apple in a decade

Shareholders' pride, neighbors' envy
Apple's market cap is $ $676 b now. It peaked at $750 b in 2015. The returns given by the stock are phenomenal by any standards. 

As we can see, even if we had purchased the stock at the high price in any prior year, our investment return would have been more than satisfactory. For instance, if we had picked it in 2005 at its high price for that year, the annual return would be 31.29%; that is our investment growing by 15 times. At 2010 high price, it would be 20.25%. We would not make much if it was bought in 2012 and 2013. 

If someone was a superb market timer and was able to buy the stock at the low price in any prior year, the story would be extraordinary. 

The entire company was available at $15 b in 2005; but, who would have turned it into $676 b by now? Not any of us. As near as last year, Apple was available at $397 b and that is a 70% upside now.

As they say, we don't need many stock ideas in our life time to become rich. Yet, not many would have the foresight, wisdom and belief in management. It looks like everything has turned out well for Apple so far; this is despite our asking the right question: for how long this magic is going to continue? Is many shall fall that are now in honor going to be true for Apple ever? May be it will one day. In the meantime, it is not inappropriate to ask, what makes Apple as a business so special?

The story that has been
Apple's revenues increased by 27.86% to $233.71 b, operating earnings by 35.67% to $71.23 b, and its earnings per share increased by 42% in 2015. This EPS is slightly different from the one reported because I have not used the weighted average number of shares outstanding.

What I find striking is that Apple has been generating cash year after year. My unsolicited advice to Apple in October 2014 for effective use of its cash went, not surprisingly, unnoticed; my consolation is that I usually write for myself, not for others. 

If the story continues the way it has been, Apple is going to outgrow and it will always be in honor. That kind of perpetual model has not been witnessed in the history of business. So it is appropriate to consider that one day Apple will face the reality and slow down. But, when will that be?

In the last ten years, Apple generated free cash flows of $235 b, significantly through its own capital. It has started raising debt only recently. It spent $59 b on capital expenditure, including acquisitions. Yet, its net cash spend was only $9 b in the last ten years. This was possible primarily due to savings from working capital and depreciation. I look at the story like this: $235 b of cash was generated with the help of $9 b reinvestment. Granted, Apple also spent $30 b in research and development; I am not sure whether innovation in iPhones, iPads or Macs in the recent years reflect that. It is not surprising that Apple has been operating with negative capital in its business. Its current cash hoard is $205 b, of which a significant part is trapped outside of US and is liable for additional taxation. Still, free cash net of tax liability is massive.

Valuation
To value Apple, we need to estimate how much it would need to reinvest in the business to achieve the expected growth rate. We know that growth is not free. However, as evident from its past, Apple has been growing without much help from reinvestment. How do we estimate reinvestment? We could use the industry standards; but, Apple has been defying it all the time. We cannot assume past reinvestment rate either, which is ridiculously amazing. 

If we assume that Apple's free cash flows are going to grow at the rate of growth in the US economy forever and use the expected rate of return considering our opportunity cost, we should be able to get a value. Two problems though: We are not sure whether even this low perpetual growth rate will be valid for Apple, because at some stage it will have to put in capital for reinvestment. It cannot continue squeezing its suppliers forever. Again, our opportunity costs differ. We could also calculate its cost of capital, but I am not interested. This is because I am more interested in how much I can make than how much Apple is actually worth.

I also used my estimates of growth and reinvestment in the next decade and made Apple a stable firm thereafter. I know my estimates are going to be wrong.

The questions to ask are: How much Apple is going to grow in the future? How much capital it is going to require to be able to show that growth? When will it stop growing and start behaving like a normal, stable firm? What is our opportunity cost at the moment? What alternatives do we have to invest our capital - treasuries, bank rates, money markets, bonds, equity market rates - how about Apple stock? Will Apple managers ever mess up?

Is there anyone who can take on iPhone? Will Macs continue their fancy? Will iPads follow the PC markets? Is there any product - it can't be watch or TV - in pipeline for Apple to hold its fort? Tough questions, which only time will be able to answer.

I come back again to that unsolicited advice.