ways one wishes to fram that value, and that this collision course is based on the apparantly exponential growth of profit that Apple is raking in.
BTW, if they ever get to the point where they can go beyond simply keeping up with demand, then that huge bundle of cash can be converted into a decrease in the price of Apple products, which in turn can increase its market share. Indeed, the mere potential of that ability may be one of the major reasons for Apple keeping such a large stash of cash.
Your last statement is most alarming, so I will start with it. You are suggesting that Apple should subsidize their products with cash, in other words, to voluntarily cut their margins, maybe even lose money on every product but "make it up in volume." If you ever hope to see AAPL plummet, this scheme is the perfect way to make it happen.
The investment of cash returns very little, especially in the current interest rate environment. Either way, Apple is not a bank. They are not in the business of becoming an investment management company (hardly their core competence). Profits are supposed to be capitalized, used to grow the business they are in. Apple's ROI is so huge now that they cannot possibly reinvest even a tiny fraction of their cash reserves in this way, let alone the billion or more which pours in every month.
As problems go, it's a great one to have, but I do find myself constantly reminding people that Apple is NOT in the business of accumulating cash. It has little value to the company if it is not spent, and none to stockholders if it's not returned in the form of a dividend. (For the record, I'm not a fan of stock buybacks.)
Your last statement is most alarming, so I will start with it. You are suggesting that Apple should subsidize their products with cash, in other words, to voluntarily cut their margins, maybe even lose money on every product but "make it up in volume." If you ever hope to see AAPL plummet, this scheme is the perfect way to make it happen.
The investment of cash returns very little, especially in the current interest rate environment. Either way, Apple is not a bank. They are not in the business of becoming an investment management company (hardly their core competence). Profits are supposed to be capitalized, used to grow the business they are in. Apple's ROI is so huge now that they cannot possibly reinvest even a tiny fraction of their cash reserves in this way, let alone the billion or more which pours in every month.
As problems go, it's a great one to have, but I do find myself constantly reminding people that Apple is NOT in the business of accumulating cash. It has little value to the company if it is not spent, and none to stockholders if it's not returned in the form of a dividend. (For the record, I'm not a fan of stock buybacks.)
Again, I'm in basic agreement. And I'm not suggesting that Apple "subsicize their products with cash", I'm simply saying that it's an option. Not for me to say what Apple chooses to do! I'm just a lowly stockholder.
My whole purpose is to spotlight the growing snowball nature of Apple's cash situation (and indeed of Apple products in general), and to suggest that there will inevitably be a positive effect of that underappreciated phenomenon on Apple's stock price.
Perhaps we are talking right past each other, I'm not sure.
Good assessment. I am fairly sure, at this point.
Again, I'm in basic agreement. And I'm not suggesting that Apple "subsicize their products with cash", I'm simply saying that it's an option. Not for me to say what Apple chooses to do! I'm just a lowly stockholder.
My whole purpose is to spotlight the growing snowball nature of Apple's cash situation (and indeed of Apple products in general), and to suggest that there will inevitably be a positive effect of that underappreciated phenomenon on Apple's stock price.
Essentially that is what you suggested. Using cash to lower the cost of products is a subsidy no matter how you cut it. One of the reasons Apple is so profitable, and we have done well as investors, is their margins. If Apple ever decided to try to use cash to "buy" market share, you as an investor can expect to get hammered. (Essentially this is what Microsoft has been attempting with products such as Zune and Xbox. How's that working out for them?)
Again, investors don't buy a company's cash position. Without a dividend, they see not of cent of it. It's about as relevant as the dark side of the moon. Cash does not improve earnings unless it is reinvested in growth.
Essentially that is what you suggested. Using cash to lower the cost of products is a subsidy no matter how you cut it. One of the reasons Apple is so profitable, and we have done well as investors, is their margins. If Apple ever decided to try to use cash to "buy" market share, you as an investor can expect to get hammered. (Essentially this is what Microsoft has been attempting with products such as Zune and Xbox. How's that working out for them?)
Again, investors don't buy a company's cash position. Without a dividend, they see not of cent of it. It's about as relevant as the dark side of the moon. Cash does not improve earnings unless it is reinvested in growth.
(Sigh) No, I didn't suggest it, essentially or otherwise. I posited it. However, since you seem disinclined to let this go, let me hypothesize a situation where such an action might make good business sense.
At one time my sister and her husband owned a small mailer in the small town she lived in. It was free, paid for by the ads my sister gathered to run in it. A few years in, the main newspaper in town decided to give their ads away for free, thus putting my sister's paper, the only competition for ads in town, out of business. Afterwards, their prices returned to normal.
Needless to say, if my sister had had sufficient reserves, this wouldn't have worked. And such is the case on any scale one might wish to mention. Thus, if one assumes parity is achieved between the products of, say, Microsoft and Apple, and Apple didn't have a sufficient cash reserve, Microsoft could use a similar approach to choke Apple to death, much as my sister's business was.
Now, I admit this is far-fetched, and it is not to be taken as a "suggestion" on my part. It is merely an example of how, in some circumstances, having a good sized bank roll is a good idea.
(Sigh) No, I didn't suggest it, essentially or otherwise. I posited it. However, since you seem disinclined to let this go, let me hypothesize a situation where such an action might make good business sense.
At one time my sister and her husband owned a small mailer in the small town she lived in. It was free, paid for by the ads my sister gathered to run in it. A few years in, the main newspaper in town decided to give their ads away for free, thus putting my sister's paper, the only competition for ads in town, out of business. Afterwards, their prices returned to normal.
Needless to say, if my sister had had sufficient reserves, this wouldn't have worked. And such is the case on any scale one might wish to mention. Thus, if one assumes parity is achieved between the products of, say, Microsoft and Apple, and Apple didn't have a sufficient cash reserve, Microsoft could use a similar approach to choke Apple to death, much as my sister's business was.
Now, I admit this is far-fetched, and it is not to be taken as a "suggestion" on my part. It is merely an example of how, in some circumstances, having a good sized bank roll is a good idea.
We both seem disinclined to let it go, so don't put it all on me. All I am telling you is, that from a stockholder's standpoint, you'd find out in a big hurry how bad an idea it would be if it ever happened. The markets get freaky whenever margins slip by even a few percentage points, since margins are one of the major determinants of earnings, which is what investors really care about. It also needs to be pointed out that for Apple to dip into their cash reserves means that they are unable to pay for something out of current cash flow. Which, with few exceptions, translates into losing money.
Bottom line: Apple doesn't need cash reserves of this magnitude to do anything short of staving off Armageddon, and since they will never have enough for that eventuality...
Bottom line: Apple doesn't need cash reserves of this magnitude to do anything short of staving off Armageddon, and since they will never have enough for that eventuality...
I think it's just a question of degree, but the huge cash pile might come into play at some point if some new technology is discovered that can only be produced in relatively small quantities and Apple could buy up or pre-order with cash, a few years' supply to get ahead of the competition. They did this to a very limited extend with Nand Flash memory a few years back.
Lets say some scroll up screen can be built with some new rare metal... $10bn in cash buys you exclusive rights for 5 years; that's a helluva market head start.
Other than that, from an investor's point of view, $15bn in dividends per year would be nice...