As recently as the late '90s, Apple (AAPL, Financial) was left for dead. Microsoft had crushed them in the PC wars, and their products were basically relegated to niche markets and nostalgic fans. In 1997, the company even needed a $150m bailout by arch-nemesis Microsoft just to stay alive.
Now, just 15 years later, the company is the world’s most valuable, having surpassed behemoth Exxon Mobil with a market cap approaching $420B. And despite being the world’s most valuable company and seeing their stock price rise almost 4000% over the past ten years, there’s reason to think there’s further room to run in the shares. The company trades at a reasonable EV / EBITDA of 7.0x, they’ve got almost a quarter of their market cap on their balance sheet in cash (almost $100B!!!), and their reasonable valuation combined with their ridiculous returns on capital just put them on the magic formula list for the first time.
So would investors be well served to put money into the company today? Or would they be better off admitting they’ve missed one of the historic 10 year stock runs and instead investing elsewhere?
Magic formula characteristics
Let’s start by looking why they’ve finally made the magic formula. With a market cap of $417B and $98B in cash and investments, the company has an EV of $319B (note: sites like yahoo! Finance list the EV higher than it actually is because they ignore all of Apple’s long term investments in the EV calculation). With trailing twelve month EBIT coming in at $47B, Apple trades for just 6.8x EV / EBIT. And while that’s not the cheapest valuation we’ve ever seen, it certainly is cheap. Warren Buffett has said before he likes to buy world class businesses at under 7x EV / EBIT.
At today’s prices, Apple qualifies on the under 7x EV / EBIT front. And it certainly qualifies as a world class business right now.
You can see what a world class business Apple is in its ROIC calculations. Because of the strong demand for their products and the pressure their market power allows them to put on their suppliers, Apple is able to finance their whole business basically on their supplier’s dime. Tangible invested capital comes in around $5B, versus their EBIT of $47B. In other words, Apple is currently earning almost 1000% ROIC!
On those measures, Apple certainly looks attractive. But let’s dig a little deeper.
Competitive Advantages
So what competitive advantages does Apple have that allows them to earn such outstanding ROIC?
There are three main ones.
The first is, quite simply, they have an ability to develop intuitive products that people want, even if the consumers don’t realize they want them at the time. In the past ten years, this has been Apple’s biggest strength and has led to the creation of products like the iPhone and iPad. But you have to question how sustainable this “advantage” will be in the future. History has shown time and again that the company that creates today’s hot products will make tomorrow’s lemons. For proof, just look at smartphone market and glance at Palm. Or RIMM. Or Motorola. Will Apple be able to avoid their fate and keep turning out products people love without Steve Jobs at the helm and with fierce competition from Google’s Android and Microsoft barreling down???
Related to this is the synergies between Apple’s product line. Once a consumer buys an iPod and has iTunes on their computer, it’s just so much easier for them to buy an iPhone or iPad. After all, they’ve already got iTunes set up with all of their stuff, so why bother buying some other product that would require substantial work to load music, videos, etc.
However, it’s questionable how strong this edge will be going forward. Consumers are storing more and more of their things on the cloud, not the desktop. And as that shift continues, it will be much, much easier to access music and files stored in the same cloud from different operating systems.
Fortunately for Apple bulls, the last one is much more sustainable. And while the previous two have been big pieces of Apple’s edge in the past, the last one will be their strongest differentiator going forward.
The second advantage is the network effects of their app store. Let’s face it, the apps are what make the iPad and iPhone great. They are the lifeblood of smartphones. Developers design apps for the iPhone (and Android) because that’s where all the customers are. Customers buy the iPhone (and Android) because all the apps are on those two systems. That’s a vicious cycle for someone like Microsoft or RIMM to try to break into with a new smartphone system, or for Kindle to break into the tablet market.
Remember, it won’t be enough for new entrants to just release a better operating system anymore; new entrants also need to do something to lure developers to create apps that will attract consumers. And, of course, to do that, they’ll need to attract consumers to their system. One way to do this is to sell the product at below cost, like the Kindle Fire is purportedly doing, but that requires deep pockets and normally an ulterior business motive (in Kindle’s case, Amazon is trying to drive more sales from their site).
Conclusion
So, what should investors do with Apple?
It’s really a matter of personal preference. It’s tough to see how much further Apple can grow, or what other markets they could access. Of course, that’s what people said before the iPhone came out. And then before the iPad. Reports have Apple eyeing the TV and possibly the textbook market, but it’s also questionable how much those could add to Apple’s bottom line at this point.
But even with those questions, Apple doesn’t really have to grow that much for investor’s at today’s prices. The company is priced relatively inexpensively, and it seems pretty probably that investors in Apple will do better than the market over the next few years.
But for more enterprising investors who are looking to substantially outperform the market, Apple isn’t the place to look. The company is no longer a tiny underdog with substantial room to run. It’s now a behemoth, the largest in the world, and it’s going to find it harder and harder to grow in the future. The fact is that this just isn’t the company that investors looking for huge gains and five baggers should look at anymore.
Instead, they need to look for smaller companies with significant room to run and competitive advantages and return characteristics similar to Apple. That’s what we look for at GuruFocus’s own Micro Cap Magic Formula Newsletter. So far, the results have been pretty encouraging, and our portfolio still looks incredibly cheap compared to the overall market.
