Here we go again. Another Apple quarter that demonstrates long term strength in its business, and another quarter where Wall Street is waving its hands in the air claiming that the business is broken. Apple shares are down over $50 (10%) as I write this.
Always remember value investor Benjamin Graham’s famous expression: In the short term the market acts like a voting machine. In the long term it acts like a weighing machine. Today, the voting machine dominates. But over the course of many product cycles, those daily votes amount to nothing. That’s why the market is volatile, and why I focus on long term investing.
Apple reported the best quarter in its history. Sales of $54.5 billion were up huge compared to $46.3 billion in the year ago holiday quarter. Earnings were $13.81 per share versus $13.87 last year. But once you adjust for the 13-week quarter in the current year versus 14 weeks last year, earnings actually grew 7% year over year.
That 7% growth comes despite gross margin dropping, which is a fact of life when you introduce revolutionary products like the iPad mini. The growth also comes despite the fact that Apple built less channel inventory this year versus last year. Add another $700 million to Apple’s top line this year (or subtract it from last year) to get a more fair comparison.
Oh, and let’s not forget the new iMacs, which were severely supply constrained. Apple sold about a million fewer Macs than last year, which equites to over a billion dollars of revenue. Let’s add that to our adjustment of Apple’s so-called “broken” business.
Wall Street is worried about earnings growth. They see the revenue growth, but they focus on the gross margin decline of 6% year over year. Wall Street focuses on the short term “optics” of a situation. And in the short term, Apple looks weak because margin weakness seems to be offsetting the revenue growth.
But look at the bigger picture. The iPad and the iPad mini are canabalizing the PC market. This includes Macs, but it also includes Windows machines. This is the quote that I found most interesting out of last night’s conference call:
”I see cannibalization as a huge opportunity for us...On iPad in particular, we have the mother of all opportunities here, because the Windows market is much, much larger than the Mac market is. And I think it is clear that it’s already cannibalizing some and I think there is a tremendous amount more opportunity there. And as you know, I have said for two or three, actually three years now I believe that I believe the tablet market will be larger than the PC market at some point. And I still believe that. And you can see by the growth in tablets and the pressure on PCs that those lines are beginning to converge.”
And let’s not forget China. Is it totally lost on investors that China has become such a huge market for Apple that they need to break it out as a separate reporting segment? $6.8 billion of Apple’s revenue (that’s 12.5%) came from Greater China. Year over year growth was only a modest 67%. Hmmm, sure seems like a broken story to me.
Speaking of China - there has been a lot of attention on the possibility of a less expensive iPhone. Until last night, I was of the view that we’d see one of these lower cost phones hit sooner rather than later. But I’m not so sure anymore. Obviously Apple can sell a TON of iPhones in China at full price. So there is no need to rush out with a cheaper product. Apple’s style is to absorb as much growth as they can with higher priced products before launching lower cost versions. I don’t think we’ll see a less expensive iPhone in 2013.
The media and the investing community is fully absorbed in the bear story around Apple. That story is probably best told by the Nomura analyst. I don’t mean this in a good way, because I honestly feel the guy is insane to put forth this analysis, but it is what it is. And the market believes it right now.
Nomura’s position is that Apple isn’t growing any more. They’re an “ex-growth” story with earnings potential “capped” at about $50 per share. Without growth, people shouldn’t pay more than about 8x earnings (so $400) plus the company’s excess cash balance, which is another $89 per share. Round it up to $490 and you have their target price.
Why 8x earnings? Apparently because that’s what Microsoft fetches. And Microsoft is also an “ex-growth” stock.
Does anyone else notice the total insanity in this statement? We have the Mac market that has been outgrowing the PC market for a very, very long time. And now we have the iPad market cannibalizing the PC market, which allows Apple to grow at the expense of Microsoft. One company is slaughtering the other. Yet we are to believe both stocks should trade at a similar earnings multiple?
As Rene said to me earlier today, “It makes you think it's humans that are doomed.” Of course humans are emotional. Investors and analysts are human. Wall Street is all about the short term. Nobody wants to get caught being wrong on a stock in the short term. The pain of being short term wrong outweighs the pleasure of being long term right. That’s why we’re seeing so many negative reports.
I thought the comments from PiperJaffray and JP Morgan were much more rational. Piper calls for investors to return to the stock once the focus shifts to new products in the next 3-6 months. Makes sense. JP Morgan uses the beautiful line, “Apples and Oranges: Fundamentals and Investor Expectations Continue to Diverge”.
I couldn’t have said it better.
Chris owns shares in, and is long on, Apple.