AAPL - Apple Inc.

[ni-co]

Apple is in the interesting position of being known by everybody but understood by relatively few. Wall Street just tries to compare them to other easier-to-understand companies instead of truly looking at what's going on, but these other companies aren't doing the same thing. I guess that to get the whole rather than just bits & pieces it takes someone who has a foot in many disciplines (arts/design/tech(software+hardware)/consumer products/finance) and that's rare.

 

Completely agree. There are very few investors out there – Einhorn being one of them – that understand AAPL's strategy. Speaking of Wall Street not understanding AAPL: Yacktman is concerned about AAPL because they don't go for market share – now that's what I call news…

 

http://www.valuewalk.com/2014/06/yacktman-sources-moats-concern-apples-strategy/

 

I can't believe that good investors still think that AAPL is in a commodity business. I realize that he doesn't say it but he certainly argues like they were.

[KCLarkin]

Speaking of Wall Street not understanding AAPL: Yacktman is concerned about AAPL because they don't go for market share – now that's what I call news…

 

http://www.valuewalk.com/2014/06/yacktman-sources-moats-concern-apples-strategy/

 

I can't believe that good investors still think that AAPL is in a commodity business. I realize that he doesn't say it but he certainly argues like they were.

 

I don't think Yacktman is wrong to be concerned about how sustainable iPhone profit margins are. They are unnaturally high compared to iPad and Mac margins.

 

His thoughts about market share in this industry are a bit off track though. In platform wars, market share is important because the ecosystem is huge part of the value proposition. All things being equal, third parties are going to develop software and build accessories for the most popular platform. Being the low cost provider is largely irrelevant. Otherwise, we'd all be using Linux computers.

 

[Liberty]

I don't think Yacktman is wrong to be concerned about how sustainable iPhone profit margins are. They are unnaturally high compared to iPad and Mac margins.

 

I think Apple would make more money on iPads and Macs if the price paid by customers was spread over 2-3 years as monthly payments. Most people think a smartphone costs a couple hundred bucks. It's not rational, but people aren't rational about money.

 

But I also think that iPhones bring more value to most people than Macs or iPads. They're always on you, very personal devices used for countless tasks throughout the day (utility and pleasure). They're more indispensable than most other devices, so worth paying up for.

[Guest wellmont]

I think ws is pretty rational about aapl right now. apple has a very concentrated, high margin product portfolio, subject to massive technological changes, and intense competition. Because of that, I would discount the multiple too, if I were trying to value it. it certainly does not have any kind of moat, in the buffett sense of the word, other than it happens to be in fashion at the moment, and it's last major product intro was a "hit". But it needs to keep coming up with "hits". At times, and not so long ago, WS has been absolutely "gaga" over apple. like when that guy who knew nothing more than the typical fanboi, started a fund to essentially buy call options on the stock as it was peaking. what I see is a common bias here that anybody who disagrees with your thesis simply "doesn't get it".  That's a dangerous way to own a stock imo.

[Liberty]

I think ws is pretty rational about aapl right now. apple has a very concentrated product portfolio, subject to massive technological changes. it certainly does not have any kind of moat, other than it happens to be in fashion at the moment. it needs to keep coming up with "hits". At times, and not so long ago, WS has been absolutely "gaga" over apple. like when that guy who knew nothing, started a fund to essentially buy call options on the stock as it was peaking. what I see is a common bias here that everybody who doesn't agree with your thesis simply "doesn't get it".  That's a dangerous way to own a stock imo.

 

Wall Street was gaga over Apple's growth, but that doesn't mean that they understood the company. I'm not saying that they've always had a negative bias against the company, just that they don't really get how and why it does what it does and how it's different from competitors.

 

But it must be because they have no moat that all their competitors are doing so well, making so much money creating high-end products that are just as good... And if there's a product line where Apple really must not have any moat, it must be in personal computers, right? That's a declining mature industry that has been around for over 30 years. Oh yeah, the competition is doing just as well as Apple there. People buy them just because of fashion, not because they have better products, and it's not like their ecosystem is sticky. They're doomed just like Nike and Porsche are doomed because of cheaper competition.

 

Please tell me what rapid technological changes threaten Apple? Or maybe, just maybe, they're a beneficiary of rapid technological changes, because they incorporate those into their products to make them better, giving people reasons to upgrade, and their massive profit advantage over their competitors mean that they can invest more in new technologies - even expensive ones like custom SOCs, aluminum milling and sapphire glass or whatever - to further differentiate their products, creating a virtuous cycle.

