Wednesday, February 8, 2012

Catalysts for Growth

Here is the Apple growth scorecard from

Often times we hear reasons why high growth can’t continue. The arguments sound something like this:

ATracking percentage growth and assuming it will continue is pretty naive, as there are only X number of people on the planet that can afford an iPhone/iPad and that number is not growing at these rates! While the growth rate may be in line with historic figures, clearly the growth has to slow down….

Catalysts for Growth:

Lower priced iPhones can generate large incremental growth. Similar for a lower priced iPad. Important in developed markets, very important in emerging countries.

The iPhone is generating a halo effect and introducing new Apple consumers to iPods, iPads, and Macs.

In the short run, new Mac, iPhone, and iPads models stimulate new demand and upgrades from current customers.

Also have the 4G LTE iPhone upgrade cycle to look forward to.

A growing tablet market with fast growing functionality, such as, textbooks and in-flight uses, new business uses, and wider acceptance by education.

Apple TV in the not to distant future

Improving gross margins caused by iPad and iPhone volume

Potential for dividend or share buyback with the excess cash as it grows ever faster.

Expanding distribution in china. China projected to surpass the US as the largest Apple market in several years. (China grew from $3 billion in FY10 to $13 billion in FY11)

Strong demand for iPhone 4S in China and stronger demand for a lower priced iPhone.

Expect to see China Telecom and China Mobile as iPhone distributors in the next year. They represent roughly 9 times the smartphone market that China Unicom currently provides Apple in China.

iPhone 5 is anticipated to be compatible with China Mobiles upcoming 4G network.

Potential for 60 million iPhones to be sold annually in China in several years.

RIM is still broken and trying to fix itself, ripe for more market share loss.

Nokia is struggling.

All of Microsoft is now smaller than the iPhone they poo-poooed in 2007.

Emerging markets represent large future growth opportunities. Asia has 655 million adults age 25-34.

Android has ramped up well in sales, but hasn’t put pressure on Apples ASP or margins.

New iPhones accounted for more than ½ of Verizon and AT&T smartphone activation in 2011. (future upgrade consumers)

Apple expanded from one carrier in 2007 to 220+ carriers in 105 countries in 2011. iPhone shipments rose from 4 million in CY07 to 93 million in CY11.

Given these factors, a strong case can be made that Apple shares discount (take into account) a significant deceleration in growth that is not justified given the short-term and long-term growth factors.

Yes the iPhone can't continue to grow at 100% every year indefinitely - but even if it only continues for another 1, 2, or 3 years, and then level out to 'standard' 20% growth (conservative), the implications for apples revenue & earnings are gigantic.

Some other fun factors:

Good smartphones reduce the need for a landline, helping to fund the smartphone.

More benefit from the overall Apple echo system as Mac sales increase and integrated cloud services arrive such as Siri.

New products we don’t even envision today. Apple TV or iTV is discussed a good deal, but what are the next 2 or 3 products after that?

If people value something highly enough, they will find a way to purchase it.
Value - not price - is what matters.

Economies of scale - for all iOS products, iMacs, and MacBooks, increasing production and sales are very positive for bottom line profits. Fixed costs are fixed (up to the point you need another factory, etc) and each additional product only incurs the variable costs of production.

Gross Margins can continue to grow as fixed costs are spread over a vastly larger number of units.

Larger volumes mean greater discounts from suppliers.

Large cash reserves allow for large, discounted purchases, special deals, and locking in a supply of new or rare parts.

Wednesday, July 20, 2011

The "Law of Large Numbers"

I think the common sense portion of the Law of Large Numbers still's harder to double the 'next' time.

And if a company remains in the same market, it's more applicable. If Apple remained only in the desktop and notebook market, it wouldn't be doubling it's earnings.

But it entered a new market recently, 'mobile' and its growth isn't anywhere near tapped out like conventional PC growth is.

I think Mary Meeker worded it something like, "each new generation of technology has been 10x the size of the last" in her mobile internet presentation.

So Apple seems to be benefiting from meeting the needs of this next new, and larger market segment. Eventually the Law of Large Number will apply to it too.

What's next after mobile, "ultra mobile"? Will Apple dominate a market for even smaller more wearable computers? Again increasing the size of the markets it in?

Will iCloud open up a new area of growth that MobileMe never really tapped into?

