Opinion

Felix Salmon

Why Apple should ignore its shareholders

By Felix Salmon
February 12, 2013

Allan Sloan neatly divides the world of Apple obsessives into two types of people:

For most people, Apple mania means buying the company’s products and playing with them. But for us financial voyeur types, the fun comes from watching the lunatic lurching of Apple’s stock price.

Financial journalists love any stock doing the lunatic-lurching thing, because that creates an easy heroes-and-villains story. Were you bearish at the top? You’re a genius! Were you bullish throughout the fall? You’re a goat!

James Stewart has a classic example of the genre this weekend, putting on his straightest face and contriving to be shocked — shocked! — that Wall Street was bullish on Apple stock during its recent decline:

Fifty of 57 analysts rated it a buy or strong buy; only two rated it a sell. Apple shares continued their plunge, and this week were trading at just over $450, down 36 percent from their peak.

How could professional analysts have gotten it so wrong?

It wasn’t supposed to be this way.

This is very, very silly: the clear implication here is that the analysts following Apple should have seen the fall coming. But you can’t time an individual stock like that: no one can. Especially when there was nothing — no thing — which caused the stock to fall. Apple stock was going up, and then it was going down. That happens with stocks: they’re volatile things. But you can’t expect anybody, no matter what their job is, to be able to anticipate all those fluctuations.

Instead, analysts generally do something else. At heart, they’re fundamental analysts: they look at a company’s numbers, and decide how much they think the company should be worth, given its revenue and profitability and prospects. Even at its peak, Apple was trading at pretty low multiples — and on top of that, it had a lot of upwards momentum. So it makes perfect sense that most analysts had “buy” ratings on the stock, with price targets somewhere north of $700. And given that nothing fundamental changed in the past few months, it would be weird for one of those analysts to suddenly slap a “sell” rating on the stock just because the ratios are becoming even more attractive as the stock gets cheaper.

With any stock, there’s always a bear case, and Stewart lionizes the one bearish analyst he managed to find, Carlo Besenius of Creative Global Investments. But even with hindsight, Besenius’s bear case doesn’t seem particularly compelling, based as it was on squishy things like “concerns about product quality and innovation”. You can always have “concerns about product quality and innovation”, and you can always be uncomfortable with “Apple’s arrogance”. But those concerns would have left you out of one of the greatest bull runs that the stock market has ever seen, over the past decade or so.

Similarly, Bethany McLean’s case for Apple being a $200 stock doesn’t actually include any ratios, or any calculation which comes to that number. Instead, she simply asserts that “built into Wall Street’s stock price targets was the expectation that the iPhone would rule the world” — and that therefore any future world which isn’t dominated by the iPhone must have Apple trading at a much lower level than those price targets.

The problem with this argument, of course, is that it’s far from clear that the price targets did incorporate global domination. It’s entirely possible that she’s right, of course, along with other bears like Jeff Gundlach, whose big Apple short last spring looked horrible for a while but now looks much smarter. But at heart, the bear case on Apple is one based on gut feeling: that the company has had its day, that its greatest glories are behind it, and that Tim Cook is not going to be able to continue Steve Jobs’s string of astonishing successes. It’s a perfectly reasonable gut feeling to have. But it won’t tell you when Apple stock is going to drop, and it won’t give you a level at which to exit your position. (McLean’s arguments, for instance, could be used to justify a $100 target, or a $200 target, or a $400 target.)

Meanwhile, the highest-profile Apple bull right now, David Einhorn, is arguably even worse than the bears. He has loads of clever ideas in the realm of financial engineering, whereby the issuance of new classes of stock would efficiently funnel money to shareholders like himself and thereby make them happy. It’s the kind of Clever Idea that activist hedge-fund managers like Einhorn and Bill Ackman often have, but it’s fundamentally a distraction in terms of Apple’s core job, which is to make insanely great products. Basically, everybody knows nothing, when it comes to the famously-secretive Apple, and it would be crazy for someone like Tim Cook to pay much attention to such ignoramuses.

Apple did spectacularly well, for most of the past 10 years, ignoring shareholders completely; at one of its competitors, Michael Dell is so sick of them he wants to buy them out and make them go away entirely. If Einhorn got his way, there might be a short-term boost in the stock, Einhorn would take his profits, the people who invest in Einhorn’s funds would make money — and Apple would in no way be better positioned for the future than it is today.