 

If Apple fails, it won't be because they can't incorporate the latest technology into their products, it'll be because they lose their culture, and that's what I'm watching for. WWDC to me was reassuring; they dug the moat a few feet deeper and wider.

 

Maybe we should talk about this again after the fall announcements... Let's see how Samsung's Galaxy S, Galaxy Tab, and Galaxy Gear do against the iPhone 6 and new iPads, as well as whatever new categories they announce.

[KCLarkin]

 

I think Apple would make more money on iPads and Macs if the price paid by customers was spread over 2-3 years as monthly payments. Most people think a smartphone costs a couple hundred bucks. It's not rational, but people aren't rational about money.

 

 

Exactly, iPhones economics are very unique. Any new products (TV, wearables) is likely to have economics more like iPad than iPhone.

[Liberty]

Exactly, iPhones economics are very unique. Any new products (TV, wearables) is likely to have economics more like iPad than iPhone.

 

Indeed, except for the added complexity that each product is part of the same ecosystem, and they help sell each other and make each other stickier. Your Apple TV is more useful if you have an iPhone, your iPhone is more useful if you have a Mac, and so on. How many people bought Macs 10 years ago because they first got an iPod?

 

Taking a cut from all the paid content (including games, movies, TV, etc) on a device that is designed pretty much just for content consumption like the next-gen Apple TV could help make the economics better. I doubt that will be gigantic, but it should be profitable and recurring.

 

In my opinion, wearables will be more accessories to the iOS ecosystem than primary devices. So while they could be a nice business on their own, I think they'll mostly help boost the iPhone business.

 

Imagine something that integrates superbly with the iPhone and makes it much better (now you can see all kinds of stuff at a glance on your wrist, and your phone now has data on your health 24/7 (HealthKit API), you can control stuff in your house (HomeKit API) - including your Apple TV - and maybe even your car (CarPlay) without even taking your phone out of your pocket, or even having it on you, etc). I could be a must-have accessory and functionally increase iPhone's ASP (you wouldn't buy the wrist band alone -- it's like an extra option on the Phone).

 

Just some speculation... I guess we'll find out soon enough.

[KCLarkin]

I think ws is pretty rational about aapl right now. apple has a very concentrated, high margin product portfolio, subject to massive technological changes, and intense competition. Because of that, I would discount the multiple too, if I were trying to value it. it certainly does not have any kind of moat, in the buffett sense of the word, other than it happens to be in fashion at the moment, and it's last major product intro was a "hit". But it needs to keep coming up with "hits". At times, and not so long ago, WS has been absolutely "gaga" over apple. like when that guy who knew nothing more than the typical fanboi, started a fund to essentially buy call options on the stock as it was peaking. what I see is a common bias here that anybody who disagrees with your thesis simply "doesn't get it".  That's a dangerous way to own a stock imo.

 

I think Wall Street is very rational about AAPL. They just happen to be wrong. It is not an accident that AAPL created the iPhone. It is not an accident that the iPhone became a hit. It is not an accident that AAPL captures the majority of profits in PCs and tablets and phones. AAPL has invested 30 years in creating integrated hardware + software capabilities that NOBODY else has. Separately, Samsung and Google can try to copy or out-innovate AAPL but there will always be an integration penalty. In 10 years, Google might have HW capabilities or Samsung might have SW but I don't think the street is pricing in 10 years of competitive advantage.

 

To the extent that the street believes that AAPL has no moat and is just a hit driven business, the stock price will always be mispriced.

 

[Palantir]

I actually do think it was an accident that the iPhone became a hit. I do not believe SJ ever believed that the iPhone would become as popular as it has, and probably expected it to be a niche product, so every other future product will likely suffer in comparison.

[Liberty]

I actually do think it was an accident that the iPhone became a hit. I do not believe SJ ever believed that the iPhone would become as popular as it has, and probably expected it to be a niche product, so every other future product will likely suffer in comparison.

 

There are two different things here:

 

Steve Jobs and Apple employees who worked on it definitely knew they had a game-changing product that was years ahead of the competition (even that isn't quite right; it's not 'years' ahead, because if it hadn't been made, it's likely nobody else would've made something as good). It's clear in the announcement and in various articles and interviews with those people.

