Apple: The Valuation Debate

 What is the correct p/e for Apple stock?

Recently, some investors have suggested that Apple ($AAPL) is so stable that it deserves a p/e ratio closer to a consumer products company like Clorox.

A p/e of 24 would propel Apple shares significantly higher. However, the reality of the comparison leaves much to be desired.

Historical perspective of past iconic tech companies like Xerox and Atari shows the risk to tech investors.

 

 

 

“The four most dangerous words in investing are: ‘this time it’s different.'” – Sir John Templeton

 

 

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Apple Stock:  The billion dollar question

If investors treated Apple the same as the rest of the market, the shares would be a lot higher.

In fact, if you applied the same P/E ratio to Apple as the rest of the stock market, the technology juggernaut’s shares would be 19 percent higher, according to calculations by Bespoke Investment Group.

Applying the same multiple as rest of the S&P’s tech sector gives Apple an estimated value more than 30 percent higher than where it is right now.

 

AAPL data by YCharts

The valuation question was recently put to Apple CEO Tim Cook in an interview.

Jim Cramer: Question to Tim Cook (AAPL)

Let’s think about that notion of the consumer and what you care about. Lets say

• a consumer product company had 5 percent organic growth
• 10 percent earnings per share,
• beat by $0.08, and at the same time
• had price increases when all consumer products companies are struggling with price decreases.
• I believe that you would sell at 24 times earnings,
• the same price-to-earnings multiple of Clorox (NYSE:CLX), which is a bleach company.

Q: Jim Cramer;

Do you find it somewhat ironic that the most basic commodity has a much higher price-to-earnings multiple than the greatest consumer product of all time?

 

“You know, for us, we look at that and we say, you know, we can invest in our company and invest in our stock and we do believe it’s undervalued.  -Tim Cook, Apple

“And so we’re buying it back, and so from that point of view there’s an opportunity in that as well.”

 

 

 

Personally, I believe that Mr. Cramer was trying to curry favor with Tim Cook as a way to thank him for an “exclusive” interview. I believe that seasoned investors find the comparison between a stable consumer products company and a tech company to be absurd. 

There is large difference between a defensive consumer products company like Clorox and a tech based- consumer product company like Apple.

I see Apple as more akin to a technology company than a consumer product company.

But, it is a distinction that can be debated. 

Below we see the large gap between the valuations of these two companies.

 

CLX PE Ratio (Annual) data by YCharts

Risk:  Of course, there is risk involved with companies like Samsung and Apple, which is why the valuation that investors give the shares is lower.

Product Risk:

Apple produces incredible products. There is no debate.

Technology products are incredibly complicated and present risks to investors. The most recent example being the Samsung Note fire hazard and recall.

It is unrealistic to operate under the impression that Apple is immune from the risks of producing complicated technology products.

An overview of the supply partners Apple uses to make it’s products:

The company’s top-200 list of supply partners includes 753 listed office and manufacturing facility locations worldwide. As you’d likely guess, the majority of those addresses are in China, Japan, and the United States. But other nations, large and small, appear. The full list of of countries involves every continent except Australia and Antarctica, including:

• Austria, Belgium, Brazil, China, Czech Republic, France, Germany, India, Indonesia, Ireland Israel Italy Japan Malaysia Malta Mexico, Morocco Netherlands Norway Philippines Singapore South Korea Taiwan Thailand United Kingdom United States and Vietnam (via Consumerist)

Stability:

Clorox:

Boring and simple products: Clorox is made from chlorine and sodium hydroxide.

Selling essentially the same product for over 100 years.

The product and the company date back to May 3, 1913, when five entrepreneurs, invested $100 each to set up the first commercial-scale liquid bleach factory in the United States.

As we see, the operating income line (in purple) is so stable. This is very attractive for investors.

CLX PE Ratio (NYSE:TTM) data by YCharts

(CLX)

I am not saying either company is a better investment.

Consumer products companies have much less risk. I can’t think of one example that got into financial distress or became insolvent. It never happens. So, the valuation is viewed completely differently.

• P/E Expansion:
• The question of whether Apple deserves a higher p/e presumes that the shares will retain their current higher p/e ~17/18. This seems to be a more serious question for investors.
• Gains from passive investing:
• Apple benefits from inflows by passive investors into the S&P 500. However, should these trends slow or reverse, Apple could be at risk.
• S&P 500 gains due largely to the likes of Apple and Facebook

AAPL PE Ratio (TTM) data by YCharts

Other issues:

• Adoption of new iPhone models
• Strong upgrade cycle of new phones
• Slipping iPad sales
• Airpod Adoption

 

 

“Business success contains the seeds of its own destruction,” “Success breeds complacency. Complacency breeds failure.Only the paranoid survive.”-Andy Grove

 

Iconic Tech Companies:

Investors have long memories. Especially for losses.

