Admiring Apple (AAPL)

– Apple Inc (AAPL) makes the Macintosh personal computer, iPod music player, iPhone smart cell phone and, two months ago, began selling its iPad device (a book reader/web surfing tablet). 

– These products are all elegantly designed, sold in Apple retail stores that are fun to shop in and buzz with excitement, and the company has the CEO of the Decade, according to Fortune magazine, Steve Jobs. 

– AAPL was the Online Stock Study in May at the Better Investing website that was led by Mike Torbenson, education director at the BI Puget Sound chapter.  

** Mike’s presentation slides, the recorded webinar (78 mins), the latest 10K and 10Q reports, and the Value Line report are all available to BI members. 

Company Background: 

S&P Stock Report: 

 – S&P reported AAPL’s CY 2009 sales as: 35% Macintosh computers (11 Million units shipped), 26% iPhones, 20% iPods (over 25 Million sold), and 10% music related. 

Mike’s Presentation: 

– In the last 15 months (1/09 to 3/10), AAPL’s price rose 350%, from $78 per share to $272. 

– In 2009, revenue by product grew (or declined)  as follows: iPod down (-2.5%), Mac up 7%, and iPhone up a whopping 93%.

** AAPL has 11% of the smart-phone market with NOK at 41% and RIM at 20% which Mike thought left lots of room for growth. 

– The iPad was introduced in April 2010 and sold 1 million units faster than the iPhone.  The iPad is now in the “early adopters” phase of growth with lots more room to grow. 

Fortune magazine’s CEO of the Decade: 

– In the past 10 years, Fortune wrote, Steve Jobs “has radically and lucratively reordered three markets — music, movies, and mobile telephones — and his impact on his original industry, computing, has only grown.”   

– In addition, he has “creat[ed] more than $150 billion in shareholder wealth….and profoundly influenc[ed] the worlds of retail and design.” 

– AAPL was worth about $5 billion in 2000, according to Fortune, just before Jobs implemented its “digital lifestyle” strategy, and today, at about $170 billion, it is slightly more valuable than GOOG. 

The New York Times: 

 – On May 26, the Times reported that AAPL had passed MSFT to become the world’s most valuable technology company.   

– Calling it the end of one era and the beginning of the next, the Times profoundly realized that the “most important technology product no longer sits on your desk but rather fits in your hand.” 

– On May 30, the Times reported that the iPad had sold 2 million devices in less than two months,  an average of 35,000 per day since its April debut. 

 Value Line: 

– VL was so impressed with AAPL’s growth prospects that it raised its EPS estimate by 40.00% for this year (FY 2010). 

– VL also thought that Apple’s long-term prospects looked “exceptionally bright.” 

Morningstar: 

– In April, Mstar raised its fair value estimate from $202 to $238 (with AAPL selling at $263.95) to reflect the iPad’s initial success. 

– Still, the star of Apple’s show, according to Morningstar, remains the iPhone given its large global market and infrastructure (175,000 apps and growing). 

SSG Discussion: 

– The following table compares SSGs by Mike (found only in the webinar recording) with mine, the Investment Advisory Service, and with Take Stock.  

