Apple Added to the F Wall Street Portfolio
September 18, 2008 | Joe Ponzio | about: AAPL
Yesterday I added Apple to the F Wall Street portfolio to the tune of 10% of our portfolio. I started watching it as it dropped below $160 on September 5th – the low end of my estimation of Apple’s intrinsic value. Let’s take a look at the purchase.
We first looked at Apple on October 23, 2007. At the time, it was trading between $182.76 and $188.60, and I felt it was somewhat overpriced, and that Apple was a $150-$180 per share business in 2007. No matter how exciting Apple’s story was, I couldn’t overpay for the “right” to own Apple’s stock.
(Interestingly enough, pretty much everyone who writes about Apple and doesn’t call for Apple $1,000 by the end of the week/month/year is an idiot in the eyes of the very vocal Apple-lovers around the web.)
At any rate, I didn’t think Apple was a $186 business last year. So, when it topped $200 in December of 2007, I didn’t bother looking at it any more. Appearing 30% or more overpriced relative to the company’s intrinsic value, I put Apple on the back burner and began looking for other opportunities.
Falling From Grace
By February 26, 2008, Apple had fallen to as low as $115.44. This can happen a lot with “exciting” businesses – people buy the stock because they love the products and the price is zooming upwards. Soon, everyone wants to get on the bandwagon. The Yahoo! Finance forums are a great place to go to follow irrational joy and fear. Just look at what the people were saying in November and December of last year.
Then, the price begins to drop and, as it drops, more and more sales come in. Regular people that thought the stock was exciting begin to see their holdings drop – $190…$180…$170.
Oh my gosh. I’m going to lose everything. What was I thinking buying a $200 stock?
By the time Apple had bottomed out, investors that followed the hype and bought at $203 expecting, as one Yahoo! yahoo said, $650 a share by the end of 2008, were down as much as 43%.
Unfortunately, one of the problems of running a website and a business and a life is that I can’t always run to my computer to write a post about what I’m buying or selling. So, F Wall Street missed an opportunity to add Apple to its portfolio.
Keeping an Eye on Apple
Over the next seven months, I kept an eye on Apple, looking for an opportunity to buy under $125 or so. I figure Apple to be a $160 to $180 business in 2008; so, a 25% margin of safety (because it is a larger, more stable company) would put me in somewhere between $120 and $135.
By April of 2008, the price had climbed outside my comfort zone, and I had to wait. For five months, Mr. Market would not play nice. Apple stayed in that $160-$180 range, and I had to ignore it entirely. If things play out perfectly for Apple, buyers at $160 or $180 can stand to make nice returns over the long-term.
But, things don’t always play out perfectly. “Exciting” is not a good enough reason to ditch a margin of safety.
A Dozen Roses for Mr. Market
Yesterday was a different story. As Apple’s price began its September spiral down – opening at $172.40 on September 2, 2008 and dropping as low as $120.68 yesterday – it slowly moved its way up my radar. Yesterday, Mr. Market presented an opportunity to buy, and I put 90 shares into the F Wall Street portfolio – about 10% of the portfolio’s assets – into Apple at $122.50.
The Plan for Apple
I like Apple. I like their products. I like their commercials. But, it won’t qualify as a “permanent” holding in the F Wall Street portfolio. If and when Apple gets back to the fair price range of $160 to $180, I’ll sell and look for another opportunity.
Filed under: Companies Analyzed (Generals)
Related Stocks: AAPL
Hey Joe, nice to see you pull the trigger!
I have one question about your rationale:
I really want to know WHY you wouldn’t permanently hold AAPL? Would it be the case EVEN IF the value increased? (this would be contradictory which is why I’m asking)
Awesome week for us 
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Hey Joe,
I ran AAPL on the fwallstreet_model-modified-for-sp500-2003-version-11
The ‘dashboard’ shows
Price Share Value Buy under
$140.91 $64.95 $48.71
also…
Company Valuation
Total Value $57,743
Per Share Value $64.95
Desired Margin of Safety 25%
Purchase Price $48.71
Current Price $140.91
Actual Discount 0%
Total Shares (Millions) 889.0
Questions:
Do you use this template in your valuation ?
