Did you buy an iPhone between October 2007 and December 2009? Over 41 million people did. Maybe you and 1.7 million others queued outside an Apple store because you had to have the new iPhone 4 in its first week of release, or you are one of the 45,000 people per day buying an iPad? The numbers are astounding.
If you are like Forrest Gump of River Road, Greenbow Alabama, who owns Apple shares, and even if you are not, you may be interested in my estimate of the company’s intrinsic value.
For those faithful to the PC, your loyalty may soon be tested. Apple’s strategy of dominating the home entertainment market is converting the world to its products, and is eating into the business world too.
While the number of sales are amazing are they enough for Apple to replace Microsoft? In the fast changing world of technology, why not? But in the slow-moving world of value investing, who knows? And thats the difficulty – working out if Apple will dominate in ten years time and betting that there aren’t two young guys in a garage somewhere cooking up the next apple, dell, windows or microsoft office.
Apple’s resurrection started with the return of its founder and prodigal son, Steve Jobs. Whilst off in the ‘wilderness’, Jobs kept himself busy acquiring a little animation studio called Pixar for $10 million, building it up and selling it to Disney for more than $7 billion. He also developed and subsequently sold to Apple his NeXt operating system – for $427 million.
Apple has a market capitalisation of $228 billion. It’s the second largest company in the US – currently bigger than its nemisis Microsoft and about $60 billion behind Exxon Mobil.
Yet as we know from Australia, market cap means little. It is Return on Equity, margins and revenue that reveal the quality and performance of a business. And in these areas Apple and Microsoft are similar.
It is however Apple’s revenue-per-employee number that truly causes the jaw to drop. Microsoft’s revenue divided by its employees equals US$630,000. Apple’s is an astounding US$1.5 million.
Despite the company’s success, things haven’t always been rosy at Apple. In the 1980’s Apple lost the personal computer war to the PC and Windows became the standard. This was in part due to the fact that the Windows platform had attracted the ‘killer app’ – Office. But dud Windows revisions and costly software upgrades left unhappy consumers to explore alternatives.
Re-enter Steve Jobs, as interim CEO of the company he co-founded twenty years earlier. Apple’s staff called him the ‘iCEO’… seriously. It was July 1997 and Apple had lost $1.8 billion in the previous 18 months.
Jobs set about replacing Apple’s board, dropped a case against Microsoft in return for Microsoft developing Office for the Mac, edified the grandeur around the brand, killed off the white labeled versions of its products that were cannibalising the company and most importantly simplified the product pipeline, killing every product except four top-end machines. This last move got the [remaining] staff more focused and inventory fell from $400 million to $100 million in one year.
The category killing machine for Apple in the late 1990’s was the iMac – in fruity colours. Remember those? And Jobs was serious about simplification. These iMacs did not even have a floppy drive. The user downloaded software from the internet and they were the first computer with a USB port. iMacs were thought of as being ahead of their time.
And being ahead of their time meant Apple could charge premium prices and generate better margins. The additional cash funded research that ultimately launched the iPod. Coinciding as it did with the emergence of the “digital life”, the iPod re-launched Apple.
Fast forward to 2010 – what is the intrinsic value of Apple? And is that value rising? Can Apple live up to the iPad’s promise that ‘…this is just the beginning’.
Apple’s Return on Equity from 2001 to 2005 looks like this: 22%, 24.4%, 27.2%. 29.6%. 28.4%. 29.3% and 27.1% forecast for 2011. I have access to a range of forecasts. While some analysts have projected iPad sales will continue for a year at the current rate of growth, others suggest that once the Mac aficionados have purchased, sales will slow significantly. Revenue estimates for 2011 range from $18 billion to more than $45 billion. The 2011 estimated decline in ROE needs to be seen in that context.
As you may know I rate companies on a quality scale from A1 to C5, using metrics designed for bank credit departments. Apple is an A1, and that A1 has been consistent for several years. Microsoft, by comparison, is an A2, but its performance has recently been declining.
Why is Apple an A1? It has no debt and even though equity has grown (from retained earnings not capital raisings) from $3.5 billion to over $10 billion, returns have been maintained. This is exceptional.
Buffett says that he likes big equity and big returns on equity and on that score Apple makes the grade. But Buffett avoids fast-changing sectors like technology because he cannot say with confidence where the company will be in terms of competitive positioning in, for example, a decade’s time. And who knows that there isn’t a couple of university dropouts in a garage somewhere building the next apple, dell, office suite or google!
So with the share price at US$258, does a discount to intrinsic value exist? Moreover, is intrinsic value rising?
On the first score the answer is yes slightly. Apple’s intrinsic value is US$262.56. On the second score intrinsic value is rising to a 2011 estimate of $305.03 – a 16 per cent increase.
For the last five years, intrinsic value has indeed increased substantially. Below is a little table to show you Apple’s share price and intrinsic values since 2005.
*Estimate. Not a recommendation. Seek and take personal professional advice.
Only a very small margin of safety exists today and while you may be optimistic about the fact that Apple’s intrinsic value is rising at a satisfactory rate, you do need to remember that the business is in a fast-changing industry. Future performance and intrinsic value will depend on whether Apple continues to strengthen its competitive advantages. Thank you to the many investors who emailed me and asked for a quick look at Apple.
Posted by Roger Montgomery, 12 July 2010
