This mail bag has to do with what appears to be a cheap company such as Apple.
AAPL just had record earnings….the best corporate earnings in human history. Of course, it tanked after earnings like it usually does.
I feel like the whole market has gone mad trading on speculation instead of fundamentals.
What are your thoughts on AAPL? Based on what I see, it’s one of the most attractive buys I can find at the moment.
In the case of Apple, roughly 50% of the business comes from iPhones. That means if I were looking at adding Apple to the collection of businesses in which I have an ownership stake, the questions on my mind would include:
- How many iPhones did Apple sell last year?
- What was the gross margin per iPhone?
- What is the market share for the iPhone?
- What is the aggregate size of the entire market?
- Is it expanding?
- At what rate?
- How can Apple avoid a fate like Research In Motion? No one saw the Blackberry collapsing and it was almost as powerful prior to the rise of the iPhone. What happens if someone else releases a ground breaking phone that consumers want more?
- Is this the best use of my money right now? Can I find another company offering the same return with a safer revenue stream not subject to disruption?
Can you project, with any reasonable certainty, the units and profitability per unit for Apple’s iPhone business for the foreseeable future?
If you can’t answer those questions off the top of your head, you’re not investing. You’re speculating.
Will any other product rise to add to the income statement, such as Apple television sets, which have long been rumored but still haven’t been officially released?
How does a $400+ billion company get larger? It is a much different company than when it was 1/50th its size. I have a friend who bought Apple shares at a fraction of their current value because the company was much smaller and growing rapidly, even though the valuation multiple was much higher back then. That is not always an irrational strategy and, in this case, it was the right call.
Again, if you can’t answer these questions quickly, and with rationally-based, specific numbers, you aren’t investing.
The question, then, is: What do you think Apple’s cash flow, income statement, and balance sheet look like in 2018 and 2023? A low p/e ratio now is never a justification for buying into a business. It’s future cash flows that matter. You must have some idea what those will look like. If Apple’s earnings fall by half, a p/e of 10 becomes a p/e of 20. If Apple’s earnings double, a p/e of 10 becomes a p/e of 5. You have to look out the windshield and not in the review mirror.
Why would you rather own Apple over Walmart? Or Wells Fargo? Or Exxon Mobil? Or General Electric? You need to be able to respond to that. If your answer is, “the current earnings yield is higher”, that’s always wrong. You aren’t dealing with a boring, stable enterprise like Royal Dutch Shell that pumps crude and natural gas out of the ground, selling it to billions of people around the world. It’s a different calculus.
That’s how I approach allocating capital in situations like this. You have to do what works for you.