 

But, they couldn't know how fast the market they were creating would unfold, because they were trailblazing. The iPod took a little while to take off too, but once it did it was massive. The iPhone wasn't an immediate super-hit. It took a little while to really get going. The one that was immediately a hit was the iPad.

[KCLarkin]

I actually do think it was an accident that the iPhone became a hit. I do not believe SJ ever believed that the iPhone would become as popular as it has, and probably expected it to be a niche product, so every other future product will likely suffer in comparison.

 

It became a hit because it was a dramatically better product than existing "smartphones". It was a better product because AAPL did what nobody else could or would do. They shrunk a Mac down into a device that fits into your pocket. They bulldozed the carriers "walled garden". Android only exists in its current form because AAPL knocked down those walls.

 

I agree that the smartphone market has particularly attractive economics which even SJ didn't foresee. You'll probably recall that AAPL originally tried to partner with Motorola on the ROKR rather than build their own phone. So in a sense, you are right. But my point is that AAPL has a unique set of capabilities. The street discounts these capabilities and treats AAPL like it is BlackBerry 2.0. If you've ever owned a Blackberry Storm, you will quickly realize how valuable AAPLs capabilities are.

[Viking]

I think what gets Apple supporters all riled up about how Wall Street values Apple is what looks to be a double standard. If other companies were viewed as critically as Apple was a year ago they would trade at much lower valuations. The good news is those who could think independently were able to buy a world class company at a crazy low price. My guess is Apple is going to over deliver on the hardware side over the next 6 months and this will lead to growing profits and much higher earnings per share (due to the ongoing aggressive share buy backs). Just as importantly, I think they will maintain the momentum into 2015.

 

An example is what if Apple removes Google completely as the default search engine on all their hardware products? What we have learned when they did this with Maps is most Apple users simply stuck with the new default setting (Apple Maps) and Google lost most of their share with Apple users. Google is clearly struggling with search in mobile. If they get booted from Apple their core business will be in trouble. Now look at Google's valuation. It is trading at a crazy high multiple. My point is all companies have risks in their core business if you look hard enough, including Apple.

[ni-co]

Wall Street was gaga over Apple's growth, but that doesn't mean that they understood the company. I'm not saying that they've always had a negative bias against the company, just that they don't really get how and why it does what it does and how it's different from competitors.

 

But it must be because they have no moat that all their competitors are doing so well, making so much money creating high-end products that are just as good... And if there's a product line where Apple really must not have any moat, it must be in personal computers, right? That's a declining mature industry that has been around for over 30 years. Oh yeah, the competition is doing just as well as Apple there. People buy them just because of fashion, not because they have better products, and it's not like their ecosystem is sticky. They're doomed just like Nike and Porsche are doomed because of cheaper competition.

 

Please tell me what rapid technological changes threaten Apple?

 

Somehow I missed your Porsche comparison, but that's exactly what I've been thinking with my comment about Yacktman. How completely ridiculous would it be if he suggested Porsche to lower its prices and go for market share to increase profits? By the way, that's what Porsche tried in the 1980s – and it almost ruined the company. That's also where investors should concentrate their worries. AAPL's biggest enemy is AAPL itself. As long as they stay laser focused they'll only grow their moat.

 

There's a great article in the recent Economist about the luxury car segment:

 

"…three German brands, Mercedes, BMW and Volkswagen’s Audi, have become ever more dominant as emerging-markets growth has expanded global demand for premium cars. Lexus, Acura and Infiniti, the upmarket brands dreamed up in the 1980s by Japan’s big three carmakers, Toyota, Honda and Nissan, have been left trailing (see chart). Together the German trio now have 70% of the market for fast, expensive and luxurious cars, whereas the Japanese have just 10%. And they are being overtaken by Jaguar Land Rover (JLR), a British (but Indian-owned) firm, which last year sold almost half a million cars, just behind Lexus.

 

…

 

As Andy Palmer, a Nissan executive, puts it, premium models account for “12% of the volume and 50% of the profits” of the entire car industry."

http://www.economist.com/news/business/21603434-japans-premium-motor-brands-are-still-far-behind-their-german-rivals-giant-carmakers

 

Sounds familiar?

