Apple Is Showing the World Two Different Faces — and That’s a Problem

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Bobby Yip / REUTERS

In the wake of Twitter’s IPO, the word frothy is getting tossed around a lot. It’s what you say when you don’t want to be alarmist about another dotcom bubble, but you still see a classic sign of a market gone loopy: a disconnect between what a company is actually doing and what investors, in valuing the company in the open market, think the company is doing.

Put simply, the efficient market hypothesis says that markets fairly value stocks based on all available information. That idea has taken a beating in the past 10 or 15 years, but it endures. And yet we keep entering periods when emotion breaks away from the rational study of information on a stock. So much so that how we see a stock and how we see a company often become two separate things.

This is evident among many growing startups. Twitter’s $25 billion valuation is based less on the company today than on a company investors expect to exist in three or four years. The high valuations of Pinterest, Uber and others rely on the same hope. What’s less acknowledged these days is that such a disconnect between reason and rationality — between the stock and the company — is happening with old, big tech giants too. And nowhere more so than with Apple.

(MORE: After Twitter: 5 Potentially Blockbuster IPOs Coming Next)

Apple the company is doing about as well as it ever has. CEO Tim Cook recently told employees that the firm “has never been stronger.” It’s one of those things CEOs are supposed to say to the rank and file, but it’s not far from the actual truth. Heading into the holiday season, Apple is releasing the high-end iPhone 5s, the lower-cost but brighter 5c, the iPad Air and iPad Mini with Retina display. All are devices at the forefront of their markets.

Apple the stock isn’t doing quite as well. Over the past year, it’s fallen 11%, even while the Nasdaq Composite Index has risen 29%. And it’s down 26% from its record high of $705 in September 2012. It’s trading at 12.9 times its recent annual earnings and 11.7 times its estimated earnings this year. The S&P 500’s average historical PE ratio is 19.4.

Apple is such a well-known company that its stock performance reflects on its consumer brand. And so disappointment in its income statement ends up bleeding into the company’s public image. Apple’s net income has been declining this year because the company hasn’t had a full quarter in a while when it had recently refreshed its mobile devices, and because gross margins have been pressured as Apple tries to compete against lower-priced Android devices.

applenetincome

It’s gotten bad enough that Apple is dragging down the tech sector’s overall earnings growth: tech stocks in the S&P 500 would have seen earnings grow at an 11.3% pace this year without Apple included, according to FactSet. With Apple, they grew only 7.2%.

Gross margins are an especially thorny issue with investors. Gross profits have eroded to 37% of revenue (or 38.5%, excluding a recent change in revenue accounting) from a peak of 47% in early 2012 as Apple has competed more on price in its iPhones, iPads and Macs. Companies in competitive industries often trade higher margins for lower prices if it means maintaining or expanding market share. That strategy has worked well for Amazon. It’s working less well for Apple.

applegrossmargins

This may be troubling news for investors seeking returns from capital gains, although Apple has been trying to compensate through higher dividends and a $60 billion buyback program. It’s not necessarily bad news for Apple itself. It means Apple isn’t holding to the idea that profits must constantly be growing aggressively, every single quarter. The company is focused instead on strategies that will keep it strong in older markets and position itself for new ones.

Apple bulls see positive signs ahead. iPhone sales increased 26% in September after 5s and 5c models went on sale. iPad Airs went on sale this month, and in an encouraging sign of brand loyalty, many buyers are replacing older iPads. One analyst, Charlie Wolf at Needham, argued that Apple’s strategy to position its devices as “the aspirational brand” in developed and emerging economies will keep growth steady in these products without waging price wars.

(MORE: The Hottest Holiday Toy Is Not What You Think)

Then there’s Apple’s ability to create or remake new technology categories. Cook’s oft-repeated promises on this front have grown so insistent, he’s either desperate or cooking up something big. Signs point to the latter, be it a wearable Apple device or an iTV. Apple has quietly made 15 strategic acquisitions this year, many unannounced, and is boosting its capital spending to $11 billion this fiscal year from $7 billion last year.

Other analysts remain bearish. “To us, Apple no longer deserves a rich multiple for the simple reason that its sales growth is pedestrian, its net income is falling and its reliance on two sensationally popular products — the iPhone and the iPad — is exceedingly high,” Per Lindberg of ABG Sundal Collier wrote in a recent report.

Such sentiments explain Apple’s lackluster stock performance this year. But they seem out of touch with Apple the company, which in some respects is still at the top of its game. A company’s operational health and its stock performance can diverge for a long while, but they inevitably come back into sync. The debate will rage over which Apple will prevail, but right now it looks like this is a well-run company trading cheaply.

15 comments
notoakie
notoakie

"Apple’s net income has been declining this year because the company hasn’t had a full quarter in a while when it had recently refreshed its mobile devices, and because gross margins have been pressured as Apple tries to compete against lower-priced Android devices.


"...Companies in competitive industries often trade higher margins for lower prices if it means maintaining or expanding market share. That strategy has worked well for Amazon. It’s working less well for Apple."


this is incorrect. Apple has never traded margins for price. margins drop due to the cost of new manufacturing processes to produce a new or refreshed product. once manufacturing has caught up, those margins then increase as the cost of manufacture drops. Apple is especially susceptible to this due to their desire to release products far ahead of competitors to prevent direct competition for as long as possible in the device's life cycle. Apple knows and plays to be the aspirational brand and is not trading margin, gross or net profit for marketshare.


in fact, your comment that, "has been declining this year because the company hasn’t had a full quarter in a while when it had recently refreshed its mobile devices" runs counter to the point you're trying to make as it's usually the first few quarters after a product refresh where gross profit margin, and thus net income, is lowest due to increased manufacturing costs always associated with newly developed product.


