The Poor Investor – Investigatory Value Investing

"Faber est suae quisque fortunae" -Appius Claudius Caecus

Apple’s Stock and the Voting Machine

Peter Lynch put it quite simply by saying, “Buy what you know.”  Now, I’d be remiss if I didn’t mention that there was a study showing this often does not work.  Here, however, it does.

The other day I walked into an Apple store to check out the iPad mini.  It was like walking into a swarm of bees in a beehive.  People were everywhere.  Everyone I know loves Apple’s products and owns at least 1 apple device.  Those I know who don’t own an Apple device plan on buying one in the near future.  I’ve used other products, talked to others who use other products, and everyone admits these devices aren’t as good as Apple devices, this includes: phones, computers, MP3 players, portable tablets, etc.  Apple products are vastly superior in every category, there’s really no debate.  The only reason you wouldn’t buy an Apple product is because you were interested in saving money, with plans to purchase one in the future when the price goes down.

As for the current state of Apple’s stock, Peter Lynch has something else to say about that:

“When even the analysts are bored, it’s time to start buying.”

There’s no question that analysts are bored with Apple, but, really, who cares?  Apple’s stock is a no-brainer at $431.72 as I type right now, March 10, 2013.  The company has $137b in cash.  With that amount of cash Apple could buy Ford and Honda and almost have enough money left over to buy Tata Motors at the companies’ current market valuations.  This is an insane amount of cash for one company.  If Apple has any problem, it’s having too much cash, not the worst problem a company could have.  Personally, I think Apple should follow in the footsteps of IBM and buy a massive amount of its own shares.  Its current share buyback program only allots $10b for this endeavor.  With $137b in cash, that is chump change.

Apple, according to a recent press release, plans on returning a lot of that cash to its shareholders:

“Apple’s management team and Board of Directors have been in active discussions about returning additional cash to shareholders. As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock. We welcome Greenlight’s views and the views of all of our shareholders.”

Cash considerations aside, Apple trades at a current P/E of 9.79.  This is well below the 5-yr. average P/E of 15.6.  Furthermore, Apple’s P/E has never been so far removed from the S&P 500’s P/E as it is now, trading at ~40% below the S&P 500’s (~43% below the Nasdaq’s), with Apple’s average P/E being 64% above the S&P 500’s since 2003.

If the P/E is any indication of investors’ expectation, they don’t seem to believe that Apple will grow much faster than ~10% per year.  However, over the last 5 years Apple has increased earnings by an average of 63% per year.  If Apple continues growing at even half that rate, you’d be looking at EPS of ~$174 by 2017.  This would equate to a share price of $1703.46 at the current P/E.  Now, I must reiterate, this is the half-growth scenario.  Staying at the average current growth rate would mean a share price of $4973.32.  Now, my hypothesis is that we land somewhere towards the lower end near $1703, taking into consideration that the market discounts the future and that the company is not going to realistically grow into being 20% of our economy— but this would still amount to almost a 4-fold gain in under 4 years.  Furthermore, either way growth pans out, you’re looking at what could be over a trillion dollar company sometime in the 2014-2015 range.

With growth and P/E considerations in mind, read these quotes by famous P/E investor John Neff:

“Low p/e multiples usually languished 40 percent to 60 percent below prevailing market multiples.”

“Low p/e companies growing faster than 7 percent a year tipped us off to underappreciated signs of life, particularly accompanied by an attention getting dividend yield.”

As shown earlier, the p/e multiple does languish more than 40% below prevailing market multiples.  Also, Apple is growing much faster than 7 percent with a pretty astonishing dividend, for what I still deem a “growth company,” of 2.46%.

Peter Lynch would love this stock, especially when looking at the P/E in terms of the growth.  While Yahoo gives a PEG of 0.5, Peter Lynch looks at it a slightly different way.  He takes the long-term growth rate, which I estimate on the low side to be 30% (Yahoo’s estimate is 20%), adds the dividend yield, 2.46%, and divides by the P/E ratio, 9.79.  This gives 3.3 for my estimate vs. 2.3 for Yahoo’s.  In One Up on Wall Street Lynch describes the interpretation of these values as the following:

 “Less than a 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better.”

He goes on to give an example of a stock that scores a “3” and deems it “fabulous.”  If we say that the number will most likely fall somewhere between these two estimates, 2.3-3.3, we’re looking at a stock Peter Lynch would undoubtedly rate as a “strong buy.”

Now, there are concerns that Apple’s moat may be drying up as companies like Google continue to steal market share.  However, in this analysis a margin of safety was added by considering Apple’s stock in light of growth drying up 50%, which isn’t likely to happen.  You have the new Macbook Air coming out, iPad 5, iPad mini 2, iPhone 5s, iMac, Mac mini, just to name a few.  And according to CEO Tim Cook, new products in new categories are on the horizon.  Some anticipate the iWatch as one.  The bottom line: it doesn’t matter what is on the horizon.  Apple could make a car and people would buy it just because it is an Apple product.  Even if Apple didn’t come out with any new products, looking at the company from a zero growth perspective, seen here (provided by Old School Value) for those interested in more advanced valuation methods, Apple’s stock has significant downside protection.

As was said by many great value investors, “Protect the downside and the upside will take care of itself.”

Let’s forget the growth concern altogether. A huge aspect not talked about very often is the strong IP position Apple has, illuminated below, from this article:

“…Apple is falling back on its IP portfolio to protect its market position. Generating revenue by suing other companies is not the ultimate goal of Apple’s recent lawsuits. Rather, each case that Apple wins confirms the validity and enforceability of its patents to its competitors. Apple can then license its patented technologies and designs and charge Google and other competitors for using them, piggybacking on their competitors’ success.

It would appear that Apple’s business model is evolving into two modes. First, use a closed model to develop innovative technologies for sophisticated user markets; patent the utilities and designs that the company engineers. Second, license those utilities and designs to businesses that wish to use them. So long as Apple continues to be the first of its competitors to patent new technologies, combining both modes would create serious revenue for Apple and help it maintain its leadership position.”

So… to reiterate the absolute absurdness of this price and to lighten things up a bit, watch this video of Bill Maher and his guests talking about Apple:

And although this video is older, I still find it extremely relevant to this post:

As Ben Graham famously said, “In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.”  Long-term shareholders that buy Apple at this price can take advantage of this phenomenon.

Disclosure: Long AAPL

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2 responses to “Apple’s Stock and the Voting Machine

  1. arizona.edu July 5, 2013 at 5:58 pm

    Very good write-up. I definitely love this site.
    Stick with it!

    • The Poor Investor November 21, 2013 at 10:58 am

      Thanks!

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