It is unthinkable to imagine a future without Apple being a dominant company. However, it is also extremely unthinkable that iconic tech companies of the past like Xerox, Blackberry, America Online, and Atari could wind up bankrupt or irrelevant.

Xerox:

On it’s best day, Apple may never achieve the dominance and financial strength of Xerox in the 1960’s.

Their revolutionary copy machine was introduced in 1959 and was one of the most dominant and profitable inventions of all time. By the time the 914 copier was retired in 1973, it was the biggest-selling industrial product of all time, and Xerox was in the dictionary as a synonym for photocopy.

 

Some may not see Xerox as a tech company. However, Xerox invented the computer mouse as as well as many other breakthroughs and helped create silicon valley.

How Steve Jobs Invented The Computer Mouse By Stealing It From Xerox

According to Gladwell, when Steve Jobs visited Xerox’s Palo Alto Research Center in the late 1970’s, he was amazed by what he saw: a demonstration of a new three-button computer mouse.

Atari:

My personal view is that Atari is the coolest tech company of all time.

You might not understand how this could be true. Steve Jobs and Steve Wozniak were dying to work there, so that should say something. As an investor, knowing that Atari went bankrupt illustrates the risk of investing in tech companies.

I’d known Steve Jobs for a long time. And I had seen Pong in a bowling alley and I had to have one. And pop in my head: I know how televisions work and I know how to design anything so I built my own Pong. And Steve came back from Oregon at the time, where he had been going to school, and I gave him my board. He wanted to run down and apply for a job at Atari. –Steve Wozniak

• 

“Atari started it all.

Atari is what brought video games into the mainstream,” says Sean Kelly, director of the Videogame History Museum.

Space Invaders became the most popular arcade game in the United States, and the most popular Atari game cartridge. Atari followed up with other blockbuster cartridges like Defender, Missile Command, and Asteroids; by 1980 it commanded a 75% share of the burgeoning home video game market. Thanks in large part to soaring sales of the VCS system, Atari’s annual sales grew from $75 million in 1977 to more than $2 billion in 1980, making Atari the fastest growing company in U.S. history. But it wouldn’t stay that way for long.

Atari is one of the most important names in video game history and the news of its recent bankruptcy marked a sad day for the industry.

 

Blackberry:

BlackBerry’s share of the global smartphone market is now officially 0%‘

In the fourth quarter of 2016, more than 432 million smartphones were sold, according to a report published on Wednesday by the research firm Gartner. Of those, just 207,900 were BlackBerry devices running its own operating system.

It is incredible that Blackberry could have become so irrelevant when it used to be so dominant.

Again, the risk of competition is intense in the technology sector.

 

• 

 

BBRY data by YCharts

Of course, there is no better example of a great tech company going bankrupt than Apple itself.

Apple was on the verge of bankruptcy in 1997 and needed to be bailed out by Bill Gates and Microsoft (MSFT). Smart investors remember that this bailout was the result of luck as Microsoft needed to prove to the Justice Department that it wasn’t a monopoly.

 

It would seem ridiculous in 1984 to imagine Apple being close to bankruptcy.

But that’s exactly what happened.

Apple Computer:

• 

Apple Computer on the verge of bankruptcy:

At the time, Apple was hat-in-hand. It had sustained losses of more than $1.5 billion in the prior year-and-a-half. It especially needed a public guarantee from Microsoft that it would keep providing and supporting software for Macs; Apple’s share of the then-booming PC market had dwindled to about 5 percent from about 15 percent in 1992. (bloomberg)

1997: Microsoft rescues one-time and future nemesis Apple with a $150 million investment that breathes new life into a struggling Silicon Alley icon.

“The unexpected revelation … prompted gasps of disbelief and loud boos from the audience of thousands of Mac users and software developers.”

In a remarkable feat of negotiating legerdemain, Apple co-founder Steve Jobs got needed cash — in return for non-voting shares — and an assurance that Microsoft would support Office for the Mac for five years.

 

Conclusion:

Tech companies offer a different risk/reward profile than consumer products companies.

If iconic tech companies like Xerox, Atari, and Blackberry can become irrelevant or bankrupt, then any tech company could be vulnerable. Apple investors should be aware of the recent p/e expansion and be cautious of idle speculation that, “This time it’s different.” The names in tech may change, but the risk to investors is the same.

 

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