There’s a lot we can talk about with respect to Apple’s solid fiscal third-quarter results–and we will–but the most important takeaway from this article is how we strive to add incremental value to your research and analysis of the iPhone giant.
First of all, we don’t play the quarterly earnings beat-or-miss game at Valuentum. You can read about how we think about near-term forecasts and what we think are the most important drivers behind a firm’s long-term intrinsic value here. Most sell-side analysts and commentators spend the majority of their time analyzing factors that impact the company’s financial performance (not necessarily its stock price) over the next couple years, a time frame that generally accounts for ~20% of a company’s total equity value.
We, on the other hand, like to spend the majority of our time looking past the focus of the 40 or so analysts covering Apple—this is where ~80% of a firm’s equity value is generated (over the intermediate to long-term). Though the near term can certainly have an impact on some of the short-term ‘pops and drops’ a stock may have, it may not be as well known that the long-term fundamentals–and a robust intrinsic value assessment–also impacts the performance of the stock over the near term.
The very idea that long-term fundamentally-based investors purchase and sell stocks—and that purchase and sell orders drive stocks up and down, respectively—reveals that long term analysis does very much impact stock performance over the short term. On the other hand, near-term dynamics (especially as it relates to previously-reported financial performance) have little, if any, bearing on the long-term performance of equity prices. However, many investors don’t spend much time thinking about long-term fundamentals, but making assumptions about the long-term is simply inescapable in the context of equity valuation. Even if investors may be using short-term price-to-earnings multiples, enterprise-value-to-EBITDA assessments, or any other multiple to assess valuation, a long-term view is heavily embedded within such multiple analysis. Read more about how the long term is embedded in the forward price-to-earnings ratio, for example, here.
Though we don’t like to talk much about the success of the Valuentum process–a combination of robust intrinsic valuation analysis with a technical and momentum overlay–in Apple’s case, the process has generated more outperformance than otherwise could have been had with either a buy-or-hold strategy—or any other strategy for that matter. Apple is a core weighting in both the Best Ideas portfolio and Dividend Growth portfolio, and the decision to add more to Apple in the Best Idea portfolio and open a new position in Apple in the Dividend Growth portfolio on July 24, 2013 (almost a year ago to this day)—a move supported by the Valuentum Buying Index methodology—has generated significant outperformance.
Another area that many of our members find indispensable is continued access to the fully-populated three-stage discounted cash-flow models. The Valuentum valuation model is academically sound and professionally-tested and includes a three stage process, with fading returns on new invested capital to a company’s cost of capital over time. Other research firms charge as much as $5,000 to $10,000 for such access, but we offer complete access to our in-depth valuation models for every firm in our coverage for a fraction of that cost. We update the models shortly after each quarterly report, making changes where necessary, and we ‘roll the models forward’ shortly after each filing of a firm’s 10-K or 20-F (the annual reports that house audited annual data). You can read about what causes fair value estimates to change here.
As an example, Apple’s fully-populated discounted cash-flow model can be downloaded . Some members use our service only for the tremendous value we provide in the valuation infrastructure. You cannot find these models elsewhere and certainly not for the price of a membership to Valuentum. We make valuation models just like the one you have downloaded on Apple available for every firm in our coverage universe. Please ask about how you can gain access to this valuable feature of our service.
With that said, Apple’s fiscal third-quarter results, released today, showed progress with respect to revenue, operating income, and diluted earnings per share. Revenue of $37.4 billion, quarterly net profit of $7.7 billion, and diluted earnings per share of $1.28 compares to revenue of $35.3 billion, net profit of $6.9 billion, and diluted earnings per share of $1.07 in the year-ago quarter. The EPS growth rate of ~20% was its highest in seven quarters.
The strong quarterly performance was fueled by solid sales of the iPhone and Mac coupled with the continued expansion of the Apple ecosystem. The firm didn’t sacrifice margins for expansion either, with the company’s gross margin coming in at 39.4%, compared to 36.9% in last year’s period. Apple continues to generate gobs of cash from operations, and management indicated that it has now taken action on over $74 billion of the $130 billion in capital it plans to return to shareholders.
On a forward-looking fundamental basis, the most important consideration is the impending launch of the iPhone 6. We’re expecting big numbers for the coming iPhone upgrade:
Though we maintain a level analytical view on new product launches, we are expecting the iPhone 6 to be wildly successful. The iPhone 6 will have a larger, sapphire crystal screen, and a faster and more efficient A8 chip. The screen size of the iPhone 5s is currently 4 inches, and we think the iPhone 6’s 4.7 inch screen size (which is expected to be released in August) or 5.5/5.6 inch screen size (which is expected to be released in September) will hit the sweet spot of usability for consumers. From our research, the iPhone 5s is a bit small for many applications (both on the enterprise and consumer level), especially as workers and consumers grow more comfortable with the larger iPad in day-to-day activities.
Though there will be other features of the iPhone 6 that will attract iPhone owners to upgrade, we think the larger size will be the most important selling point. We think the iPhone 6 launch could drive an upgrade rate of 12%-14% of existing iPhone owners. Though this rate approximates peak levels, we think the iPhone 6 will have even greater success on the basis that consumers didn’t truly know the optimal usability size until the iPad proliferated. With the iPhone’s installed base of 260 million users, an upgrade rate in the mid-teens would offer a significant boost to Apple. Because the iPhone is a more portable, workable device than the iPad, we don’t think much cannibalization will happen as a result of the size adjustment…We’re very excited about what the ‘lack of cannibalization’ means for Apple, especially as new and more powerful iPad versions hit the market.
Valuentum’s Take
There’s a plethora of varying opinions on Apple, but we think we can add incremental value to your research and analytical process on the iPhone maker via the Valuentum process and access to the extensive valuation infrastructure backing the fair value estimates. Also, please don’t forget that you can reach out at any time to the Valuentum team with any questions you may have.
We’re not making any changes to our weighting in Apple in the Best Ideas portfolio and Dividend Growth portfolio in light of the quarterly results, and we continue to believe shares will converge to our $103 per share fair value estimate. If the iPhone 6 launch goes well, the higher end of our fair value range ($120+) may be attainable. The firm remains one of our best ideas. To access Apple’s landing page, please click here.
What is considered a ‘Best Idea’ at Valuentum?
A best idea in Valuentum parlance is a holding in the Best Ideas portfolio and/or the Dividend Growth portfolio. We typically add shares to the Best Ideas portfolio when they register a high rating (a 9 or 10 = a “we’d consider buying” rating) on the Valuentum Buying Index and hold them until they register a low rating (a 1 or 2 = a “we’d consider selling” rating) on the Valuentum Buying Index. We don’t add all firms that register a high score on the Valuentum Buying Index to the actively-managed portfolios due to sector weighting or overall market valuation considerations, among others. The Valuentum Dividend Cushion is a key factor behind adding companies to the Dividend Growth portfolio and is used in conjunction with a company’s annual dividend yield, its price-to-fair value ratio and Valuentum Buying Index rating.
Computers & Peripherals – Hardware: AAPL, BBRY, CRAY, HPQ, IBM, LXK, TDC