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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Monday, February 23, 2009

Apple Inc (AAPL): Snapshot- Apple's Cash Growth

Apple Inc (nasd:AAPL) $91.21- Here's a quick snapshot of Apple's cash holdings over the past 9 quarters. In the case of Apple, it's extremely important to focus on cash flow opposed to accounting (GAAP) income due to the massive build of deferred revenue on its balance sheet. Total deferred revenue is $9.7B, $7.3B of which is iPhone related. Accounting EPS is often a poor gauge of a firm's actual earning power due to the many ways to legally (and illegally) inflate, obscure, or mislead actual performance. However, all one needs to do is follow the cash. The concept of investing is inserting cash into a vehicle that will return a larger cash amount back in the future. Cash flow, not earnings, best reflects a firm's investment prospects.

Apple's cash holdings swelled from $11.9B (Dec '06) to $28.1B (Dec '08), an increase of $16.2B. In terms of cash per share, Apple reported $31.20/share for Dec '08, and increase of $17.76 from the $13.44/share reported Dec '06. In the last 8 quarters, Y/Y cash growth has averaged north of 50% (per annum).

Just in the past 4 quarters, Apple's cash has ballooned $9.7B from $18.4B. Cash per share has increased more than $4 the past two periods, and last quarter (Dec 08), cash/share rose $10.71 from prior year quarter. What gives this cash holdings data meaning is the comparison to EPS. Apple's TTM EPS is $5.39, but TTM increase in cash/share is almost double, $10.71. Obviously, iPhone sales are responsible for the wide disparity.

Using price multiples as a valuation metric, Apple trades at 17x TTM EPS, but only 8.5x TTM cash/share. That's a massive difference, and many make the mistake of using PE ratios to compare Apple to its peers which is unreliable due to the EPS distortion caused by iPhone revenue referral.

Of course, the market is forward looking, as TTM ratios are less meaningful due to being historical-based metrics. However, the iPhone should continue to exhibit decent sales being a solid product in a growing market segment. This will cause the disparity between accounting EPS and cash flow to continue. Considering that Apple has historically traded at 40-50 TTM PE multiple, valuation is attractive on a long-term investment horizon. In my opinion, the short-term economic challenges are priced-in, but the long-term competitive advantage and earnings power is being ignored. That's the nature of the current mood of the market, and AAPL will probably go lower before it goes a whole lot higher. Eventually, when the economy shows signs of regaining its footing, and investors are comfortable owing stocks again, AAPL will go much, much higher. Downside risk is somewhat limited due to Apple's cash position and strong products that should at minimum, support valuations not terribly too much lower than the current share price.

Yet, risk still exists, and I would imagine shares stay range bound $75-$105. Apple's fundamentals provide strong support, but breaking through resistance above ~$105 and ~$115 will require sustained money flow from cash coming off the sidelines. Hence, participation by institutions and funds that have longer-term investment outlooks. Recently, Apple hasn't been able to sustain any sort of rally off positive news as traders have been quick to take profits, as well as selling/shorting into market weakness and rises of increased pessimism. If/when the equity investor were to return, Apple would be a popular choice at current levels.

Disclosure: long AAPL


Anonymous said...

Good post. Steve Jobs is out and here comes such reports on apple's cash.

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nac said...

Turley, an interesting article, as always. You might want to extend your analysis by looking at the Cash Flow Statement to determine the sources and sinks for cash.

Ankit Gupta said...

If total deferred iPhone revenue is 7.3B, and we assume a large portion was generated from the last quarter (just doing some rough number), then that 7.3B will be used over the next 7 quarters, which means that they already have 1B per quarter of revenue, no matter how bad the economic storm gets.

Analysts are expecting just under 8B in revenue for the current quarter. That means that 12.5% of this quarter's revenue is already secured. From my point of view, unless the analysts have accounted for the deferred iPhone revenue already (efficient market?), we've just gained a 12.5% margin of safety. Apple is a premium brand for most people and so the larger risk at hand is if sales drop more than that 12.5%, and so the deferred iPhone revenue can't make up for it, they could miss expectations.

I don't think Apple will have trouble with blowing away expectations though because people all around the globe want the iPhone, especially China and India. The pricing doesn't work for them yet partly because their phones are not subsidized through the carrier and so spending $600 up front is a lot for them. I think we'll see Apple come up with a solution for that and keep revenue increasing thanks to international expansion.

Note: I could be entirely wrong on most of this, I'm still doing a lot of research. Overall, the attractiveness for me comes from the fact that even if we don't factor in the deferred revenue, they have a ton of cash, and the P/E ratio for the sector is much higher than Apple. Factoring in cash, I got a P/E ratio around 12 (few weeks ago anyway), which is what some railroad companies trade at, and Apple is no railroad company, they have a lot of room to grow still. IMO, the deferred revenue is a margin of safety that can only help because I don't know if future expectations factor in the deferred revenue or not.

Cranny said...

I keep wondering when the market will wake up and start understanding the deferred revenue value in Apple stock. I thought publishing the non-GAAP numbers would do it, but it appears not. Perhaps the revelation will occur this quarter, when a near-dead consumer really impacts sales (yes, resistant doesn't mean immune), and yet Apple will steal beat analyst estimates. Certainly not by the huge amount we would have seen, but a beat nonetheless. The 'guaranteed ' revenue will really stand out in this seasonally weak quarter and will be further amplified against weaker sales figures.

If you add in some future products - new Mac desktops, new iPhones, maybe a new tablet/netbook, new Apple TV. You're right, put these wildcards in with a market that starts to right itself, and this stock will take off.

Anonymous said...

If Apple’s cash holdings continue to grow at an annual rate of 50% (year-to-year), it will take just 1.4 years for that cash to double.

Even if the growth rate drops to 25%, it will take just 2.8 years for that cash to double.

And as the following videos note: "The growth in any doubling time is greater than the total of all the preceding growth!"

Cheap iPhone said...

While we are busy having the recession we had to have Apple is out there doubling their earnings!

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