iTunes is not very profitable (pennies per song, tv show, book or movie and 30% on apps while most are free, ad-supported); it's a service whose ecosystem forces lock-in. amazon and google, on the other hand, have profitable ecosystems in retail and advertising, respectively, making their act of sacrificing hardware profits for total marketshare the more profitable endeavor overall. compare this to the gaming industry where Sony and Microsoft sell their machines at or below cost to profit on games, and the ownership of locked-in software then commits the owner to the respective ecosystem.


need more proof? look at your own second chart that shows gross profit margin. the peaks and valleys actually all correspond to Apple's product cycles, which i'm shocked you havent bothered to research or mention in the article. each peak comes during lulls in their product releases and refreshes, the highest peak occurring in early 2012, when Apple released pretty much nothing. it then nosedives right at the halfway point of 2012 when the Retina MacBook Pro was released and further dives as later that year, the iPhone 5, new iPod Touch, a refreshed iPad, the new iPad mini, and a redesigned iMac all came out at the same time. it's the manufacturing costs of these new products that drove down gross profit margin as the new technologies for parts and manufacturing, plus increased labor, all ate into the GPM across their whole lineup. GPM will take a hit again as the newly redesigned iPad Air, iPad mini with Retina Display, iPhone 5S and iPhone 5C all include new tech that will eat into the margin again in late 2013. of course, Apple could, and in some cases has, increased their prices slightly to overcome GPM they find unacceptable. the latest iPad mini with Retina Display and Mac Pro are fine examples of this.


Apple traditionally avoids lowering prices to compete with other brands, especially brands that are in a completely different sector than Apple's obviously high-end focus. while other brands followed the iPad with lower priced hardware, the iPad's price has stood firm since its introduction in 2010. the iPhone has also stood firm since 2009, seemingly frozen in their $649/749/849 pricing scheme no matter how much new tech they include as it's refreshed and redesigned.


in fact, the only product they have consistently lowered in price over the years is the iPod lineup. what once began in 2001 at $499, they now range from $49 to $399.


i expect better journalism from Time than this.

Sierraa
Sierraa

All this talk must make tech companies like http://5spot.ca laugh im sure they will soon go public to and do the exact same thing although this is ridiculous what apple is doing 

yutubenut
yutubenut

valuation, frothy, PE, ?!?! what the heck are you talking about? I buy stocks like everyone else; based on media hype/coverage and price direction. bought First Solar five months ago sold after a 20% gain, don't even know what they do, make some kind of sunscreen lotion I guess....

ndnv631
ndnv631

there are YouTube video comparing iphone 5 display to iphone 5S display which shows in plain sight that they used cheap display to save money but charge customers the same price as a good quality display.Don't believe the video, take your iphone 5 into the Apple store and compare yourself. They overcharge for memories also

Godofbiscuits
Godofbiscuits

—Apple is such a well-known company that its stock performance reflects on its consumer brand.

That's just flat out a bad, bad, bad, terrible assumption.

But worse, that second graph is an appallingly misleading one:  You have a zero-based stock-price y-axis, but a scaled-to-fit profit-margins y-axis?
Just horrible.  You make it look like Apple's profit margins have gone on Mr. Toad's wild ride instead of normalizing them first, then plotting them at least against a zero-based axis.  C'mon, people.  You're starting to look like Business Insider.

aztecian
aztecian

how 'bout they show a face where they contribute instead of evade paying taxes with off shoring and quit enslaving workers in china.

vstillwell
vstillwell

Who cares what Wall Street thinks? They're corrupt and ignorant. If they were so smart and markets were so efficient, then 2008 would have never happened and the Fed wouldn't have to keep pumping trillions into the economy to keep it afloat. I guess those markets aren't so efficient after all.  

AdamChew1
AdamChew1

At WS the companies that are favored are the ones not making any profits but the promise that they will.

Yes there is no frame for them to be profitable as long as their revenue grows and very acceptable too when accompanied by a loss.

I wish to ask Per Lindberg of ABG Sundal Collier whether he will will to be paid in future profits and yes which company wouldn't like to be in Apple's shoes when profits are concerned.

Perhaps Per Linberg is making billions for Sundal Collier and if that is the case I would shut up


GaryDauphin
GaryDauphin

The problem with valuing companies like Twitter  for "the company they will be three or four years out" is that many of them won't even be relevant in 3 or 4 years.  Ask MySpace how quickly the tide can turn!  

GaryDMN
GaryDMN

Apple keeps growing, yes it is growing and their margins are the envy of their competitors, yet they are held to a different standard than their competitors. Google, Facebook and Twitter are not competitors, they are in the ad distribution business. Motorola is a failure, while Samsung's phone margin's are getting lower and lower, because of price competition in the Android device markets. Then there are the billions of dollars in claims they will be paying to dozens of patent holders, who's patents they have violated. Google not only has to deal with the failure of Motorola, but will be on the hook for the largest patent infringement losses in history.

DeweySayenoff
DeweySayenoff

@notoakie So, how much did you get paid by Apple for that apologist rant?  Just curious.

DeweySayenoff
DeweySayenoff

@GodofbiscuitsThe graphs start at 2009.  Apple started somewhat before then.  Why do you infer a zero based stock price when the valuation is OBVIOUSLY 5 Billion?  What, you can't read scales?

I'm fricking HAMMERED and can read the scale.

And you didn't do anything to address the gross stock valuation impact on the rest of the tech sector.  What was THAT to you? Fantasy?  Not worth looking at?

Please...  If you're going to make a point, make a valid one.

PacificSage
PacificSage

@vstillwell  

Can't wait to get the new 15' MacBook Pro with Retina display and preloaded with all the software I need. Uhhhh....what were you saying?