Was I right about Apple?

Three months ago after Apple’s last earnings report, the insanely negative market reaction forced me to voice my opinion in a post here. The market reaction was clearly unjust and I tried to show why. Yesterday, Apple released their first quarterly earnings in the new format. No more ASP (Average Sale Price) or iPhone unit sale numbers. But before we get into the what the earnings looked like, let me just say that the stock was up almost 7% today based on this latest report.

Usually, stocks jump higher when earnings beat expectations and the forward moving guidance is strong. However, Apple reported revenue drop year over year of about 5%. How then is the stock of a company that is shrinking in revenues (which it hasn’t done for a long time) rewarded by an increase in valuation. Most so called financial experts will tell you that this is because expectations were so bad that somewhat decent news of the 10% growth in services revenue, 62% gross margin in the services business and the 1.4 billion installed base of the iPhone is what is being received positively by investors. Suddenly everyone is focusing on the positives in the services business because the same saturation (read as penetration) that Apple has in the world is now a good thing because all those people are prospective or actual customers of Apple’s services business. What a wonderful growth opportunity. Suddenly, the decline in the iPhone sales is not that much of a problem because this opportunity has surfaced. Only if someone saw this strategic shift 3 months ago.. Yeah, I did. Were investors delusional to the fact that one day the world will be saturated with iPhones? Did they think every individual in the world someday will have an iPhone in their hand before iPhone unit sales will shrink? Let us crunch some numbers to see where Apple stands compared to the rest of the market.

This time last year, Apple had reported an installed base of 1.3 billion (I am using last year’s number because this was known when people dumped the stock 3 months ago because they were mad at Apple for not releasing iPhone unit sales numbers going forward). Let that sink in a little. Every 5th person in the world has an iPhone. Now lets take out the kids who are too young to have a phone of their own and the baby boomers who think they are smart enough themselves to need a ‘SMART’ phone. Now you’ve got about 25% of the world’s population with iPhones. Think about the reach that this gives Apple. This matter is subjective but still worth a thought.

I promised numbers so lets get to it. After today’s spike, Apple has a P/E ratio of 13.85. This means that its stock is priced approximately 14 times its earnings per share. I will compare it to Google since the other popular smartphone OS is made by Google. (Not using Samsung because they also have other larger consumer and industrial electronics businesses integrated). Google has a P/E ratio of 40.97 as of close today. This means that you have to pay $41 for each $1 of Google’s earnings while you can pay $14 for each $1 of Apple’s earnings. Lets look at some of the other tech culprits’ P/E ratios to see how Apple compares.

Looking at the above, while Microsoft and Amazon are now neck in neck to be the largest company in the world, Apple seems to have fallen behind. However, the P/E ratio will suggest that Apple is by far the cheapest stock to buy while people are willing to pay $130 for each dollar of Netflix’s earnings. Why is that? That is because Netflix has the same kind of dominance in streaming that Apple commands in smartphones. People are worried about companies like Huawei and others entering the market but show me one iPhone user that wants to trade in his iPhone for a Huawei.

Finally, lets talk cash. Apple’s cash pile after yesterday’s earnings is now $245,000,000,000. Yes that is 9 zeros after 245. At a $784 billion valuation, investors are saying that Apple is only worth 3.2 times its cash position. On the other hand, Amazon is worth 25 times its cash position according to investors. Why is the value of Apple’s cash hoard so massively underestimated? I think I know the reason. Because Apple has been conservative with its cash. They’ve given dividends to their investors and held on to the rest rather than being reckless with it by spending it on acquisitions that often fail to materialize. Theoretically, Apple can go out and buy its payment partner, MasterCard for an all cash deal. (MasterCard has a P/E ratio of 40 by the way). This would boost Apple’s valuation up drastically. But investors seem to have forgotten the saying about the bird in the hand being worth two in the bush. Amazon on the other hand does not give dividends to its investors puts all of its profits back into the business to keep growing infinitely and while it has worked successfully in the past, past success does not guarantee future success. Amazon most certainly has had its fair share of failures too. But this post is about Apple and the point is, Apple is cheap. If you are a value investor in the market for big tech, Apple is a screaming deal by comparison. I assume here that you being a value investor means you are willing to be patient.