 

Keep in mind that cars, by their very nature, are commodities – exactly like smartphones and PCs. However, this industry is not a commodity business at all. Porsche, BMW, Mercedes and Audi follow a very simple recipe: It's all about creating great customer experience. Customer experience comes first, great brand names and high margins follow. This has nothing to do with fashion or hype and it's certainly not a hit driven business. AAPL follows this model, and Wall Street doesn't understand it at all. This has nothing to do with being irrational, they simply don't get it because nobody else in the tech industry follows this simple recipe.

 

What gets me is that they (meaning WS investors, analysts etc.) don't use their eyes and brains to observe and understand what people (probably even they themselves) love about Apple products. It's not about the technical specs or even single features – it's all about the experience of using the products: how they buy them, design, simplicity etc. AAPL nails this – and this experience is almost impossible to be replicated by competitors by now.

[Liberty]

Good points, ni-co.

 

I suppose that in 10 years a management guru will write a best-selling book about how consumer products are judged on different criteria than business products and a large number of people will have their 'ah-ha' moment... Until then, well.

[txlaw]

Once again, the false notion that "Wall Street thinks Apple is doomed" is trotted out unnecessarily by folks justifying their supposedly contrarian position on Apple. 

 

IMO, the market pricing on Apple is not necessarily irrational.  The pricing takes into account the potential downside risk (not just uncertainty) of someone/anyone coming in and really making an assault on Apple's moat.  Keep in mind, the success of competition doesn't mean that Apple is doomed -- it simply means that Apple's profit per share won't necessarily grow at a rate that justifies its market valuation.  And there's even the downside risk that profit per share could shrink (though that's not likely due to Tim Cook's excellent decision to re-allocate excess capital to buybacks).  It's actually pretty easy to put together a model for Apple where unit sales for the most profitable products grow, consolidated gross margin remains the same, buybacks are at a healthy run rate, and software/services revenue grows -- but where ASPs decline at a clip that makes AAPL pretty much fairly valued given the potential downside risk of disruption/commoditization. 

 

The debate is not really about whether Apple will not be a great company that executes well and comes out with good products.  It is all about valuation.  AMZN is a fantastic company, but it's not clear that it is "cheap," so to speak.  GOOG is a fantastic company (despite not being so great at product design, they have a much better biz model than AAPL, IMO), but it's definitely not clear that it is "cheap."  It's not a good idea to say that AAPL should be considered cheap "relative" to these other guys.  It's like saying Facebook and Uber have been valued at these insane amounts and, therefore, the company I am invested in ought to be valued the same way.

 

There's another thing I am seeing on this thread that I think is wrong-headed.  Posters are assuming incorrectly that "commoditization" means that everything becomes a toaster -- no differentiation whatsoever and no real market for a "high end."  But that, of course, is not what "commoditization" really means in the context of disruptive innovation theory.

 

Low end disruptions (which occur when there is "commoditization") attack the least profitable customers who are willing to buy "good enough" products/services based on price.  Price is always the main determinant for the decision to buy a "good enough" product rather than the "high end" product -- indeed, that is the only reason why anyone would buy a supposedly inferior product.  Arguably, this is the major reason why people buy Android hardware -- certainly, people who think Apple products are way superior should consider that "price" is the main factor, rather than bad taste. 

 

When you have a situation where "commoditization" is occurring, the "high end" incumbent basically feels no pain and little threat until disruptors start pulling customers from the high end and taking absolute profit share away from the incumbent.  To put it another way, practitioners like Jeff Bezos who believe in the theories behind the Innovator's Solution (he recommends that book to his management team) always have the view that your margin is my opportunity, and the incumbent tends to not be worried about this as long as they can retain what they view as the "high end." 

 

Furthermore, the profit pool for products rapidly changes in the "high tech" world.  That is, unlike say the profit pool for financial transaction rakes, which tends to grow with GDP, the profit pool for tech hardware sales can fluctuate wildly in a relatively short period of time.  Ultimately, you have to ask yourself, what does the profit pool for hardware sales look like going forward and what is the annual run rate of profit share that Apple will capture going forward in the face of competition that may not even want to earn profits from hardware sales themselves.  If the vast majority of people say that hardware is good enough to where I really want to buy hardware on the cheap and re-allocate spending to software and services, many of which will be modular in nature, then there's a real possibility that expecting $40 billion of profit from hardware sales for one company is a bit optimistic.

