It is no secret that Buffett tends to shy away from technology companies. One one side, people say he simply doesn’t understand them and can’t predict the future with any degree of certainty or comfort; on the other side of the fence, people say the industry changes too fast and today’s leader could be tomorrow’s old news.
The Apple Revolution
There is no question about it-people love Apple’s products right now. Years ago, the MP3 player hit the market-and then seemed to die almost as quickly. Then came the IPOD-and everyone wanted one.
Building on that, Apple recently released the Iphone, selling 1.4 million phones to date. And the Mac? Brilliant marketing (remember the “I’m a PC, I’m a Mac” commercials) helped bring Mac to the home user. The Mac isn’t sweeping the nation, but it is breaking into Microsoft’s market share-sitting comfortably now at 8%. As the de facto standard for graphic and video designers, web designers, programmers, etc., the Mac certainly has a future.
The Numbers Boost
What have these products done for Apple owners? In 2001 and 2002, Apple was running at negative cash flow, burning through some $500 million of excess cash in two years. Even 2003 was less than stellar, bringing in just $32 million of excess cash-a mere $0.02 for every dollar invested in the company.
As the IPOD took off (launched initially and slowly in 2001), so did Apple’s owner earnings. Between 2005 and 2006, the company generated in excess of $3 billion of owner cash. In the last twelve months alone, the company has produced more than $3.6 billion of excess cash-generating nearly $0.50 for every dollar invested in the company.
Turnarounds seldom turn. But, they do turn from time to time.
Putting A Value On Apple
How do you value a company like this? Remember that the value lies entirely in the future-no matter what has happened in the past. Everything we do must be an educated guess-and that is where we will start.
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-the last quarter’s shareholder equity-and Apple’s value comes in around $140 billion. With 880 million shares outstanding, Apple’s intrinsic value lies in the $159 per share range.
A Fair Assumption?
No company-not even Apple-can grow rapidly forever. Now, I’m not a huge fan of Wall Street; still, it doesn’t hurt to see what the analyst consensus is on Apple-just to see whether or not our 25% is hyper-aggressive or ultra-conservative (to the point of scared).
Yahoo! Finance reports that the average analyst estimate for Apple’s earnings growth is about 26% for the next year. I wouldn’t base my future on that, but it does provide a tinge of comfort that I’m not being scared with my numbers.
Is Apple Overpriced?
If you agree with the above assumptions, then yes. The stock price can do anything over the next few weeks and months; still, price follows value. If Apple were fairly priced today (about $186 a share), it would have to grow at 21% for ten straight years, at which point it would be generating $24 billion of excess cash each year.
More importantly,the new Apple is currently converting roughly 15% of its revenue into owner earnings. Even if we assume that this pattern could continue (before the iRevolution, it was converting about 1.6%), Apple would have to be bringing in $161 billion of revenue ten years from now. If it only converted 10%, it would have to be generating revenues in excess of $240 billion a year. That’s more than Motorola, Nokia, Microsoft, and Dell are generating-combined!
A lofty goal to say the least.
Apple: Growth At A Reasonable Price
There is certainly some growth left in Apple. Unfortunately, that growth doesn’t seem to be at a reasonable price-unless you think we’ll live in an Apple-dominated world in ten years. Then again, many are clamoring for a Google-dominated earth-and Google’s phone could be devastating to the Iphone. Or, it could not materialize at all.
Sounds a bit like gambling to me.
Joe,
First of all, I’d like to say I’ve been visiting this blog for the last two weeks or so that I’ve found it. I am thoroughly enjoying your thoughtful entries and appreciate the time you must put into them.
Correct me if I’m wrong; in response to the above question (I am fairly new at this, and am still learning lots), I think differing discount rates have to do with the “safety” of the investment (that may be the wrong word)? E.g. for small caps you may want to use a higher discount rate for the risk you are taking; it is what you expect to earn with that type of investment annually.
