Rule #1 Question of the Week: What About Apple?

This week's question for Phil Town comes from Dave, about Apple (AAPL):

Dear Phil Town,

A coworker recommended your Payback Time book to me as a smart way to get into the market.  I must say I agree with her, the book as fantastic and I've learned a lot about how things work out there. That being said, I've started analyzing some companies and one in particular has me stumped. The company in question is Apple. As for the 4 Ms, Apple has meaning for me (I own several of their products and I work in the tech industry), has a moat based primarily on Brand, has exceptional management (Steve Jobs), and appears to have a good MOS.

Here are the numbers I've gathered to this point (straight from MSN):

[Numbers listed as he typed them.]

2006
2005
2004
2003
2002
2001
2000
1999
1998
1997

Sales

19,315.00
13,931.00
8,279.00
6,207.00
5,742.00
5,363.00
7,983.00
6,134.00
5,941.00
7,081.00

EPS

2.27
1.55
0.34
0.09
0.09
(0.05)
1.09
0.90
0.52
(2.07)

Equity

11.67
8.90
6.48
5.76
5.70
5.59
6.12
4.83
3.04
2.34

Cash

2,901.00
522.00
(427.00)
1,144.00
(58.00)

ROIC

22.9
12.3

Based on these numbers, I've calculated my growth ratios as follows:

ROIC
Sales Growth
EPS Growth
Equity/BVPS Growth
Free Cash Flow Growth

1 Year
5 Year
10 Year

1 Year
5 Year
10 Year

1 Year
5 Year
9 Year

1 Year
5 Year
10 Year

1 Year
4 Year
10 Year

22.9
12.3

39%
25%
10%
46%
72%
25%
31%
14%
24%
455%
28%
n/a

I don't know if those numbers are right, but I think they are. FY2006 was good for Apple, which is why the percentages seem skewed. So, moving forward with my analysis, I get the following:

• Current EPS: 2.76 (from MSN)
• My estimated 5yr EPS growth: 21.5 (based on equity growth)
• MSN 5yr EPS growth: 19.5 (I use this since it's the lower of the two
  choices)
• Future PE: 39 (19.5 x 2)

So if the growth rate is 19.5%, that means my money would double in 3.7 years (72/19.5). In 10 years, my money would double 2.7 times (10/3.7; yes,  I'm an engineering type). This gives me a 10yr EPS of 18.77, and a 10yr stock price of $732.03. Dividing that by 4 gives me a sticker price of $183.01 and a MOS of $91.50.

Given that the stock is trading just below the MOS currently ($85.42 as I write this), is this just a good deal? Or am I missing something fundamental? Or am I really over-analyzing all this?

Sorry to bombard you like this, I'm just hoping I'm doing this right and not missing something fundamental.

Thanks,

Dave Luke

My response:

You rock, Dave!

It's time to talk about Apple because I go WAY back with these guys.  A private biz I bought into bought a Lisa in 1982.  You remember that precursor to the Mac?  $10,000 in 1982 bucks.  Because it had a graphic user interface.  Then came the Mac.  Which I bought immediately. 

Then Jobs let the 'big guys' talk him into hiring John Scully to 'manage' the business because they thought he was too young and inexperienced, and what happened?  It turns out that deciding what the future technology is that people will buy is a bit harder than
selling sugar water -- but as Scully struggled, he blamed Jobs of all people; the Board of big guys sided with the superstar from Pepsi; and Steve found himself fired by the guy he hired.  Et tu, Brutus?  Stabbed in the back! 

So he licked his wounds and started NeXT Computer with Ross Perot and some other folks and built a beautiful state of the art computer that didn't beat Windows NT into the market and got smoked.  I know because I and my partners were there. 

What a ride that was -- but it ended in about 1991, and it was also the last Steve Jobs computer I bought until last month, when I bought another Mac.  And I think I'm not alone.  This new Mac duo runs Windows perfectly on the Intel chip.  It is as if I'm on a Lenovo.  It's fast, runs all the software, and it's easy to shift between the Mac interface
and Windows.  Awesome. 

And then I bought a little tiny iPod thing that clips to my workout clothes. 

And then I downloaded music on iTunes. 

And then I saw the iPhone demo and got in line for that...

Gee, am I an Apple product consumer?  Duh.  I LOVE their stuff.  LOVE IT. 

So yeah, Dave, I think I see point about Meaning.  It passes that test for me, too.

Moat -- brand, secrets, switch and even some toll moat thrown in there.  Apple has serious moat.  You want a Mac, a Dell won't do.  That's a brand.  You call it by name.  That's a brand. 

You get all your software on it, that's a pain to switch from.  You want to seamlessly download iTunes, iPhone, iCal, etc... that's a toll bridge, baby! 

And they have a total lock on the Mac operating system and are about 5 years ahead of any other phone mfg with the iPhone tech... All secrets type moat.   

Bottom line test for a big moat -- do the Apple products sell for a premium, and can they raise their prices with inflation?  Duh.  Big moat.

Management.  Jobs.  He proved his value so many times.  Here's his managment style:  "That's bs.  Get rid of it.  That's bs.  Get out of my sight. Hmmm.  That's cool.  Move over and let me sit down and play with it."

He's totally driven by a huge BAG that just keeps getting bigger.  Make it the best consumer product in the world.  He could take over Disney.  I love this guy.  Hard core?  Yes.  A-hole?  Sometimes.  Building huge value for Apple owners?  Always.   Honest?  Always.  BAG?  Huge.

MOS. Nice job on the numbers (no pun intended).  I like your conclusions and I do believe there is a nice big MOS here.  And I say that based on my own decision to switch off of Dell/Lenovo and to ask the seminar producers where I speak to buy Macs as well.  Which they did. 

I see the Mac back at 10% of the market in a few years and Apple dominating the phone biz and the iTunes biz.  And then coming up with something else.  So yeah.  I'm in.

Watch the arrows though. This is a Google sort of ride.

Now go play.

Phil Town