 

Again, Apple is a great company.  It could be a great business trading at a fair value.  It could adapt so that the earnings per share continues to go up for a long, long time.  But I don't think that's as clear cut as people think it is.  It's a difference in handicapping, not a misunderstanding of how the company operates.

[Liberty]

Once again, the false notion that "Wall Street thinks Apple is doomed" is trotted out unnecessarily by folks justifying their supposedly contrarian position on Apple. 

 

Maybe folks say that, but I didn't say that, and I want to make that clear. A few posts above I said that WS varies between positive and negative on Apple, but the constant is that most of WS doesn't understand Apple. That's a different point, and it doesn't imply that they have to have a negative view of the company.

 

As for the rest, we've already gone over it. Time will tell who's right.

[PatientCheetah]

Once again, the false notion that "Wall Street thinks Apple is doomed" is trotted out unnecessarily by folks justifying their supposedly contrarian position on Apple. 

 

IMO, the market pricing on Apple is not necessarily irrational.  The pricing takes into account the potential downside risk (not just uncertainty) of someone/anyone coming in and really making an assault on Apple's moat.  Keep in mind, the success of competition doesn't mean that Apple is doomed -- it simply means that Apple's profit per share won't necessarily grow at a rate that justifies its market valuation.  And there's even the downside risk that profit per share could shrink (though that's not likely due to Tim Cook's excellent decision to re-allocate excess capital to buybacks).  It's actually pretty easy to put together a model for Apple where unit sales for the most profitable products grow, consolidated gross margin remains the same, buybacks are at a healthy run rate, and software/services revenue grows -- but where ASPs decline at a clip that makes AAPL pretty much fairly valued given the potential downside risk of disruption/commoditization. 

 

The debate is not really about whether Apple will not be a great company that executes well and comes out with good products.  It is all about valuation.  AMZN is a fantastic company, but it's not clear that it is "cheap," so to speak.  GOOG is a fantastic company (despite not being so great at product design, they have a much better biz model than AAPL, IMO), but it's definitely not clear that it is "cheap."  It's not a good idea to say that AAPL should be considered cheap "relative" to these other guys.  It's like saying Facebook and Uber have been valued at these insane amounts and, therefore, the company I am invested in ought to be valued the same way.

 

There's another thing I am seeing on this thread that I think is wrong-headed.  Posters are assuming incorrectly that "commoditization" means that everything becomes a toaster -- no differentiation whatsoever and no real market for a "high end."  But that, of course, is not what "commoditization" really means in the context of disruptive innovation theory.

 

Low end disruptions (which occur when there is "commoditization") attack the least profitable customers who are willing to buy "good enough" products/services based on price.  Price is always the main determinant for the decision to buy a "good enough" product rather than the "high end" product -- indeed, that is the only reason why anyone would buy a supposedly inferior product.  Arguably, this is the major reason why people buy Android hardware -- certainly, people who think Apple products are way superior should consider that "price" is the main factor, rather than bad taste. 

 

When you have a situation where "commoditization" is occurring, the "high end" incumbent basically feels no pain and little threat until disruptors start pulling customers from the high end and taking absolute profit share away from the incumbent.  To put it another way, practitioners like Jeff Bezos who believe in the theories behind the Innovator's Solution (he recommends that book to his management team) always have the view that your margin is my opportunity, and the incumbent tends to not be worried about this as long as they can retain what they view as the "high end." 

 

Furthermore, the profit pool for products rapidly changes in the "high tech" world.  That is, unlike say the profit pool for financial transaction rakes, which tends to grow with GDP, the profit pool for tech hardware sales can fluctuate wildly in a relatively short period of time.  Ultimately, you have to ask yourself, what does the profit pool for hardware sales look like going forward and what is the annual run rate of profit share that Apple will capture going forward in the face of competition that may not even want to earn profits from hardware sales themselves.  If the vast majority of people say that hardware is good enough to where I really want to buy hardware on the cheap and re-allocate spending to software and services, many of which will be modular in nature, then there's a real possibility that expecting $40 billion of profit from hardware sales for one company is a bit optimistic.

 

Again, Apple is a great company.  It could be a great business trading at a fair value.  It could adapt so that the earnings per share continues to go up for a long, long time.  But I don't think that's as clear cut as people think it is.  It's a difference in handicapping, not a misunderstanding of how the company operates.