I think the Law of Large numbers has attacked Microsoft, and their glory growth days from the PC market are past. Apples innovation has allowed them to move on to the next market and future markets and is enjoying the 10X opportunities Mary Meeker was describing.

The Law of Large numbers is still back there, having it's normal effect on other companies. Apple has been able to stay in front of it with market insight and innovation.

We are just in the damn unlucky position of having a stock that can double its earnings while only having a p/e of 1/5 that. Bad bad luck, what's an investor to do.

When corn is on sale, buy corn.

Friday, September 3, 2010

Future growth

What holds promise for the future? The next generation of iPad I believe! A video camera and FaceTime will offer a cost savings and convenient way for corporate america to have video conferencing in the office and out.

Small business that can't afford an iPad, or don't want to wait, iPod Touch has the camera and FaceTime now.

The WiFi phone without a contract or monthly bill.

Thank you Steve!

Wednesday, September 1, 2010

Perhaps Apple should split itself into multiple companies to avoid the law of large numbers:

Apple #1: iPods (w/o iPod Touch) - low growth

Apple #2: iPod Touch - high growth

Apple #3: iPhone - high growth

Apple #4: Apple TV - hobby growth with interesting potential

Apple #5: iAds - high growth, (started at 0)

Apple#6: Macs - high growth

Apple #7: MacBooks - high growth

Apple #8: iPad - high growth

Then, when they are selling for an average p/e greater than today's Apple, they can claim there would be tremendous efficiencies by combining into one company...and the p/e would go up again! (Despite having paid millions in banking fees to Goldman or others)

Alas, I jest. The patient investor will be rewarded as inefficiencies in the market are worked out over time. When corn is on sale, buy corn. (Oranges, etc.)

The mobile internet is big, there are many areas for Apple to excel in yet untapped. Apple innovates, others regurgitate.

Imagine what Christmas sales will be like this year with the product refreshes they announced today.

iPod Touch, the ultimate stocking stuffer.

Friday, August 20, 2010

Recently I was in a discussion with Horace Dediu of and I wanted to formalize the thoughts and continue here...

To make money with stocks (beyond index fund growth) you need to take risks. The risk you should take is on companies that show an ability to surprise. I mean really surprise, as in “where did all that new money come from?” If you can predict accurately the so can everybody else. The kicker is that even the company’s own management must be surprised. Not even they can tell what’s coming. In Apple’s case I’m pretty sure that iPod and iPad were all bigger than anyone there expected them to be. They created new markets. New markets can’t be measured.

I think there is a lot of logic and value in what you are saying, but I’m not in complete agreement. Example, a simple model of Apple using your FY end, TTM earnings of $15.27, a P/E that makes the stock come out to recent levels…turns out to be about 17, then the ‘big’ assumption…I’l use 20% growth. (low by recent standards, unknown in the future and especially the out years)

As you can see, this provides very good appreciation for the stock price, and I don’t think the variables I’ve used are really over estimating the markets outlook for Apples future. But as a short term minded species, we don’t seem to look much farther than the next quarter, or perhaps year.

Personally I plan on needing money and successful investments beyond the time frame of one year, and like looking further out into the future. If Apple can do a fraction as well in the future as the current management team has done in the last few years, I don’t think the market has properly discounted the future cash flows at all.

I think Apple is significantly undervalued, and believe a P/E of 17 is undeservedly low based on the actual growth rate. I’m not saying this to wine, I’m saying it as I appreciate the investment opportunity.

Year growth rate EPS P/E ratio Share Price
2010 20% 15.3 17 $260
2011 20% 18.3 17 $312
2012 20% 22.0 17 $374
2013 20% 26.4 17 $449
2014 20% 31.7 17 $539
2015 20% 38.0 17 $647
2016 20% 45.7 17 $776
2017 20% 54.8 17 $931
2018 20% 65.7 17 $1,118
2019 20% 78.9 17 $1,341
2020 20% 94.7 17 $1,609

Factors I think the market may be missing/under valuing:

The value of the Apple management team regarding innovativeness, design, production quality and efficiency.

The value of Apple’s brand and following. (quantity, quality, income level)

The value of the OS and it’s scalability.

The value of understanding customer needs and wants. (and technical ability to meet them)

The value of the profitable portion of the market. (not simply market share)

The size of the mobile internet vs. the size of the desktop PC market. (been estimated at 10x as large)

The customer's appreciation for design and quality once they experience it.