What justifies your purchase in the $100’s range? (is the valuation from this template completely wrong ? )
Look forward to hearing from you ! Thank-you for your time.
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Alex, Joe – I hope you don’t mind if I step in to help answer Alex’s question.
It seems that the growth and discount rates you are using in your model differ from Joe’s assumed rates in his valuation.
From Joe’s October 2007 post (linked above) on Apple:
“Let’s assume Apple can grow owner earnings at 25% for the next two years. Then, growth will slow to 20% for the following two, ultimately capping off at 15% for years 5-10. After that, growth will slow to 5%.
Using a 9% discount rate, the value of Apple’s future cash would be $126.7 billion. Add in $13 billion%u2014the last quarter’s shareholder equity%u2014and Apple’s value comes in around $140 billion. With 880 million shares outstanding, Apple’s intrinsic value lies in the $159 per share range.”
In the comments section of the Oct Apple analysis, there is also a link to “What discount rate should I use?”
Just keep in mind that Discounted Cash Flow (DCF) models are extremely sensitive to the growth and discounts rates you are assuming, as well as the “jump off” Free Cash Flow (FCF) value the model uses (the Excel spreadsheet uses the most recent year’s FCF as the starting point, which may not always be a realistic assumption).
That’s why I’ve doctored the Excel spreadsheet that you and I use to allow for the user to change the last free cash flow cell to input your own estimate, much in the same way that the sheet lets you input your own growth and discount rates.
All of this should just remind you why we need to allow for that “margin of safety”. The DCF valuation is really an estimate, no matter how many decimal points you choose to put on the value.
Hope this helps.
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Alex – It just occured to me that you might ask how Joe came up with his growth assumptions.
Because the Excel spreadsheet shows a FCF Growth Rate of 5.6%, right?
To understand this, you have to understand how the model estimates the future growth rate.
If you look at the formulas used, you will see that the calculated FCF growth rate is the median FCF growth rate of several selected time periods (1998-2005, 1996-2006, 2000-2007, 1998-2003, 1999-2004, 2000-2005, 2001-2006, 2002-2007).
You’ll notice that the FCF growth for 2001-2006 and 2002-2007 in the spreadsheet is 0.0%. How is that possible? If you look at the row above showing FCF by year, you’ll see that the FCF for 2001 was -$47 million, and 2002 was -$85 million. The FCF for 2006 was $1.563 billion, and 2007 was $4.735 billion. What happens is that the formula can’t compute what the growth rate from a negative number to a positive number is, so it comes out as zero! (And really, what is the growth rate from -$85M to $4.735B? All I know is that the company did a great job!).
Those 0% years drag down the median FCF growth rate over the time periods.
So you can’t blindly take the median FCF that the spreadsheet calculates. This is why projecting the growth rate is an art combined with the science of mathematics. It works great if the company has a long history of positive cash flow, and the flow is predictable. But sometimes you don’t even have ten year’s of data. The model also gives you a distorted FCF calculation in those instances. There are so many ways to calcuate the future growth, you can eyeball the year-by-year growth, look at three year periods’ growth, factor in management’s CROIC (Joe’s got a post on that, too), or just throw caution to the wind and guess. Whichever one ends up being the “correct” rate is dependent on a mix of experience, past performance, and luck. I would suggest that you never assume a growth rate of more than 25% for more than 10 years, but I should never say never. Let’s just say that those types of growth scenarios are either unlikely and/or require everything to fall into place exactly. That’s not exactly valuing stocks with a margin of safety.
OK, that was quite a lot of writing, but as you can see I’m enthusiastic about this stuff, and I hope I’ve shared with you what little I know about attempting to value stocks based on the future owner earnings (yes, it’s a little different than free cash flow, so I’ll plug Joe’s explanation of it, because you can buy it here on his site. No, I don’t know Joe personally!) of the business without trying to sound like I know it all.
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Thanks Allen!