 

Very good point, unlike Google, Apple is as good as its latest and greatest products. Based on its previous records, it has a very good chance of continuing to innovate. In DCF valuation, the magnitude of economic profits matters but so is the duration of economic profits. The difference in expected durations should explain much of the valuation difference between Apple and Google. Michael Mauboussin wrote several excellent piece on this topic.

[Liberty]

Very good point, unlike Google, Apple is as good as its latest and greatest products. Based on its previous records, it has a very good chance of continuing to innovate. In DCF valuation, the magnitude of economic profits matters but so is the duration of economic profits. The difference in expected durations should explain much of the valuation difference between Apple and Google. Michael Mauboussin wrote several excellent piece on this topic.

 

What multiple is Nike getting?

[PatientCheetah]

Very good point, unlike Google, Apple is as good as its latest and greatest products. Based on its previous records, it has a very good chance of continuing to innovate. In DCF valuation, the magnitude of economic profits matters but so is the duration of economic profits. The difference in expected durations should explain much of the valuation difference between Apple and Google. Michael Mauboussin wrote several excellent piece on this topic.

 

What multiple is Nike getting?

 

we can all agree to disagree - 22.5x 15E, nike is on a upswing, gaining market share, Adidas/Puma/Reebok are absolutely getting crashed (check the number of profit warnings from these 3), only worthy competitor in performance athletic wears is UA, it is in a virtuous cycle of taking market share and able to spend more on marketing and R&D

[abyli]

Not many people understand why Apple is so successful after so many years is beyond me. It is not about new functionality, it is not about how many files you can store in iPod...

[KCLarkin]

Once again, the false notion that "Wall Street thinks Apple is doomed" is trotted out unnecessarily by folks justifying their supposedly contrarian position on Apple. 

 

IMO, the market pricing on Apple is not necessarily irrational.  The pricing takes into account the potential downside risk (not just uncertainty) of someone/anyone coming in and really making an assault on Apple's moat.  Keep in mind, the success of competition doesn't mean that Apple is doomed -- it simply means that Apple's profit per share won't necessarily grow at a rate that justifies its market valuation.  And there's even the downside risk that profit per share could shrink (though that's not likely due to Tim Cook's excellent decision to re-allocate excess capital to buybacks).  It's actually pretty easy to put together a model for Apple where unit sales for the most profitable products grow, consolidated gross margin remains the same, buybacks are at a healthy run rate, and software/services revenue grows -- but where ASPs decline at a clip that makes AAPL pretty much fairly valued given the potential downside risk of disruption/commoditization. 

 

The debate is not really about whether Apple will not be a great company that executes well and comes out with good products.  It is all about valuation.  AMZN is a fantastic company, but it's not clear that it is "cheap," so to speak.  GOOG is a fantastic company (despite not being so great at product design, they have a much better biz model than AAPL, IMO), but it's definitely not clear that it is "cheap."  It's not a good idea to say that AAPL should be considered cheap "relative" to these other guys.  It's like saying Facebook and Uber have been valued at these insane amounts and, therefore, the company I am invested in ought to be valued the same way.

 

There's another thing I am seeing on this thread that I think is wrong-headed.  Posters are assuming incorrectly that "commoditization" means that everything becomes a toaster -- no differentiation whatsoever and no real market for a "high end."  But that, of course, is not what "commoditization" really means in the context of disruptive innovation theory.

 

Low end disruptions (which occur when there is "commoditization") attack the least profitable customers who are willing to buy "good enough" products/services based on price.  Price is always the main determinant for the decision to buy a "good enough" product rather than the "high end" product -- indeed, that is the only reason why anyone would buy a supposedly inferior product.  Arguably, this is the major reason why people buy Android hardware -- certainly, people who think Apple products are way superior should consider that "price" is the main factor, rather than bad taste. 

 

When you have a situation where "commoditization" is occurring, the "high end" incumbent basically feels no pain and little threat until disruptors start pulling customers from the high end and taking absolute profit share away from the incumbent.  To put it another way, practitioners like Jeff Bezos who believe in the theories behind the Innovator's Solution (he recommends that book to his management team) always have the view that your margin is my opportunity, and the incumbent tends to not be worried about this as long as they can retain what they view as the "high end." 