Larry
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Hi Joe,
Great site! Love your insights and enjoy reading your ideas and explanations. I’m just having some problems following your information on AAPL. I’m looking at the morningstar data and I’m not sure where you got the $500 million excess cash from 2001 to 2002 and $32 million from 2003.
On a different note, is there a way to factor in a “brand moat” in the valuation? Or should it even be included? I mean iPod has become such a household name that here in the Philippines, a lot of people refer to any MP3 player as an iPod.
Brian
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Hey Joe,
Coincidence! that you’re discussing APPLE, I just mentioned about it yesterday in my blog post. http://indiainvestor.wordpress.com/2007/10/23/the-numbers-look-good-what-next/
My level of comfort with the company isn’t that great: I recollect when Steve Jobs, left the company, their fortunes turned, when he came back, the company started to grow anew again.
It almost seems that the fortunes of the company revolve around 1 personality… when he goes the company well ambles around. That fact doesn’t boost my confidence when I look at it, from the viewpoint, of what will happen in the future. This is very different from other companies like Berkshire or J&J, GE or even a Microsoft where the original brilliant businessmen even if they aren’t around the company would pull ahead on it’s own steam… well I’m sure quite a few might doubt about Microsoft 
but Steve been at the helm of affairs for a long time now, so lets not turn the conversation into that direction.
Secondly, it’s in a business, where the competition is not just loaded with tons of cash, but has greater market reach worldwide. Take the mobile market(with Nokia, Sony, innovators like HTC, etc.) or the pc/software market (with the Dell’s, HP, Microsoft). So it’s got a lot of big daddies to fight off, which have larger war chests and much more marketshare worldwide.
I’m just not sure, how Apple would do 10 years down the line… So for me this is in the I love the products …kind of company, however I’m not sure about the future.
As Yoda would say “Unclear is the future. Always in motion is the future, but never in so much motion as presently.” Especially in the mobile phone space, there is just too much happening in the industry…
Regards,
Sanjay Shetty
I blog at: http://indiainvestor.wordpress.com
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From a business perspective I’m still not sold on the Iphone redefining the cell phone market. For starters, it seems to me the exclusive arrangement with ATT will open up a new market as there are 3-4 other big players in the wireless business (sprint, verizon, etc). Just like in the mid 1980s, the mac was way ahead of it’s time but Microsoft won because open would not open up the Mac for other providers. History could repeat itself..
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>It almost seems that the fortunes of the company revolve around 1 personality..
I agree totally with Sanjay. To paraphrase Buffet – buy a business that a fool can run, because one day a fool might be running it. That statement in and of itself may explain why Buffet stays away from Tech. Apple tanked when Jobs left. It is back strong now, but unlike BNSF (Buffet’s latest acquisition) where the rails will still be choo choo-ing in 20 yrs, no one can predict what Apple will look like in even 5 years!
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Could you please indicate which value of the current FCF you use to arrive to a future cash of 126.7 Billion?
If I take your assumptions for growth rates, discount rate and a current FCF of 3.6 Billions, the sum of the future cash flows I come up with by integrating the curves plus the cash from ther balance sheet gives me an intrinsic value of Apple in the range of 300$.
My calculations use the formula A/(A-1)*((A^N)-1) and for the Perpetuity Period the formula : (A(1) *A(2) *A(3)*PGF) / (DR-PGR) where:
A=(1+Growth rate) / (1+discount rate
N= Number of years for each period
PGF=(1+growth rate for the Perpetuity period)
DR= Discount Rate
PGR = growth rate of Perpetuity period
Thank you,
best regards, Bruno
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Question!
Does Apple currently generate as much much revenue as Motorola, Nokia, Microsoft and Dell did 10 years ago. I don’t know the answer to that, but it may be surprising.
Sometimes the sheer magnitude of numbers can make our initial calculations seem obviously flawed.
It’s remarkable what several years of perspective can do.
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Joe,
Why did you choose to use a 9% discount rate instead of the 15% discount you have used in previous valuations.
Dave
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