Effortless Computing by Apple

Image: Apple

Apple is the best loved technology company today, with its array of sleek design, and cool user interfaces. Its users are rabid defenders of the company, and are in fact their best advertising, while developers can't stop building app after endless app to try to ride the wave. The other tech companies seem to be playing an losing game of catchup, and appear to be at least 1 generation behind every time Apple launches something new. 

Its revenues are growing faster than its cost base, and growth investors might find Apple actually cheap, but from a value investing point of view, Apple certainly does not have enough safety margin to embark on a new investment now. Read more below.

Disclosure: I currently have no holdings in APPL, though I do own its competitors such as MSFT, which APPL has played no small part in making them into value-plays by reducing them to what seems like yesterday's technologies. I also am writing this on an iMac.  

Apple (NASD: AAPL)

11Jun11

P=325.9

APPL’s FY10 ends 30Sep10.

In a way, this review on AAPL is grossly overdue. Among the most talked about IT company and best reputed, AAPL’s share price has gone astronomic, and might be deservingly so, given its high ROE, market dominance in its new product lines and rabid fan base. And in terms of relative valuation metrics, AAPL isn’t exactly way overpriced, with PERs ranging less than 15x. However, AAPL faces key-man risk, with Jobs ill and hence might have to retire, and with already multiple generations of its products (Iphone 4, Ipad 2, Ipod many), it is hard to see what the next big thing is going to be. Its execution on its current products have been good, and its reputational asset is valuable, where everyone wants one, even though technically it might not be the best product. It also has built a strong ecosystem to support itself, with its app store and itunes, with icloud probably enhancing and entrenching its user experience. Some of its minor projects have not taken off, like mobileme or apple tv, but APPL at least isn’t pouring more money into a bottomless pit and forcing the issue, unlike companies like MSFT who has been losing money on its internet business with no end in sight.

Anyway, a review on AAPL is necessary, even if only to benchmark against my other investments in IT, such as MSFT and peripheral businesses like BBY. AAPL pays no dividend, given its ROE is significantly higher. In a way, the reason why I have put off reviewing AAPL is because of the gambler’s fallacy, which is a behavourial bias that what has already done well for so long is only overdue for a fall, which is a misinterpretation of the regression to the mean. The way to overcome such a bias is a fact based objective evaluation about the investment case, putting aside prejudices and other heuristics that can cloud objectivity. The question remains, is it overpriced? And I mean on a trailing basis with assumptions of decreased growth going ahead (not increased, but decreased).

What better place to start than watch the latest keynote video from Apple’s developer’s conference where they introduced iCloud. What comes to mind as I watch Jobs introduce it is, effortless computing. They have decided to make thumbdrives redundant, or for that matter, filetransfer completely effortless and seamless. And what Jobs has introduced is only scratching the surface of what is possible. Monetisation is only a matter of time. With each upgrade cycle, they are charging. With each cycle, they are gaining market share and getting more people to buy their hardware.

So, we love the story. Let’s see how the financials pan out.

EPS_10=15.15

PER_10=21.5x

BVPS_10=51.68

PB_10=6.3x

BVPS_2q11=65.68

PB_2q11=5x

EPS_1H11=12.83

APPL’s strongest quarter is 1Q which coincides with the Oct-Dec quarter of the calendar year, or Christmas season. If we consider 1h=2h, EPS_11f=12.83*2=25.66. PER_11f=12.7x, which is not expensive for a growth company.

FCFF indicates that APPL is priced to have an LTEG of 6.5%, which indicates it is overpriced. At 0% LTEG, APPL’s FV=155.16 or about half its current price. 

The Greenblatt ratios indicate that ROCE=34%, which is high, but the earnings yield is low, EY=6.15% using 2010 data.

Conclusion: APPL is priced too richly for me. While the growth prospects are great, and APPL has built up a strong ecosystem of products surrounding its innovative hardware, APPL is certainly not a value proposition.