Excellent answers. Clear, definitive, and well-explained, much appreciated. Just to let you know, it was the zero’s that came up under 2001-2006 & 2002-2007 that were throwing me off. Once i made adjustments in the FCF and banished the negative numbers (while adjusting the others to even it out), the valuation started to come together (in my head!) and on the spreadsheet.
It is amazing to see how much the valuation changes after making the correct modifications. Thank you for your insight, I will make sure that i am more careful in examining where the rates are coming from.
Thanks again,
Alex
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Hey mosguy, its interesting you would say that…..without properly understanding the POINT of the spreadsheet.
Heck, you could do it on a piece of paper, its called Fundamental Analysis and DCF method for Intrinsic value.
As much as the Assumptions are correct, the spreadsheet WILL give you VALUABLE information as to whether the stock is overpriced or undervalued.
Nobody said the spreadhseet should be used in making a FINAL decision!
It is the BASIS of PRELIMINARY research to weed out opportunities from the rest.
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Mosguy,
Like Amit said, a discounted cash flow analysis is only one part of determining what the intrinsic value of the company is.
It helps to have a spreadsheet when you are doing DCF analysis for hundreds of companies.
Each company has many factors to consider, some unique to that one company, which may fall outside the scope of a spreadsheet’s valuation.
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Amit D: I look at Apple today and it appears underpriced relative to the business’ value. The question is: Who will be the leader ten years from now? I don’t have the confidence — today — to declare Apple a permanent holding because I don’t have any reason to believe — with any true confidence — that it is virtually guaranteed to be the leader ten years from now.
Alex MacKinnon: I don’t use that — or any “super spreadsheet” — in my valuations. Sometimes I’ll open Excel to work out the numbers; sometimes I’ll figure it out in my head. That said, a big thanks to…
Allen: Thanks for clarifying things! I couldn’t have put it better myself. Those are the flaws of automatic spreadsheets. I can’t stress enough — investing is 99% art. The 1% science that goes into the spreadsheet can really mess things up if you don’t look at the rationale and provide your human input and reasoning into the numbers.
I don’t think spreadsheets are bad…unless they lead an investor to blindly trust the past to predict the future. Spending a month running a business will give any investor a whole new appreciation for not relying on the past. Every day, we have to fight to grow revenue at our company. The fact that it grew x% last year offers very little insight into this year’s growth (or shrinkage) without an in-depth understanding of the business and our management.
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I just want to add to what Mosguy said by mentioning Munger. You can calculate, chart and manipulate the numbers all you want but try not to get too “physics envy” when making an investment. I like to first understand the business and the fundamentals of how the business works. From this you can derive how the business will operate in the future. It will also help with calculating growth rates, earnings expectations, future revenue, profit margins, etc.
To me, I think it’s more important that the “business” jumps out at me rather than the “value” in the business. When they both them come together, you have found a wonderful thing. Remember what Buffett said… “Time is the enemy of the poor business and the friend of the great business. ”
With that said, I do look for “asset” plays, where the value of business is significantly greater than the break up price or it’s trading at 2-3x cash flows plus a lot of liquid assets on hand. Like Joe said, these are not “permanent” holding. An excellent example is Buffett’s purchase of Sanborn Maps in late 1950s. Joe has a post on that too.
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Joe – to follow up on Edward – What are your thoughts on DELL ? The FCF looks a little more stable than AAPL, though certainly not the explosive growth Apple has shown in the past 10 years. The two might be an interesting comparison for an article.
Appreciate as always.
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Apple closed at $105 with a market cap of $93B. Their June 28th balance sheet shows $20B in cash and short term investments. $27B in total assets (cash and short term investments included). The cash to price ratio looks interesting but you never know with these markets.
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I personally find AAPL to be an attractive buy right now (closed at about 100 today) and have been buying this week. While I am seeing this as a value play, I just read about Whitney Tilson (of the Value Investing Congress) being short Apple, even at its current price. It is interesting how value investors can look at a company and see it so completely differently…
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Mr. Market is already slowly coming to his senses. As I write, Apple is selling for a little above $141 per share.
A plus ten percent gain in one day is not too shabby!
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