** After the table, I discuss AAPL’s quality and several key SSG judgments as well as its financial condition.

Apple Inc                   (AAPL)	MikeT	ArminF	Take Stock	Investment Advisory Service (IAS)
Date	4-20-10	5-11-10	Same	3-10-10
Data	S&P	Same	Morningstar-Hemscott	S&P
Price	$270.83	$258.08	Same	$224.84
52 week High &          Low Price	$272.18 & $119.38	$272.46 & $119.38	Not Used	$224.48 & $89.58
Last Quarter of     Reported Data	Q2 ending       3-31-10	Same	Same	Q1 ending      12-31-09
Software Used	TK 6	Same	TS Online	TK6
Project Growth      From End of	Last Quarter	Same	Last FY	Last Quarter
Sales Growth	15.00%	17.00%	12.20%	17.00%
EPS Growth	15.00%             (PP)	17.00%	12.20% initial 08.23% final	17.00%
High PE	25.0	20.8                  (from 2009)	30.0	25.0
High EPS	$23.69	$25.83	$9.34	$19.91
High Price	$592.30           (20% > VL on 4-9-10)	$537.30           (8.5% > VL on 4-9-10)	$280.24         (23% < VL on    4-9-10)	$497.70          (8.2% > VL on 1-8-10)
Value Line Estimated High Price = $365-495 on  4-9-10 and $305-460 on 1-8-10
Low PE	16.0	9.5	13.1	15.0
Low EPS	$11.78	Same	$6.66	$9.08
Low Price	$125.90            (PVQ option)	$111.90             (Low PE x      Low EPS)	$87.25               (Same)	$136.20
Upside/Down	2.2	1.9	0.13                    (imputed)	3.1
Total Return	16.9%	15.8%	2.0%	17.1%
SSG Buy Under	N/A	$218.25	$135.50	N/A
RV/PRV                       (no outliers)	90.6/78.7	86.2/73.7	Not Used	96.6/73.9
Quality	N/A	S&P = B	TS = 6.3	IAS = 1.0
PTPM – 5 yr ave	19.6%                Trend up	19.6%                Same	18.3%                   Trend N/A	19/6%               Trend up
ROE – 5 yr ave         Ending Year Equity	N/A	21.5%               Trend up	Not Used	N/A
ROE – 5 yr ave          Begin Year Equity	30.4%            Trend up	Same                  Same	28.4%                   Trend N/A	30.4%               Trend up
Debt to Equity –       5 yr ave	-0-                      Trend even	Same                Same	Same                     Same	Same                Same

Quality:

– Before beginning his SSG, Mike evaluated whether AAPL was a quality company by looking at its past performance in SSG Sections #1 and #2.

** For historical Sales and EPS, he found that the last 5 years looked very good and the results from the most recent quarter (Sales up 49%, EPS up 86%) were excellent.

**  For historical Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE), he saw that the last 5 years were trending up and looked good while AAPL’s zero debt looked very good. 

** Mike also compared APPL to other technology companies and to its Value Line industry (Computer and Peripherals), and concluded that Apple was a quality growth company.

– A typical BI/NAIC approach to quality is to assess whether the graph lines in Section #1 are up (growth), straight and parallel (consistency) and also whether the trends in Sections #2A  and #2B are up or even.  

– And, S&P rates AAPL a B for Quality, 5^th out of eight grades, while IAS rates its Quality a 1 out of 5, most favorable.

Mike’s SSG:

Estimating Future Sales and EPS Growth:  

– Mike looked at several indicators to estimate Apple’s future Sales growth: its last 5 years growth (31.9%); VL’s 3-5 year estimate (15.5%); its last quarter’s growth (48.6%); and TTM Sales growth (40.7%). 

** Mike thought 15-20% seemed justified, so he chose 15.00% (presentation slides, PDF pages 24 & 25). 

** Value Line’s 15.5% estimate was actually for Sales per Share and VL does not make a Sales growth estimate. 

** 12.00% was Morningstar’s long-term Sales growth estimate and 28.17% was Zacks.com’s. 

– To estimate future EPS growth, Mike used the Preferred Procedure (PP) which involves making four other estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Taxes, and Shares Outstanding. 

** Relying on his 15.00% Sales growth estimate, he changed only one of the defaults: PTPM from its five-year average of 19.6% to last year’s 28.0%, a huge increase of nearly 8.5%. 

** His PP came to 15.40% EPS which he rounded to 15.00% to match his Sales estimate. 

** Instead of estimating 28.0% for the next 5 years, his PP would have been considerably different had Mike used 21.0% PTPM (last 2-year average), or 23.4% (last 3-year average).   

** Moreover, Mike could have also used VL’s estimated Taxes of 30.0% (instead of the default 31.7%), or VL’s estimated Shares Outstanding of 975.0M (instead of the default 969.6M). 