The value of the “integrated whole” Apple provides that makes life easier for the average user who is not an IT major and doesn’t want to spend their time trying to be one. (iTunes, iLife, better security and freedom from viruses, UI, apps, etc.)

The value of the fundamental base Apple has laid in the past decade that can now be built on that is missing from other competitors operating model. (software, hardware, retail, R&D, halo effect from previous quality products)

I see these as tremendous assets, and having great value in the years to come, not only the next year. The value may well be greater 5 years from now as Apple is leading in product innovation while other competitors are trying to catch up. Apple's first mover advantage may well grow as new products are introduced that take advantage of the foundation Apple has put down in the past 10 years.

Things I disagree with:

Apples lack of financial leverage.

Not having a share buy back to support the share price and concentrate earnings.

Holding too much cash at low interest rates, especially considering the current cash generation ability.

Not offering a modest dividend to attract income oriented investors and funds, even though I do dislike double taxation.

Monday, July 21, 2008

AAPL July 21, 2008 financial results

The short term market was without mercy as AAPL dropped in after-hour trading like they had committed the ultimate financial sin. To a short term trader, perhaps they did. AAPL provided conservative short term guidance. They guided towards $1.00 EPS when they just reached $1.19 this quarter.

Clearly Apple Inc. isn't trying to maximize their short term share price. In fact, I believe they may be doing just the opposite. And I don't mean this in a negative way. I believe there is evidence they are controlling the factors within their reach to maximize the share price in a longer time frame, such as, 3-5 years.

This would make sense given a relatively young management team, with some years to retirement, and products, brand, and intellectual property that is ramping up to say the least. Again, AAPL is not pulling the levers to maximize the share value now, they are building a powerful engine to dominate in their markets in the maximize the share price then, not today.

There are several reasons I believe this:

1) Apple is offering a very generous back to school program. Offering a free iPod, even a touch, with the purchase of a computer for school. They are increasing cost and losing some revenue to build their client base for years to come. Many of these college "kids" will become Apple fans for life...effecting their classmates and family. The time is right with Vista irritation high and OS X offering high user satisfaction. Once with a Mac, and many of these students will never go back to a machine running a MSFT operating system! This is money well spent, and will bring delayed gratification to the company.

2) As mentioned in the conference, Apple is being careful with their profit margins so that competitors can't just come in and offer similar products under Apple’s price level. Apple isn’t eking ever last dollar out of a sale, but they are building and protecting market share. This isn't a short term profit maximization strategy, but a long term building approach.

3) Apple invested in a small, but intellectually advanced chip design company. At this point in time, it doesn't appear there will be a quick payback for this investment, but their may well be a better ability to differentiate their products with custom, proprietary chips. A move that would further distance their iPhone and iPod touch from the competitors and make copying their features more difficult. Again, a longer term strategy, oriented towards market share growth.

4) Apple is recognizing revenue from the iPhone in a 24 month subscription method. This will delay the recognition of revenue and smooth it out. And also delay the taxation of that revenue.

5) Apple is investing in Apple Stores around the world. Stores designed to showcase their products with employees who can explain them to potential buyers. Contrast this to the typical discount department store.

6) App store currently offers many free Apps and only takes 30% of the revenue. This could be increased in the future such that all apps have a minimum price and Apple receives a 35% revenue cut, once it’s well established and the iPhone is in use in the mega-millions. (It’s rather generous now to offer free App hosting and charge nothing for the free ones.)

I believe this longer strategy fits in well with a young management team that is compensated with stock options. Options that are given now and may be exercised in the future when the price is higher. This may be frustrating for a short term investor who always wants the stock at a new high, but for longer term investors, their goals may match up very well with the strategy that AAPL is executing with great skill and expertise.

Short term investors don’t like the EPS guidance for next quarter, but Apple is becoming the leader in PC growth, smart phone user satisfaction, operating system user satisfaction, and providing innovative products to electronic consumers.

Apple isn’t perfect, but many companies would kill to have their faults and their future potential.

Obviously, many investors do not like this approach and sold today. I take a longer view and appreciate what Apple is building both for the user, the long term investor, and themselves. I wish more people took this longer term view to value creation.

Your thoughts are appreciated.