The day that Apple starts embarking on elaborate financial engineering in order to placate hedge-fund investors is the day that it loses sight of its core mission and starts turning into a mess like Hewlett-Packard, constantly trying to “deliver shareholder value”, whatever that might mean. When Tim Cook became CEO, he was given a restricted stock grant of 1 million shares, which don’t fully vest until 2021. The point was to keep him focused on a time horizon much longer than anything David Einhorn might be thinking about, and the message was that he shouldn’t worry about the stock price fluctuating up one month and down the next: so long as he builds an excellent permanent franchise, he will end up hugely wealthy. Apple listened to shareholders before, when it fired Steve Jobs and brought in John Sculley. It won’t make that mistake again.

Therefore, to use Sloan’s distinction, Cook rightly belongs with those of us who are interested mostly in buying the company’s products and playing with them, rather than those of us glued to the gyrations in the corporate share price. Let Wall Street worry about the Apple share price: very little harm is done to the company if it’s low, and Apple is so incredibly profitable that it has zero need for Wall Street or any kind of outside investment.

Apple shares are an interesting speculative vehicle, in which a lot of money can be made and lost. But they don’t help shape the fortunes of Apple itself — not any more. A close reading of the stock price might tell you something about herd mentality among mutual-fund managers, and the problems of being so big that people feel forced to buy your stock. But the share price has never been particularly useful in terms of being able to predict what’s going to happen next to Apple the company. Let New Yorkers worry about the stock: in Cupertino, they have much more important things to do.

Comments
19 comments so far | RSS Comments RSS

There are a lot of different threads here. The bottom line — “in Cupertino, they have much more important things to do” — is right on. And it’s not just true for Apple. Most firms would make better decisions if they ignored the market, but with the “shareholder value” movement and the institutionalization of stock options as compensation (a misaligned incentive) that’s not going to happen.

I’m most interested in your characterizations of what sell-side analysts do and what investment managers do. You say, “But you can’t expect anybody, no matter what their job is, to be able to anticipate all those fluctuations.” Yet, that is what analysts and investment managers purport to do. It might be a fool’s errand, but it is the job description at most firms.

The gap between the promise of differentiated insight and realized unanimity is a valid story, no matter how obvious it seems to you that the analytic community should be absolved for all having the same opinion.

Sure, it was Apple, the darling of the market and the best story of an investing generation. And it looked cheap on most metrics and the numbers were forecast to keep going. But something was changing.

Don’t you think maybe more than one publishing analyst could have figured that out?

Posted by tombrakke | Report as abusive
 

I think that Einhorn’s perpetual preferred idea is overly complicated, but Apple should return a huge amount of its $130+ billion of cash to the shareholders. In the extreme hypothetical that Apple continually builds great products but forever keeps the bulk of the cash inside the company, it frankly doesn’t matter if they have great products and are making money hand over fist. A shareholder payout of $0 is still a shareholder payout of $0.

As for the argument that a special dividend or big stock buyback would just be a distraction for management, I couldn’t disagree more. Frankly, I think that Apple’s ongoing tax engineering is more complicated than Einhorn’s proposal – though both are more complicated than simply paying excess cash to shareholders. Similarly, having to invest a pile of excess cash that’s bigger that big is a needless complication for Apple’s CFO and Treasurer. To put it in context – it’s an amount of money larger than all but a handful of mutual funds or equal to the assets of around the 20th largest bank holding company in the U.S.

Both Apple and Einhorn suffer from losing sight of the basic principle of getting excess cash out of the company for the benefit of its shareholder owners. So what that Apple has not incurred full U.S. tax rates on its non-repatriated cash? That cash is sitting in short-term securities earning nothing, with no reasonable future use for most of it. Unless Apple thinks that there is going to be a repatriation tax holiday, it makes more sense to have $0.75 or $0.80 on the dollar in hand than the full dollars sitting overseas earning next to nothing.

Posted by realist50 | Report as abusive
 

Apple fell because of the law of large numbers. Show me a company which has had a better than market return from the day they became the largest company in the world by market cap. The last 5 to hold that title:

Apple
Exxon
Cisco
MSFT
GE

Of that group I think only XOM has a positive real return since taking the top spot. When you get big there are just too many dollars of rev you’ve got to defend from the dozens of competitors trying to eat your lunch.

If Apple would pay out 1/2 free cashflow you’d have an $700 stock again.

Posted by y2kurtus | Report as abusive
 

If no one can do what analysts purport to do, why are they being paid at all? That’s the subtext of commentators like Stewart, and it hardly seems silly. Perhaps over-simplified. The complex story is certainly not that they are fundamental analysts — that is the cover story. What they actually are is salesmen. This is too obvious mention, which, perhaps explains why you neglected to mention it.

