Tuesday, June 12, 2012

Apple: My Largest Position

I have long been a fan of the Apple’s products. I have an iPhone 4 and before that an iPhone 3, I have old iPod Nano and Shuffle, and back in university I had an 11’’ Powerbook, which despite giving me a “cool” factor, turned out to be an awful experience. Besides this I’m thinking of buying an iMac and patiently awaiting the new iPhone. So you could say I’m a bit of an Apple junkie. These days it’s hard not to be …

Shame on Me!

This said, one of my big “misses” was not buying Apple shares when I first realized that headphones were magically turning white all around me. As if that wasn’t enough, I failed to see the obvious once I bought my first iPhone, and then again when I exchanged it for a new model. Instead of making my annual contribution to Apple’s investors I should have been one of them. Thankfully I came to my senses last year when I started building up a position in Apple shares.

What really matters

Despite being the most appreciated and followed company in the World, I feel it is misunderstood by most. Allow me to explain. The market is constantly worried about what Apple’s next iPhone or iPad is going to be like, what the next quarterly sales will be, the patent war with Google and Samsung, if Siri doesn’t understand the Irish or the Canadian, if Tim Cook is the man for the Job, etc. Some of these are valid concerns, but they don’t focus on the big picture. Apple’s most important asset is the ecosystem it created, call it the Apple Ecosystem.

Apple managed to create an ecosystem where a user has a seamless experience between all Apple products. What this does for Apple is create customer loyalty. Once you buy an Apple product, say an iPhone, you are very likely to do two things: 1) When the time comes to buy a a MP3 player, a tablet, a laptop, etc you will most likely chose Apple, as it will work in sync with your other device(s), 2) when time comes to buy a new phone, chances are you will stick with Apple. Last November UBS issued a survey that stated that the iPhone has an 89% retention rate, blowing past the closest competitor (HTC with 39% retention). Customers are willing to stick with Apple, even if the competition offers faster and/or cheaper gadgets. It is all about the ecosystem.

This ecosystem is the propeller behind Apple’s amazing sales growth.

Every day, on my way from work, I pass by an Apple store, and let me tell you, for a company that has so few products, and only updates then once a year (at best), it is mighty impressive to see that the store is always packed. And when Apple launches a new product, there is a line at 8 am that goes around the block. No wonder that, at $5’647, Apple has the highest sales per sq. ft. among retailers. This is the sort of thing that makes me a happy shareholder.

 Source: retailsails.com (2011)

Another important piece of the puzzle is that Apple is becoming more enterprise friendly: according to CEO Tim Cook, 92% of the fortune 500 companies are testing or deploying the iPad (this was last October). Besides this, Apple is also trying to get into the classroom, as it pushes the iPad as a useful tool for students. These two markets are huge and relatively untapped.


Last quarter Apple reported a YoY sales growth of 58%, a growth in net income of 93%, and profit margins expanded from 24.3% to 29.6%. The company is debt free and the stock is trading at a trailing PE of 14. If you back out the cash the PE shrinks to a measly 11. This compares to an inexpensive multiple for the S&P500 of 13 and 15.5 for the Nasdaq 100.

Please do take a moment to let those numbers sink in.

One of the popular arguments to “explain” Apple’s valuation is the law of large numbers. The company can’t keep growing at this level for long. I agree, the growth rate should decline during the next years, but its current price, the stock is priced for no growth at all. Another favorite reason is that if you assign a multiple of 20 (x-cash), this would mean that Apple’s market capitalization would be $1 trillion, and that is just too much. I wonder what happened when the first company was close to the $1bn mark, and the $10bn and even the $100bn mark. Back then that should have been unimaginable as well.

At this price the best thing Apple could do is start buying back shares, aggressively. Despite already haven approved a buyback and started paying a dividend and don’t think Apple will be aggressive in this field.

Happy to own it

I have a high conviction that the shares are considerably undervalued, and because the situation seems so clear to me, I have already backed up my truck and made Apple my largest position. 

Disclosure: Long Apple

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