Always Question What You Read From Financial Publications

I recently clicked on this attention-grabbing headline, “Apple's Bizarre Valuation: Something's Got to Give,” and felt compelled to comment on the article after reading it. The article starts with the following graphic.

There’s one other graphic in the post.

Looking at these graphs and the title of the article, “Apple's Bizarre Valuation: Something's Got to Give,” you probably already guessed that the author concludes Apple’s (AAPL, Financial) valuation is low and Amazon’s (AMZN, Financial) stock price should fall. These two graphics, a short blurb about Amazon’s low profits and a quote from a random “expert” are basically the entire article. That’s it. There’s no further qualitative or quantitative discussion. There’s not even a disclaimer telling readers to do more research or investing is difficult or you can lose money.

What’s disappointing is that this article was published on Fortune’s website, a widely viewed and reputable publication. This specific post on Apple was unusually bad so I singled it out, but I don’t want to pick on Fortune. I often find content from other mainstream financial sources whether it be TV, radio or print, to be nearly as shallow and misleading.

The points are:

1. Be careful who you trust. I tend to think in economic terms by questioning people’s incentives. I believe the mainstream financial press’ incentive is to get views for advertising dollars. In that model, sensational headlines and controversial conclusions draw more attention than nuanced articles with accurate information. For instance, the author writes, “Amazon, by today’s valuation, is worth 80 Apples.” The number 80 comes from dividing Amazon’s PE ratio of 912.59 by Apple's PE ratio of 11.43, not by citing market capitalization or enterprise value where Apple is much bigger.

2. Don’t assume headline numbers are accurate or that they tell the whole story for a company’s prospects. Here are some examples from this particular article.

• In the first table, Microsoft (MSFT, Financial) has a trailing 12-month PE ratio of 36.44. The PE ratio is high because of an impairment charge that Microsoft took for its purchase of Nokia. From Microsoft’s most recent 10-K: “During the fourth quarter of fiscal year 2015, we recorded $7.5 billion of goodwill and asset impairment charges related to our Phone Hardware business.” Microsoft is unlikely to have recurring impairment charges of that magnitude. If you back out the Nokia impairment charge, Microsoft would have a TTM PE of 22.
• The article implies that Apple’s valuation is low because of its TTM PE ratio of 11.43. This ignores the fact that Apple had a phenomenal past 12 months where net income grew 35% over the previous 12 months. Many consumers upgraded to the larger display Iphone 6 and 6s devices. Simply looking at Apple’s trailing PE ratio ignores the risk that the last 12 months could have been the peak of a product cycle and earnings may fall in the future. Falling earnings would raise the PE ratio.
• For someone to dismiss Amazon, Facebook (FB, Financial) and Google purely by looking at TTM PE ratio, one may overlook the possibility that these companies could outperform expectations. These companies are not cheap. However, each of these companies have immense competitive advantages and a history of monetizing new products and services. In my last post, Whitney Tilson discusses his admiration for Google and Facebook’s business models. Amazon also has an enviable division with Amazon Web Services, which has experienced explosive growth in the last year. For the most recent quarter, Q3’15, AWS reported $2.1 billion in revenue and $521 million in operating income. Revenue rose 78%, and operating income rose 432% year over year.
• In the second table titled “Free Cash Flow” (FCF), the author is actually using “Cash Flow from Operations” numbers which is not the same thing as FCF. FCF is “Cash Flow from Operations – Cash Flow from Capital Expenditures.” Here are the figures for cash flow from operations and free cash flow for the last 12 months.

In this post, I write more about how companies misrepresent earnings and elaborate further on why people shouldn’t take headline numbers at face value.

Disclosure: Long Apple and Microsoft