 

Furthermore, the profit pool for products rapidly changes in the "high tech" world.  That is, unlike say the profit pool for financial transaction rakes, which tends to grow with GDP, the profit pool for tech hardware sales can fluctuate wildly in a relatively short period of time.  Ultimately, you have to ask yourself, what does the profit pool for hardware sales look like going forward and what is the annual run rate of profit share that Apple will capture going forward in the face of competition that may not even want to earn profits from hardware sales themselves.  If the vast majority of people say that hardware is good enough to where I really want to buy hardware on the cheap and re-allocate spending to software and services, many of which will be modular in nature, then there's a real possibility that expecting $40 billion of profit from hardware sales for one company is a bit optimistic.

 

Again, Apple is a great company.  It could be a great business trading at a fair value.  It could adapt so that the earnings per share continues to go up for a long, long time.  But I don't think that's as clear cut as people think it is.  It's a difference in handicapping, not a misunderstanding of how the company operates.

 

Here is a pretty good response to your theory:

http://stratechery.com/2013/clayton-christensen-got-wrong/

 

While I disagree with your analysis, this is exactly my point. If the above rational beliefs are priced into AAPL (and will always be priced into AAPL), it is unrealistic to expect further (relative) multiple expansion. Any remaining discount to fair value (if it exists) will never close.

 

Last year, the market was pricing in a doom scenario. The doom discount is now gone. The easy money has been made. So, as you say, it is now a matter of handicapping. And while it is tempting to bet against those wall street bozos, as a disciplined investor, I prefer a bigger margin of safety.

[Liberty]

we can all agree to disagree - 22.5x 15E, nike is on a upswing, gaining market share, Adidas/Puma/Reebok are absolutely getting crashed (check the number of profit warnings from these 3), only worthy competitor in performance athletic wears is UA, it is in a virtuous cycle of taking market share and able to spend more on marketing and R&D

 

Adidas/Puma/Reebok are all playing in the higher end, right? The low end is a zillion semi no-name brands, but Nike isn't really competing against them. They'd rather have profit-share than market-share, right?

 

So who's threatening Apple in the higher end, the only area where they play? Who's nipping at their heels to offer the very best overall customer experience? Samsung? HTC? Motorola? Xiaomi? LG? Lenovo? Huawei? Nokia? Blackberry?

 

But we can agree to disagree.

[Liberty]

While I disagree with your analysis, this is exactly my point. If the above rational beliefs are priced into AAPL (and will always be priced into AAPL), it is unrealistic to expect further (relative) multiple expansion. Any remaining discount to fair value (if it exists) will never close.

 

Last year, the market was pricing in a doom scenario. The doom discount is now gone. The easy money has been made. So, as you say, it is now a matter of handicapping. And while it is tempting to bet against those wall street bozos, as a disciplined investor, I prefer a bigger margin of safety.

 

The doom sentiment is gone, but we're pretty far from real enthusiasm IMO. What we're seeing now is more mild-skepticism, somewhat-intrigued. A discount to fair value gives them a great opportunity to do buybacks, and I don't think that we can say with such certainty that it'll never close. The weighting machine has to kick in at some point, but the longer it doesn't, the more effective the buybacks will be.

 

I think that at some point, sentiment will turn really positive again and we'll get closer to fair value, and that'll be a time to harvest profits or sell. But I'm not selling until bigger screen iPhones hit a ramped up China Mobile (big screen phones are very popular in Asia, where they are often a person's only computing device) and until I've seen what new categories they have waiting in the wings. WWDC boosted my confidence in the quality of the company's current work, so I'm hopeful that they have good things planned (it was a remarkable event, I can't imagine any other company doing so many good things that will matter to their customers right now, so who's catching up to them?).

 

One last thing: Many people say that Apple is a 'hit driven business' and that they're only as good as their last product. That's true, but it's not as scary as it might first seem. They're not writing novels or making hollywood movies. They're not starting from scratch every time and crossing their fingers, hoping that they'll make something people enjoy based on purely subjective taste attributes. The iPhone 4 was based on the original iPhone, and iOS 6 was based on iOS 5, and the iPhone 5S was based on the iPhone 5, and so on. They're not starting from scratch all the time and hoping to re-conquer their whole customer base all over again. They're evolving a hit product into something even better, and they have a sticky ecosystem that acts as a scaffold to build on. And they're not just trying to make something that people like based on intangible subjective taste, they're solving real-world problems that their customers have, or giving them new tools they didn't know they needed. That's a lot more concrete a target than trying to write a hit song. You can have a company culture that is set up to do just that. If it wasn't the case, why would Apple's personal computers still dominate profit-wise and quality-wise in a decades-old mature declining industry with lots of competition? In fact, I'd say that Apple's strengths are more important for smartphones than personal computers, so maybe the competition will have an even harder time storming the castle there?

