Q1 2014: Apple vs. Wall Street

Last night Apple released its financial results for the holiday period, which is their Q1 of fiscal 2014. If you’re into this sort of news you already know the Street reacted very strongly to the numbers … and not in a good way. The stock tanked after hours, and as I write this morning the stock is down a whopping 7.5% on a day when the overall market (and practically every tech stock) is trading higher. Wall Street hates Apple right now. But is it justified? Were the results really that bad?

I don’t think they were, but having worked as a sell side analyst for more than a decade I understand how the game works. Analysts publish expectations and in the short term stocks trade based around investor sentiment relative to these expectations. I think it’s a total waste of time to try to predict what the market will do on any particular trading day, so I invest with the long term in mind.

So if you’re watching the stock you just need to realize that all stocks react swiftly and violently to whatever is perceived to be “good” or “bad” news in the short term. Also, in the short term, stocks don’t tend to move much based on ideas around the long term vision. Long term vision only matters to Wall Street when the vision is executed and produces a tangible result right now.

But even the short term results that Apple posted aren’t bad. How can you call record setting revenue, shipments and profitability a bad thing? Let’s go through a few quick numbers.

Revenue of $57.6 billion was a new record, coming in 6% higher than last year’s holiday quarter. Gross margin was stable and within the range the company predicted, coming in just shy of 38%. Earnings per share were $14.50, which is also a new record and beat last year’s $13.81per share.

These record setting financials were driven by record-setting iPhone, iPad and Mac shipments. If you want the numbers, Apple sold 51 million iPhones, 26 million iPads and 4.8 million Macs. The average selling price (ASP) of the iPhone in the quarter was up a lot, reaching $637 as a result of a mix shift to the iPhone 5S. Wall Street thought Apple would ship 55 million iPhones, so analysts are deer-in-headlights stuck on this number as if it’s a big disappointment, forget the record breaking actuality.

There are also a couple of fine points worth discussing here. In this most recent quarter Apple started giving away more free software. Because of accounting rules, they’ve had to defer more revenue than ever before. If we want to compare apples to apples we have to adjust for this. When I look at last year’s 10Q filing I see the deferred revenue balance was $7.3 billion, while it climbed to $11.8 billion in the most recent quarter. That’s about a 60% (or $4.5 billion) increase in deferred revenue! Had it not been for this policy change it’s reasonable to assume reported revenue would have been a few billion higher.

Apple actually said revenue would have shown 10% growth (not the 6% reported) if it hadn’t been for this deferral, foreign exchange effects (the US dollar his higher this year) and huge drop in iPod sales (something that we can probably all agree is now done, and we won’t see this kind of impact again).

While many analysts don’t bother, with companies that have a lot of moving parts I like to look at trailing four quarter (T4Q) data. Apple posted 9.1% year over year growth when we look at T4Q numbers. That’s actually a good sign, since last quarter this same data showed a 4.5% contraction in T4Q revenue. In other words, Apple is showing growth again.

That’s probably enough about last quarter. Especially considering that the real reason the stock is tanking today is due to the Q2 guidance. But I had to set the stage by illustrating that Apple is actually pulling in record profits right now.

For the next quarter (Q2), Apple is guiding to only $42-44 billion in revenue, which doesn’t look pretty against the year-ago $43.6 billion revenue performance. It’s too easy for analysts to point to the “Apple isn’t growing” story again and again. The truth is there probably is some small growth in Q2 when you adjust for foreign exchange headwinds and deferred revenue changes, but it’s not exciting revenue.

And that’s sorta the key knock against Apple these days. It isn’t growing at levels that excite people. The growth is slow and boring. It doesn’t inspire strong emotional reactions that spark higher stock prices.

Thankfully we don’t need to care about any of that if we invest for the long term. Analysts are estimating EPS to reach about $43 this year, so even when you totally ignore Apple’s massive cash pile the stock is valued at 12x earnings.

Looking at Apple another way, the company produced over $44 billion in free cash flow last year (defined as cash flow from operations minus capital expenditures). That number is obviously growing right now, albeit not as quickly. The company is worth $458 billion in the public market, which is 10.4 times the cash it generated last year alone.

I may not agree with Carl Icahn’s view of what Apple should do in regards to its capital structure, but I definitely agree with him that the stock is CHEAP.

Ridiculously cheap. Especially for the dominant US smartphone platform where developers make multiples more money than they do from Android customers. Especially for a company that is posting incredible growth in China (iPad 64% YoY and Mac 28% YoY, iPhone just launched on China Mobile with expected big ramp this year).

I think that to sell Apple stock today is to call Tim Cook a liar when he says there are exciting new products coming. It’s to completely ignore the idea that Apple is a a whole lot better at launching game-changing products compared to you or I.

I look forward to whatever Apple brings us this year. I am very curious about game-changing solutions involving iBeacon and Touch ID. I’m intrigued when Tim Cook answers an analyst question about mobile payments saying, “The mobile payments area in general is one that we’ve been intrigued with, and that was one of the thoughts behind Touch ID. But we’re not limiting ourselves just to that.” What’s Apple got in mind beyond mobile payments? Maybe that’s a topic for another day. I

The bottom line is Apple is actually growing by an amount most mature businesses would kill for. It faces interesting growth prospects that I don’t think many of us fully understand. But where the stock price is today we certainly aren’t paying for any of those upside opportunities.

I’m staying long and strong …

(Disclosure: I like Apples. I hold the stock too.)