Posted by maynardGkeynes | Report as abusive
 

There are a LOT of contributing factors to the recent “super-correction” in AAPL, but that’s over and done with, so let’s move on. The really important question is, where does AAPL go from here? The answer boils down to growth: Is Apple through growing, or not? If it’s not, then its stock will not only recover, it will go on to new highs. If it’s through growing, then it’s only worth what everyone seems to be clamoring for; better dividends.

But since even a modicum of dispassionate research shows us that Apple is still growing quite handily, then really, the whole flap over what Apple should do with its cash pile is, to paraphrase the Bard, much ado about not much. Since we can make a rough determination that, first appearances to the contrary, Apple grew somewhere between 25-30% last quarter, once the extra week last year is removed from the equation, then that makes a nice anchor point for anyone serious about trying to estimate just how much Apple might grow this fiscal year. And yes, I know that Apple gave an earnings estimate for the present quarter that is far below that base number, but what’s new? Apple has often over-performed its estimates, and at times by very large amounts.

Now, I’m not saying that I know Apple is going to grow 25-30% in fy 2013. What I’m saying is that there’s a good chance that they will, based on last quarter’s real growth figure. And if it turns out that Apple does grow that much in fy 2013, then anyone salting away Apple right now, or refusing to sell it, is going to be the person who looks like a genius come next year. And I am also saying that I agree with the author that it really doesn’t matter a hill of beans what I or anyone thinks. In the long run, what matters is what Apple does. Will ye, nil ye, AAPL will follow Apple, not the other way around.

Posted by 1984macman | Report as abusive
 

There is a genuine concern about where Apple’s future growth & profits will come from. The iPhone will face margin pressures, and there is not another product known to outsiders that will replace that growth. There are few such product lines in existence. The watch seems like a dud – watches are jewelry, and Apple, for all its sleek design, is a tech company.

My thoughts on expansion are:
TV – this could be Apple branded flat-panels, or a beefed up AppleTV box. This might even involve a merger of purchase of content. Or it could be a google-like fiber/wireless roll out so that users of AppleTV* (* denotes my imaginary product) could completely cut ties with cable/DSL and have Apple provide the bandwidth.

Software – an expansion of their OS, and possibly a spin-off/investment in Office-alternatives. Office has no real competition – OpenOffice on Linux and GoogleDocs are not viable options yet. There is huge profit in this, as well as a desire to see some better engineered software in that space.

In retrospect, the move from the iPod to the iPhone was natural. You had phone makers trying to shoe-horn a music box into their products, when it was more natural for Apple to bring phone functions into their iPod. I don’t see another transition like that, or a market as strong and vibrant as the one for cellular handsets.

I bought AAPL on the dip. They have a massive, talented, engineering team, and is still an attractive place to work (at least from the outside). The sell sign will come from a huge misstep, and it should be fairly apparent if it happens.

Posted by winstongator | Report as abusive
 

“fundamentally a distraction in terms of Apple’s core job”

Capital allocation? That is what shareholders hire management to do. That is a core function. They decide whether to retain earnings for investment or pay dividends. Apple (after investing back in the business) is buying T-bills with their retained earnings. After a long while of this, it is perfectly rational for shareholders to wonder whether investing in near zero yielding governmet bonds is such a great thing…

If you own a hot dog stand that has become very successful due in large part to a great operator you’ve hired, you might tell him to invest in the business as he see’s fit, but to kick back anything beyond that. It doesn’t do much good sitting in the till.

Posted by eliwhit | Report as abusive
 

I think you hit it on the head Felix when you used the example of HP chasing shareholder value. Analysts just looked at the ‘average’ for the tech sector, or the ‘best’ for shareholder value in the tech sector, and then assumed – without really bothering to investigate and understand – that Apple “makes computers so must be the same” and then applied the figures from HP, Dell and others to Apple and came up with inflated numbers they actually believed.

To paraphrase that saying “Those who can, invest, those who cannot, analyse”. Whether it be S&P and others missing the weakness in the US sub-prime debacle, or tech analysts missing the point about the Apple philosophy, it all points to their opinions being amazingly over-valued. Just because you can do sums doesn’t mean you know which things to add up!

Posted by FifthDecade | Report as abusive
 

Thanks for the reminder that these funny stock ticker thingies are actually connected to companies making products & services.

This is the most cogent reminder I’ve seen in months that whatever else financial engineering might do, it depends on a solid engine of (in Apple’s case) engineering, design, production and marketing.

Posted by WaltFrench | Report as abusive
 

Thanks for the reminder that these funny stock ticker thingies are actually connected to companies making products & services.

This is the most cogent reminder I’ve seen in months that whatever else financial engineering might do, it depends on a solid engine of (in Apple’s case) engineering, design, production and marketing.