### I no longer use the PP because it involves too many estimates and too much guesswork for me: see Pondering The Preferred Procedure 

Armin’s SSG: 

Estimating Future EPS Growth: 

– When I did my SSG, the SEVEN analysts I ALWAYS check were estimating long-term EPS at an average of 18.85% with Value Line high at 23.00% and Yahoo Finance via Thomson Financial low at 17.10%. 

– Reuters.com was 17.69%, Zacks.com and CNNMoney via FactSet CallStreet were both 18.00%, Morningstar.com was 18.20%, and S&P via BI was 20.00%.  Reuters 11 analysts ranged from a high of 30.0% to a low of 5.00%. 

– I decided to use 17.00%, the lowest estimate (rounded) of the seven. 

### To learn more about Estimating EPS, click here.  

Forecasting the High and Low PEs: 

– Even though 2009 was unusually low (and well below the five-year average of 34.8), I chose to use its 20.8 as my Forecast High PE. 

– I thought 2009’s Low PE of 8.6 was too low to use for the next 5 years, so I used 9.5 for my Forecast Low PE which was proportional to my Forecast High PE (5 year average High PE / 5 year average Low PE = Forecast High PE / Forecast Low PE or “X”). 

Take Stock: 

– TS initially estimated 12.2% based on AAPL’s historic growth, but reduced that to 8.23% EPS by mechanically applying its version of the Preferred Procedure. 

– TS also used 30.0 as its Forecast High PE, the maximum it is designed to permit. 

Investment Advisory Service: 

– IAS is a pay service from IClubCentral which delivers three SSGs each month that satisfy the BUY criteria along with an explanatory narrative.  Its AAPL SSG was made available for free (but without the narrative explanation) at the StockCentral website.  

– IAS used 17.00% estimated EPS (which seems reasonable to me since I used the same value <grin>) and 25.0 & 15.0 Forecast High & Low PEs) which seem moderately conservative since 30.0 & 20.0 are often used as maximum limits. 

Final Results: 

– Of the four studies, only IAS satisfied the SSG Buy Criteria in March, but today, or even 3-4 weeks ago, its SSG would not: 

• Mike got a 2.2 U/D (min 3.0 required) and a 16.9% TR with a Forecast High Price that was 20% greater than VL’s estimate;
• I got a 1.8% U/D and a 15.8% TR with a Forecast High Price that was 8.5% greater than VL’s estimate;
• Take Stock got a .13 imputed U/D and a 2.0% TR with a Forecast High Price that was 23% less than VL’s estimate; and
• IAS got a 3.1 U/D and a 17.1% TR (last March when AAPL was selling for $224.84) with a Forecast High Price that was 8.2% greater than VL’s January estimate. 
• However, IAS’s SSG would not satisfy the Buy criteria at the price I used ($258.08) or at AAPL’s current price ($263.95 on 6/3).                                                             

– I analyzed Apple some 30 months ago (on 1/18/08) when it was selling for $171.25 per share and, unlike now, it was then not close to a SSG Buy; if you’re interested, click here. 

  Financial Condition: 

– Value Line gave Apple an A++ for Financial Strength, its highest grade.  The company had no debt and $2.5 billion of cash assets as of 12-26-09. 

– Morningstar found that Apple had a cash “hoard” of $34 Billion and an annual cash flow of almost $10 Billion which means, Mstar believed, almost unlimited financial flexibility. 

– The Bob Adams one-click Annual Report spreadsheet gave Apple a 60 out of 100 with 11 Bullish and 7 Bearish results: 

** The Bullish-good things include: no debt; sales are increasing and increasing faster than related costs; ROE gets a green flag (excellent); and free cash flow margin is also excellent. 

** The Bearish-not-so-goods include: accounts receivable are increasing; cash flow growth is not increasing as fast as sales growth; and the price to sales ratio gets the only red flag (danger). 

### Bob just updated his spreadsheet and the latest version is No. 4.14, dated 5-22-10. 

### You can get this super-duper, easy to use spreadsheet for free, along with an explanation of its many features, by going to my Favorite Links page: click here. 

 Armin 

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