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JakilaTheHun (99.94)

Is Buying Apple Today Like Buying Microsoft in 1998?

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September 09, 2009 – Comments (23) | RELATED TICKERS: AAPL , MSFT , BBRY

It's rare that I venture into the world of megacap companies.  I'd rather find underpriced small cap companies, particularly ones in volatile industries.  Yet, it occured to me in all my time of being on CAPS, I had never once looked at Apple's (AAPL) financials.  There were reasons for that:

(a) It's a megacap company and large companies typically have less room to grow

(b) It's too heavily followed to create much in the way of huge pricing inefficiencies on the downside; plus, it's been a trendy stock for years, which drives up its price further

(c) I've never felt comfortable analyzing companies with their hands in too many jars

All the same, given AAPL's market dominance over the past few years, you'd think I might have looked into once before just so I'd know what was up with it. 

Well, today was the day!  I glanced at Apple's financials and while I realize I could be missing some growth catalysts in the pipeline or that I could be underestimating Apple's growth in the smartphone market, I'm left with one major takeway:

Apple's stock has INSANE EXPECTATIONS priced in!

To be sure, Apple has a great balance sheet, strong cash flows, and a very bright near-term future, but it would have to have one phenomenal performance over the next decade to justify the current stock price.

The Valuation Dilemma

As a value investor, the first thing I look at when analyzing any company is their balance sheet.  I want to see is the company is in sound financial shape and how much their underlying net assets are truly worth.  In Apple's case, their balance sheet is very sound and their Net Tangible Assets are worth roughly $28.50 per share.  Of course, if you're buying Apple, you're too terribly interested in the assets.  You're interested in the earnings, cash flows, and future growth. 

Apple's earnings and cash flows are spectacular --- but are they $170-per-share-spectacular?!   It's reasonable enough to assume that AAPL earns $6 per share for the current fiscal year.  When you consider all the cash flows they are raking in (tucked away on the cash flow statement as "deferred revenue"), it might not even be a stretch to say they have truly earned over $10 per share this year.  If you assume that $9 - $10 per share is a reasonable approximation of their "real profitability", then you could argue that AAPL is worth somewhere between $150 - $200.

But should that be the end of our analysis?  Should we simply assume that Apple will meet these expectations?   

The Problem with Apple

Of course, given Apple's dominance in the smartphone market, it doesn't seem unreasonable to claim that they will continue bringing in mega cash flows over the next few years.  But the funny thing about stocks - you don't really make much money by buying companies that merely live up to expectations and do nothing more.  

Apple may have earnings upwards of $6 per share and free cash flows upwards of $10 per share for their current fiscal year when all is said and done, but just two  years ago, earnings were around $2.30 per share and free cash flows were around $1.80 per share.  From this, we can tell Apple has experienced phenomenonal growth over the past three years, but how long will it last?

Should we simply assume that Apple continues to grow free cash flows over the next decade?  Will its earnings and cash flows stay flat?  Or will their earnings begin to "normalize"?  

There is a concept in business called "abnormal earnings."  The basic premise is that a company can gain a huge competitive advantage for a limited amount of time and earn these "abnormal earnings", but eventually, the rest of the market will catch up.  

Whether or not Apple's cash flows begin to erode depends upon a number of factors.  Can competitors such as Research In Motion (RIMM), Palm (PALM), Nokia (NOK), and T-Mobile (DT) undermine AAPL's market dominance at some point?  Will the huge margins that the iPhone brings in begin to dwindle sometime over the next few years as smartphones become the norm and the market continues to become more competitive? 

Maybe the most pertinent question is Apple a "fad"?  Apple set itself up as the anti-Microsoft (MSFT) over the past several years, but at this point, it might be safe to say that Apple is the more dominant gorilla.  In fact, Apple's $153 million market cap is closing in on Microsoft's monstrous $220 million market cap!  How can Apple claim to be the little guy when it may very well overtake Microsoft in size at some point in the near future?  Could we see an Apple backlash or Apple fatigue develop sometime soon?

My real point here is that a lot can happen in the next decade and Apple's stock already has very high expectations priced in.  Maybe they meet them.  Maybe they don't.  But what are the odds that they significantly exceed those high expectations?  The odds are low in my estimation.  

Apple in 2009 Is Microsoft in 1998?

Which brings to the question I posed in the title of the article:

Is buying AAPL today like buying MSFT in 1998? 

To be sure, there are distinct differences and AAPL has had a much better record of finding growth catalysts than MSFT, but people thought MSFT was invincible at the end of the '90s, as well.  In September '98, MSFT traded at around $27.  In September '09, it now trades around $24 - $25.  In other words, if you bought into MSFT 11 years ago and held today, you basically had a "lost decade" on your investment.  

It wasn't that MSFT collapsed.  It wasn't that MSFT's dominance was dramatically weakened.  It was priced with very high expectations in 1998 and one can say that it has done little more than meet them.  While the stock did have moments where it traded upwards of $30, as a long-term investment, it has been a dud.

Apple is a great company.  They will probably continue to rake in cash flows from the iPhone and maybe even gain more market share.  But it's going to be very difficult for them to grow their earnings and cash flows much more over the next 10 years. I wouldn't completely rule out that buying AAPL at over $170 per share will yield one very little return over the next decade.

 

 

23 Comments – Post Your Own

#1) On September 09, 2009 at 9:01 PM, awallejr (82.73) wrote:

MSFT eventually turned into a mature company.  It is arguable that AAPL might be attaining that status as well now. Good analysis, + rec.

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#2) On September 09, 2009 at 9:26 PM, starbucks4ever (98.97) wrote:

Very true. I would say that the most likely a annual return for Apple shareholders over the next 17 years is 4%.

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#3) On September 09, 2009 at 9:43 PM, afreakout (93.69) wrote:

You guys ever used/owned an iPhone?  Apple can double in size from here within 10 years, no sweat.  Not everythign you need to know is on the balance sheet.  The iPhone is head of class in an emerging market.  The phone has only a tiny share of the phone market at this point despite being a vastly superior product.  I'm looking upward here.  Sometimes...you get what you pay for.  This is a much different beast than 98' MSFT.  I owned 98' MSFT as an allowance hording 13 year old.  Don't own AAPl now though..:D.  But if I had owned an Iphone when the market crashed I sure would have bought up a bunch of AAPL at it's lows! 

 

I own an iPhone now and have referred to it in various vulgar ways, but one I can post here is that it's a "gift from God".  Count me as a beleiver in Apple's 29 P/E ratio.   I think one day most people will own an iPhone or an iPhone-inspired device. 

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#4) On September 09, 2009 at 9:57 PM, JakilaTheHun (99.94) wrote:

I think one day most people will own an iPhone or an iPhone-inspired device. 

The bolded portion highlights the potential problem.  

Isn't everyone trying to copy the iPhone at this point?  Both Palm and T-Mobile already have copycat devices.  I'm sure more are on the way.  

I'm not saying you're wrong.  I am saying that it's very rare for a company to earn "abnormal profits" for over a decade, unless they have a monopoly or effective monopoly via a patent (e.g. pharmaceutical companies).  

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#5) On September 09, 2009 at 10:08 PM, JakilaTheHun (99.94) wrote:

I can't edit the blog, but for the record:

Disclosure:  I hold no position in any of the companies mentioned in this article.  

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#6) On September 09, 2009 at 10:34 PM, TMFBabo (100.00) wrote:

In a word, "yes."

AAPL is a fantastic company, but a company worth $153B is not going to grow indefinitely at 25% to 30%, especially if it has to rely on a pipeline of cool products that keeps producing more money than before.  All it takes for the stock to flatline or fall is for AAPL to grow "only" 20%.

I remember telling someone a while back that if you did like AAPL the stock, the time to buy was when it was under $100.  At this point, it's just not an attractive buy.  There is no built in margin of safety with all of this expectation priced in already as you've said.

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#7) On September 09, 2009 at 11:15 PM, guiron (< 20) wrote:

I think one day most people will own an iPhone or an iPhone-inspired device. 

The touch interface is very difficult for typing. I have a BB Curve which I use for work, and I don't really want one of their new touch interfaces. I don't like to type long emails on any PDA, but at least with the Curve I can do that pretty accurately, which has never been my experience without a real keyboard. AT&T has no wireless presence here, and the choice of other carriers is limited, so I'm not getting an iPhone anytime soon anyway, but I don't really want one.

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#8) On September 09, 2009 at 11:17 PM, Mark910 (< 20) wrote:

what an assenine statement...two years later MSFT was 60$...are you saying aapl will more than double in 2 years?.. or are you looking at a stock at end of a economic downturn and saying thats applies to all equities , all time periods.  with all due respect(high score) I am throwing the BS flag on this one.

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#9) On September 09, 2009 at 11:19 PM, guiron (< 20) wrote:

And, yeah, Apple is not a good buy now. I'm not one to fight the tape for too long, and I am a bear but making money in this rally anyway, but I don't want to touch AAPL unless it drops below $100 again and the situation and outlook for the company are as good as they are now.

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#10) On September 09, 2009 at 11:26 PM, JakilaTheHun (99.94) wrote:

two years later MSFT was 60$

Right and one year after that MSFT traded under $22.  It's called a bubble and it popped.  

And yes ... AAPL *could* go up to $300 at some point.  It could also fall back down to $100.  The point is that you don't know and I wouldn't exactly count on a major stock market bubble along the lines of the one that formed in 1999 and 2000 coming in any time soon.  You're much better off sticking to analyzing the fundamentals.  

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#11) On September 10, 2009 at 1:33 AM, portefeuille (99.44) wrote:

Can competitors such as Research In Motion (RIMM), Palm (PALM), Nokia (NOK), and T-Mobile (DT) undermine AAPL's market dominance at some point?

How does Deutsche Telekom fit in there.

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#12) On September 10, 2009 at 1:46 AM, JakilaTheHun (99.94) wrote:

Port, 

T-Mobile MyTouch

T-Mobile unveils myTouch 3G

I'm not sure about the specifics in regards to whether/how much revenues T-Mobile's smartphones generate for DT.  I am under the assumption that, unlike AT&T, Sprint, and Verizon, they actually record revenues from smartphone sales.  I could be wrong on that, though.  

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#13) On September 10, 2009 at 1:47 AM, JakilaTheHun (99.94) wrote:

unlike AT&T, Sprint, and Verizon, they actually record revenues from smartphone sales.

Or that is to say, they are actually in the "smartphone business" so to speak, whereas the other carriers merely use smartphones from outside companies in order to boost their own business.  Like I said, I might be off on that.  Just the impression I get from T-Mobile's advertising here in the states. 

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#14) On September 10, 2009 at 11:55 AM, Mark910 (< 20) wrote:

Jakila, thank you for your civil response to my comment written past my bedtime.  However, your response is making my point in that you can pick to finite points on graph to say anything.  http://finance.yahoo.com/echarts?s=MSFT#chart2:symbol=msft;range=my;compare=^gspc+aapl;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

Maybe MSFT has leveled off for reasons you explain(yes minus the bubble), just trying to figure out what is so bad about a company up 30K% that has followed the rest of market into a lost decade.

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#15) On September 10, 2009 at 12:05 PM, Mark910 (< 20) wrote:

Jakila, thank you for your civil response to my comment written past my bedtime.  However, your response is making my point in that you can pick to finite points on graph to say anything.  http://finance.yahoo.com/echarts?s=MSFT#chart2:symbol=msft;range=my;compare=^gspc+aapl;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

Maybe MSFT has leveled off for reasons you explain(yes minus the bubble), just trying to figure out what is so bad about a company up 30K% that has followed the rest of market into a lost decade.

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#16) On September 10, 2009 at 12:06 PM, Mark910 (< 20) wrote:

My computer just went to never/never land...sorry for the double post

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#17) On September 10, 2009 at 4:57 PM, anticitrade (99.66) wrote:

Jakila,

I looked into AAPL about 6 months ago and felt the same way.  It is amazing to me that the marketing power of Apple have allowed them to charge a premium for their MP3 players as well as their stock.  At one point I considered simply offseting the premium that people pay for stocks like Apple and Google out of my analysis.  However, ONE day it won't be cool to say "I own stock in Apple" and the premium will start drying up. 

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#18) On September 10, 2009 at 7:39 PM, Tastylunch (29.53) wrote:

Jakila I agree

It seesm to me if nothing else if AAPL wants to keep their shares appreciating they need to start paying a meaningful dividend

Otherwise when their growth rates inevitably slows the growth mutual funds will drop them and the value funds will still leave them alone. This is more or less what happened to Microsoft.

It's a tough transition to go from a growth stock to an income blue chip.

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#19) On September 11, 2009 at 12:06 PM, bigpeach (31.57) wrote:

Finally, someone wants to talk about something other than macro economics or market direction.

I don't entirely disagree with you. I have no plans to add to my AAPL position at this price, however I most certainly would not consider this a sell. The analysis here I believe is missing a few points.

Apple has about $35 per share in cash, making the operations $135 per share. Operating cash flow (I no longer consider GAAP earnings meaningful due to subscription accounting) exceed $11 per share for the trailing 12 months. Does that really sound like it's priced for high expectations? To me that seems like fairly modest growth (or even no growth) expectations.

Apple has far more room for growth than Microsoft did in 1998. Microsoft was nearing a monopoly in its two core products, Windows and its Office suite. Not so with Apple. Apple's profits are currently driven by Macs and iPhones. The iPod (where they have little room for growth) no longer makes a large contribution to the bottom line. Macs represent approximately 10% of the US PC market. iPhones are something like 20%, but I forget the precise figure. Quite a lot of room for growth just in the US.  Additionally, Apple is not much of a global company. Nearly all of its sales come in the US, leaving huge growth opportunities internationally. The current effort to begin distribution of the iPhone in China could provide insight into how much growth potential Apple really has.

Apple has one of the widest moats around. The company is consistently able to maintain premium pricing, and no competitor has shown any sign of being able to crack their armor. Will this last forever? No, certainly not, but there's a reason savvy investors buy wide moat firms. Apple's operating margins year to date are higher than the previous year. Doesn't sound like the company is losing it's pricing advantages just yet.

So is Apple a buy? You decide. My feeling is that even at $170 it will continue to generate outsized (but probably not spectacular) returns.

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#20) On September 11, 2009 at 12:18 PM, sangerso (43.39) wrote:

People who bought microsoft lost a decade of investment?? Every share that was bought in the beginning of 98 is worth eight shares today...

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#21) On September 11, 2009 at 12:27 PM, JakilaTheHun (99.94) wrote:

bigpeach, great counter-argument.

Sangerso, I'm using split-adjusted figures from Yahoo.  

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#22) On September 12, 2009 at 10:13 AM, Roto1177 (79.07) wrote:

Jakila- Great write up- I have AAPL as a cost of $100 and change- did ok and was wondering if it was time to get out or stay in. Great debate among you all- lot of food for thought. Here is something that I think might also be interesting (along the lines of bigpeach)- I have only owned a PC, never a MAC. I will be buying a MAC next- I wonder how many people are going to switch (they only have 10% of the personal computers here in the US). I wonder if that can grow? Also I think more people will be buying more I-phones soon- just my opinion. Holding till $225!! :)

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#23) On September 12, 2009 at 11:32 AM, bigcat1969 (93.38) wrote:

Steve Jobs is a bit of a wild card.  I don't believe he will still be around in a decade and when he either retires or passes away, Apple's stock will do a short term crater.  I don't really know what he means to the company as a manager, but he is held in very high regard as a public figurehead if nothing else.

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