Now, just 15 years later, the company is the world’s most valuable, having surpassed behemoth Exxon Mobil with a market cap approaching $420B. And despite being the world’s most valuable company and seeing their stock price rise almost 4000% over the past ten years, there’s reason to think there’s further room to run in the shares. The company trades at a reasonable EV / EBITDA of 7.0x, they’ve got almost a quarter of their market cap on their balance sheet in cash (almost $100B!!!), and their reasonable valuation combined with their ridiculous returns on capital just put them on the magic formula list for the first time.
So would investors be well served to put money into the company today? Or would they be better off admitting they’ve missed one of the historic 10 year stock runs and instead investing elsewhere?
Magic formula characteristics
Let’s start by looking why they’ve finally made the magic formula. With a market cap of $417B and $98B in cash and investments, the company has an EV of $319B (note: sites like yahoo! Finance list the EV higher than it actually is because they ignore all of Apple’s long term investments in the EV calculation). With trailing twelve month EBIT coming in at $47B, Apple trades for just 6.8x EV / EBIT. And while that’s not the cheapest valuation we’ve ever seen, it certainly is cheap. Warren Buffett has said before he likes to buy world class businesses at under 7x EV / EBIT.
At today’s prices, Apple qualifies on the under 7x EV / EBIT front. And it certainly qualifies as a world class business right now.
You can see what a world class business Apple is in its ROIC calculations. Because of the strong demand for their products and the pressure their market power allows them to put on their suppliers, Apple is able to finance their whole business basically on their supplier’s dime. Tangible invested capital comes in around $5B, versus their EBIT of $47B. In other words, Apple is currently earning almost 1000% ROIC!
On those measures, Apple certainly looks attractive. But let’s dig a little deeper.
Competitive Advantages
So what competitive advantages does Apple have that allows them to earn such outstanding ROIC?
There are three main ones.
The first is, quite simply, they have an ability to develop intuitive products that people want, even if the consumers don’t realize they want them at the time. In the past ten years, this has been Apple’s biggest strength and has led to the creation of products like the iPhone and iPad. But you have to question how sustainable this “advantage” will be in the future. History has shown time and again that the company that creates today’s hot products will make tomorrow’s lemons. For proof, just look at smartphone market and glance at Palm. Or RIMM. Or Motorola. Will Apple be able to avoid their fate and keep turning out products people love without Steve Jobs at the helm and with fierce competition from Google’s Android and Microsoft barreling down???
Related to this is the synergies between Apple’s product line. Once a consumer buys an iPod and has iTunes on their computer, it’s just so much easier for them to buy an iPhone or iPad. After all, they’ve already got iTunes set up with all of their stuff, so why bother buying some other product that would require substantial work to load music, videos, etc.
However, it’s questionable how strong this edge will be going forward. Consumers are storing more and more of their things on the cloud, not the desktop. And as that shift continues, it will be much, much easier to access music and files stored in the same cloud from different operating systems.
Fortunately for Apple bulls, the last one is much more sustainable. And while the previous two have been big pieces of Apple’s edge in the past, the last one will be their strongest differentiator going forward.
The second advantage is the network effects of their app store. Let’s face it, the apps are what make the iPad and iPhone great. They are the lifeblood of smartphones. Developers design apps for the iPhone (and Android) because that’s where all the customers are. Customers buy the iPhone (and Android) because all the apps are on those two systems. That’s a vicious cycle for someone like Microsoft or RIMM to try to break into with a new smartphone system, or for Kindle to break into the tablet market.
Remember, it won’t be enough for new entrants to just release a better operating system anymore; new entrants also need to do something to lure developers to create apps that will attract consumers. And, of course, to do that, they’ll need to attract consumers to their system. One way to do this is to sell the product at below cost, like the Kindle Fire is purportedly doing, but that requires deep pockets and normally an ulterior business motive (in Kindle’s case, Amazon is trying to drive more sales from their site).
Conclusion
So, what should investors do with Apple?
It’s really a matter of personal preference. It’s tough to see how much further Apple can grow, or what other markets they could access. Of course, that’s what people said before the iPhone came out. And then before the iPad. Reports have Apple eyeing the TV and possibly the textbook market, but it’s also questionable how much those could add to Apple’s bottom line at this point.
But even with those questions, Apple doesn’t really have to grow that much for investor’s at today’s prices. The company is priced relatively inexpensively, and it seems pretty probably that investors in Apple will do better than the market over the next few years.
But for more enterprising investors who are looking to substantially outperform the market, Apple isn’t the place to look. The company is no longer a tiny underdog with substantial room to run. It’s now a behemoth, the largest in the world, and it’s going to find it harder and harder to grow in the future. The fact is that this just isn’t the company that investors looking for huge gains and five baggers should look at anymore.
Instead, they need to look for smaller companies with significant room to run and competitive advantages and return characteristics similar to Apple. That’s what we look for at GuruFocus’s own Micro Cap Magic Formula Newsletter. So far, the results have been pretty encouraging, and our portfolio still looks incredibly cheap compared to the overall market.
