Wednesday, April 18, 2012

Why buy Apple stock?

That Retired Guy (TRG) doesn't usually invest in single stocks, and he avoids investments that have a lot of hype around them, so AAPL would seem to be the anti-TRG stock.  Even so, a small number of shares were purchased into the TRG portfolio at the end of February.

TRG likes Apple products, but great products don't necessarily mean the stock is a good investment, and TRG is not a 'fan boy' for Apple;  he's never waited outside a store for a product release.

What got TRG's interest was Apples first quarter earnings release on January 24 (Apple's fiscal year runs October 1st to September 30th, so the first quarter was October 1st to December 31st and was released on January 24).   Apple's first quarter earnings for the 2012 fiscal year were unbelievable.  More the 100% over the year earlier period, and more the 70% over the previous quarter.  By all accounts, it was amazing, and the press said so.  Apples stock surged.  It was up about 20% within a few weeks, a big increase, but the fact is that Apple is making a lot of money, and a lot more every day.  After a little analysis, TRG came to the conclusion that as fast as the stock is moving, earnings are still going up a lot FASTER.

The graph below shows EPS vs Apple share price in percent terms for the past 5 years.  Yes, earnings are up 1,410% in 5 years!  Amazing.   The stock price is up (only) 415% in that period.  It can be argued that if investors were predicting this earnings rise, then the stock price would have gone up earlier to reflect the expectation.  TRG finds that explanation a little short simply because nobody thought it possible for Apple (or any company) to make this much money back in 2007, and certainly not in 2008-2009 during the financial crisis.

AAPL Earnings Per Share Chart

The other possible argument is that the first quarter was a one off and the future will see more 'normal' earnings numbers.  There's some truth to this, the first quarter included Christmas, so the quarter results may not be replicated in the second quarter.  Still they did release a new IPad in February, and a new IPhone is expected later this year, so it seems likely that they will do reasonably well.  Most estimates are that Apple will earn $8 to $10 billion in the second quarter...  We will know in a few days (second quarter earnings for apple will be released on April 24).  Just looking at the chart above, you can see that when earnings have taken a step back it's usually not a big step, and within a few quarters new highs persist.  Someday this trend will end, but is that day today?

Steve Jobs is of course gone, and there is naturally some concern that Tim Cook does not have the same genius for innovating new products.  TRG calls this the "Gerry's dead, Fish suck, get a job" argument.  In the short term (next year) it doesn't seem like an issue.  The products in the pipe now are still children of Steve, the real challenge will come a year or two down the road.  There is no way of knowing, but personally, TRG has a feeling that the design team at Apple is still healthy, there have been no big headline departures from Apple's design department, and there does not seem to be any determinable tension with Tim Cook as CEO.  If we get to the end of next year and all we have is marginally updated IPads and IPhones, then it's time to worry, for the moment, Tim Cook deserves the benefit of the doubt.  Roomers about IPhone 5 suggest that it will be a major release, TRG will have a close look at it when it comes out.

Yet another argument is that Apple's earnings come on the back of unusually high profit margins on it's products, and as the competition catches up with Apple, these margins are sure to shrink.  This is true, but at the moment, the competition is pretty far behind.  Ultimately, this is a similar argument that Apple without Jobs can't continue.  Without new products, Apple might start to loose it's shine towards the end of next year.  It's worth watching closely, but at the moment new products seem to be ever on the way, and as always they have been impressive.  Furthermore, the competition still seems miles off.  When the new Apple products stop impressing, and the android phones/tablets start making waves, then TRG is selling the stock.

There has been some recent talk about network providers becoming more stingy about iPhones.  This may be true, but it would be a mistake to overestimate the impact.  On the conference call for Apple earnings, Tim Cook stated that sales of the iPhone 4S were limited because the company could not produce enough of them.  In the past, Apple handles high demand by slowing the roll out to new markets, so this quarter, anything that slows iPhone 4S adoption can probably be rectified by rolling it out to new markets (China got it in January/February).

TRG likes to look at this wikipedia list of larges corporate profits.  Notice that Apple's first quarter profits rank 4th in the quarterly list.  Impressive, especially when you note that every other company in this list is selling 'Oil and Gas'.  But here's the really amazing thing.  On the yearly profits list, Apple is at 17, and that was for the period ending October 26, 2011; so it does not include the $13.1 that was just earned.  If Apple can produce earnings over $10 billion in the next three quarters it stands a very good chance of being at the top of this list at the end of this October.  Keep in mind that this list is inflation adjusted, and includes all public corporations.  It's reasonable to expect that the largest public corporations are more profitable than any state owned or private companies, so it can be reasonably argued that topping this list will make Apple the most profitable company IN THE HISTORY OF COMPANIES...  EVER!

No guarantee it will get there this year, but TRG is rooting for Apple.

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