Posted by WaltFrench | Report as abusive
 

Apple investors are cry babies, plain and simple. The stock has long traded at a significant discount to immediate peers like Google and Amazon, neither of whom can match the company’s profit picture, operating margins, cash, revenue diversity, nor who pay any kind of dividend.

No less, the company trades at a significant discount to cross-industry ‘gold standard’ companies like Walmart, Coca Cola, Nike, Southwest or Procter & Gamble.

Finally, Apple is exceedingly transparent with analysts and investors in breaking out its sources of revenue, cost structures, channels, etc., in stark contrast to its competitors.

Apple **should** ignore its investors ala the Jeff Bezos approach, as all of their attempts at transparency have only bitten them in the butt, something that I wrote about here:

Cry Babies: The Strange, Confusing Path of the Apple Investor
http://thenetworkgarden.blogs.com/weblog  /2013/01/cry-babies-the-strange-confusi ng-path-of-the-apple-investor.html

Check it out, if interested.

Posted by hypermark | Report as abusive
 

Bert Dohmen called it, check his tweets from last summer. He gave some very good reasons to be out of AAPL in December and January:

But maybe you’re right when you make a theological pronouncement like, “But you can’t time an individual stock like that: no one can. Especially when there was nothing — no thing — which caused the stock to fall.”

I guess the rest of us will have to continue to invest based on information, as the theology of AAPL you espouse is just beyond us.

Posted by bvanho1 | Report as abusive
 

Speak for yourself bvanho1! It’s a simple premise: profits are more important than market share, excellence is better than mediocrity, usability is better than features, engineering is better than buying off the shelf, innovation is better than protecting a thirty year old franchise, targeted approaches are better than scatter gun shooting.

It’s called brainpower. It’s got nothing to do with theology.

Posted by FifthDecade | Report as abusive
 

With regards to Apple, it’s growth has been a function of its product development being one step ahead of those of its competitors, something which currently is not the case.

The iPod, iPad, and iPhone were all groundbreaking products that were way ahead of anything being produced by their competitors at the time. However, these days, Apple looks more like Microsoft…just releasing updated versions of its flagship products. They have no new groundbreaking products in the pipeline, and Samsung has caught up to them, and is now churning out products with similar functionality at a fraction of the price.

Here in China, for example, Samsung products have become much more popular than Apple, something that wasn’t the case as recently as eighteen months ago.

Apple needs to come up with another groundbreaking product if it wants to keep growing….it’s been almost six years since the first iPhone was released, and almost three years since the first iPad was released. Apple can’t live off them forever.

Posted by mfw13 | Report as abusive
 

Well, everyone knows that the Korean Copyshop copies other peoples ideas – they don’t actually have any of their own.

Posted by FifthDecade | Report as abusive
 

So, what is the point of owning stock again?

No claim on current profit, no claim on retained earnings.

Is the hope that you find a sucker or sell before management does actually crater value?

This is a serious question. Buffet’s story of reinvested earnings making stocks better than bonds only works as long as management doesn’t destroy the firm before you realize your gain. It also is based on the idea that the earnings would be invested in more productive ventures than stockholders could find. If it’s just going into tbills again it makes no sense.

AAPL’s price shows the flaws in the idea of the stock market and corporations more than it reflects anything about AAPL itself.

Posted by Zdneal | Report as abusive
 

It’s funny how many people seem to think that cash is a bad thing to have in a company. I guess Kodak wouldn’t mind a bit now.

When it comes to owners destroying companies though I suspect this is far less likely to happen to Apple (who had a near death experience already thanks to listening to speculator shills) than it is to Microsoft whose share price hasn’t moved in a decade, and whose profits are based on just two, decades-old technologies.

When a years supply of NAND chips costs $7 billion, and the rest of the computer is similarly expensive, you soon get through a pile of cash if an idea doesn’t pay off.

Posted by FifthDecade | Report as abusive
 

Interesting tidbit re Apple and Amazon: they’re both selling (less cash and to one significant figure) at 2X sales. Mr. Market seems to think that a dollar spent at Amazon (and the promise of more to come) is worth about as much as a dollar spent at Apple. Seems crazy to me, but I’m sure that Mr. Market can stay crazed for much longer than I could stay solvent betting against him, so I won’t (except for possibly being long Apple).

Posted by MaysonLancaster | Report as abusive
 

“So, what is the point of owning stock again?
No claim on current profit, no claim on retained earnings.
Is the hope that you find a sucker or sell before management does actually crater value?”

Didn’t some economist win the Nobel prize for explaining this? Was it Modigliani? It’s all beyond me.

Posted by Kaleberg | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •