Sunday, January 10, 2016

Making Sense of Apple's Valuation

When Apple’s stock price moves significantly it is hard not to pay attention.  The company is iconic and its products are everywhere.  Apple’s stock price hit a high of $134.54 on April 28, 2015.  It closed on Friday at $96.61, a drop of $37.93 or more than 28%.  That translates into the disappearance of more than $209 billion in equity valuation.
The question, of course, is why the drop?  The popular answer in the financial media is a shortfall in the sales of the new iPhone 6s and 6s plus.  This shortfall has been inferred from reported slowdowns in the sales of Apple’s suppliers.  Some fear the shortfall could be as large as 25 to 30%.  But what does that mean in dollars per share?  Apple earnings over the last 12 months were $50 billion.  The iPhone accounted for about 70% of that.  This means that a shortfall of 25-30% in iPhone sales in fiscal 2016 translates into lost earnings of about $10 billion or less than $2 per share, not $38.
Remember that the value of a company is the present value of its expected future cash flows.  Holding the discount rate constant, for Apple’s stock price to fall by 28%, its expected cash flows, in all future years, must drop by that percentage.  The story, therefore, cannot be the iPhone 6s and 6s plus unless the issues with those phones has led to doubts about all future Apple products – both future iPhones and other new products yet to be introduced.  But what is the bad news that could have caused such a reassessment of all Apple’s future products?  By most accounts, the Apple watch has lived up to expectations.  Mac computer sales have held up well despite the lack of new machines which are expected soon.  So what bad news vaporized $209 billion of market value?  As far as I can tell there hasn’t been any.  As always, Apple is secretive about new products and it is those new products that will produce essentially all the future cash flow.
This means one of two things and both are related to investor sentiment.  One is that the high price of $134.54 was unrealistic.  Perhaps the result of irrational exuberance related to the introduction of the iPhone 6.  The other is that the current price of $96.61 has been artificially depressed because of the negative buzz surrounding the iPhone 6s.  A reading of analyst reports indicates that most accept the second hypothesis because they retain price targets in the $130s.  But clearly all the people selling the stock for less than $100 have a different view.
This what makes valuing companies like Apple so difficult and makes the market so mercurial.  Almost all the value comes from unknown future products.  Investors attempt to infer the success of those future products from scraps of information about current products.  But those scraps are far too meager to be able to draw any reasonably accurate conclusions.  Instead, they serve as catalysts for sentiment that drives the price up and down in the short run.  If only there were a way to tell when that sentiment was overdone – if only.

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