[PatientCheetah]

we can all agree to disagree - 22.5x 15E, nike is on a upswing, gaining market share, Adidas/Puma/Reebok are absolutely getting crashed (check the number of profit warnings from these 3), only worthy competitor in performance athletic wears is UA, it is in a virtuous cycle of taking market share and able to spend more on marketing and R&D

 

Adidas/Puma/Reebok are all playing in the higher end, right? The low end is a zillion semi no-name brands, but Nike isn't really competing against them. They'd rather have profit-share than market-share, right?

 

So who's threatening Apple in the higher end, the only area where they play? Who's nipping at their heels to offer the very best overall customer experience? Samsung? HTC? Motorola? Xiaomi? LG? Lenovo? Huawei? Nokia? Blackberry?

 

But we can agree to disagree.

 

Yes, Apple has a strong and defensible niche in the high end. HTC, Samsung, and Xiaomi are strong competitors but still not good enough for many. What do you think the right multiple should be for Apple? The high end smartphone market is a mature market and competitors are not going away anytime soon. Maybe the market multiple is fair? That gets us slightly over $700, not really a reach. I wouldn't pay a higher multiple for Apple than the multiple that Microsoft is getting. Who knows, maybe Microsoft is still very undervalued.

[ni-co]

we can all agree to disagree - 22.5x 15E, nike is on a upswing, gaining market share, Adidas/Puma/Reebok are absolutely getting crashed (check the number of profit warnings from these 3), only worthy competitor in performance athletic wears is UA, it is in a virtuous cycle of taking market share and able to spend more on marketing and R&D

 

Adidas/Puma/Reebok are all playing in the higher end, right? The low end is a zillion semi no-name brands, but Nike isn't really competing against them. They'd rather have profit-share than market-share, right?

 

So who's threatening Apple in the higher end, the only area where they play? Who's nipping at their heels to offer the very best overall customer experience? Samsung? HTC? Motorola? Xiaomi? LG? Lenovo? Huawei? Nokia? Blackberry?

 

But we can agree to disagree.

 

Yes, Apple has a strong and defensible niche in the high end. HTC, Samsung, and Xiaomi are strong competitors but still not good enough for many. What do you think the right multiple should be for Apple? The high end smartphone market is a mature market and competitors are not going away anytime soon. Maybe the market multiple is fair? That gets us slightly over $700, not really a reach. I wouldn't pay a higher multiple for Apple than the multiple that Microsoft is getting. Who knows, maybe Microsoft is still very undervalued.

 

I think you're underestimating how important it is that the market underestimates the stability of AAPL's cash flows.

 

With its current balance sheet, AAPL could easily buy back 20-30% of their current market cap over the next 2 years. If you're willing to give them only a long term market multiple of 15 that's your upside from here. Not bad, but not that attractive either.

 

However, this doesn't take into account that AAPL creates enormous free cash flows. I'd say AAPL's cash flows over the next 5-10 years are a lot more certain to stay on current levels or increase than for example MSFT's. Macs and iPods clearly show that AAPL can keep up high margins in very competitive markets over long periods. Evenly important: It has always been in AAPL's DNA not to squander this cash – something the market doesn't give it credit for at all. Moreover, AAPL under Tim Cook has vastly improved its capital allocation. He is no Singleton, for sure, but Cook's clearly going into the right direction.

 

A company with these cash flow creation abilities and good capital allocation is much more valuable than an average S&P500 company, regardless of its size. This is where I think market sentiment is still wrong.

 

Please note that this is about AAPL as is. I haven't mentioned their growth opportunities at all. This is where the market is staring towards, thereby completely forgetting that AAPL is this cash machine. To me, growth opportunities add only optionality. That said, there is a vast opportunity re. tablet growth, AAPL gets zero credit for. There is also vast growth opportunity in the traditional PC market (it's true that this means they have to gain market share there, but they are clearly on track to do just that). The kicker is new categories, though that's too speculative for me to pay up for it in any way.

 

This completely differs from the market view, in which AAPL "has to" come out with new categories to defend their position.