Wednesday, March 21, 2012

Is Apple a Buy?

Apple Inc. (AAPL) is the most talked about stock in the market today. It recently broke above $600 per share and it is setting new highs almost on a daily basis. In response, analysts are outdoing one another by raising their price targets. They argue that at just 17 times trailing earnings, and 14 times expected 2012 earnings, AAPL is still a cheap stock. Indeed, AAPL does offer more value than many other highfliers. For example, Lululemon Athletica (LULU), an apparel maker, generates just a fraction of the sales that AAPL produces, yet LULU is selling for 65 times trailing earnings and 60 times expected earnings. So what gives?

One reason why AAPL looks comparatively cheap is because it is so huge. With a market cap of $565 billion, it is the largest stock in the S&P 500 Index by far. In fact, it is 35% larger than the second-largest stock (Exxon Mobil). Investors simply cannot get their minds around a company this big being able to generate the kind of growth typically seem only in small-cap companies. APPL's revenues were up 14% in 2009 then they surged 52% in 2010 and 66% in 2011. Over the past four quarters, sales are up 68%. In other words, despite the company's already gigantic size, revenue growth is still accelerating. One could reasonably argue that there is still plenty of room for growth, especially in international markets. Imagine, for example, how much larger AAPL could get once it establishes a real foothold in China.

Another problem has to with skepticism about the company's ability to continue coming out with revolutionary must-have products--especially now that its co-founder and inspiration, Steve Jobs, has passed away. The stereotypical AAPL customer is young and extremely passionate about the company's products. I personally know a few who live in my house. They refuse to consider buying any competing products. These kinds of customers don't really care if iPhones drop calls or iPads overheat. If APPL builds something, these consumers will run, not walk, to the nearest store. But how long can AAPL count on this lemming-like behavior? How long will customers leap every time the company announces a new product? AAPL depends heavily on exactly the kinds of customers who are also the most fickle. Do something that really upsets them and they will abandon you in a second. And you can bet that the competition is not sitting still. They haven't had much success so far, but competitors are doing their best to try to beat AAPL at its game. Indeed, the next hot gadget may come from a company we haven't even heard of yet.

So is AAPL a buy? I have been around long enough to know that momentum can take any stock much higher--or much lower--than you could possibly imagine. Right now, upside momentum is clearly on AAPL's side. Take a look at the price chart and you will see that for three straight years, AAPL shares increased at a fairly steady rate. However, starting about three months ago, the gains suddenly accelerated. It's a bit like watching Usain Bolt running at full speed unexpectedly shifting into a faster gear. Therefore, I would not be surprised to see this stock go higher, but that's not a bet I'm willing to make. I simply find it impossible to believe that the world's largest company can maintain annual revenue growth rates of 65% for much longer.

Friday, March 16, 2012

Apple Stands Falsely Accused

"In the theater, our job is to create fictions that reveal truth—that's what a storyteller does, that's what a dramatist does." You can be excused if you mistake this for a quote from George Orwell's 1984. Unfortunately, it is a real statement released by the Public Theater in New York City to defend the lies behind Mike Daisey's accusations against Apple Inc.'s working conditions in China.

Daisey is a performer who put together a fictional piece about Steve Jobs. However, he somehow convinced a prominent member of the media that his story was really true. Ira Glass, a highly respected journalist who hosts the radio show This American Life, devoted an entire episode to Daisey and his lies against Apple. This American Life is distributed by Public Radio International and airs on National Public Radio affiliate stations.

Daisey made up lies about the Foxconn factory in Shenzhen, China. For example, he said he met workers who were just 12-years old, and he said he met workers who were exposed to chemicals that were so toxic, it left their hands shaking "uncontrollably." Apple took a lot of heat for what was supposedly going on at this factory. Now we know they were lies.

The unfortunate truth is that Foxconn has a history of treating workers badly. Indeed, a number of Foxconn employees have committed suicide. As a result, it is not difficult to understand how someone (even a respected journalist) could be duped into believing the worst. Furthermore, because NPR has long been accused of having a liberal, anti-business bias, it is easy to imagine the folks putting together the show champing at the bit. They no doubt knew this story would be big. It turned out to be one of the most popular episodes in the program's history.

But journalists are supposed to be skeptical, and they are supposed to check out the facts. Thanks to Rob Schmitz who works for another show that airs on NPR, Marketplace, we now know the truth. To Mr. Glass's credit, he and Public Radio International have retracted the story. That's more than what some others may have done. Better late than never, yet the damage is already done.

As for Mr. Daisey, he remains defiant. He thinks his only sin was not making it clear to Mr. Glass that he was putting on an act. But he has been selling his fiction as truth to other media outlets as well. Unfortunately, Daisey has victimized the very workers he claims to be protecting. Employee abuse is a real problem in China, but due to Daisey's lies, the next person who comes along with a real story about worker abuse will get a much less receptive hearing.

Wednesday, March 14, 2012

Goldman's Muppet Clients

Goldman Sachs is in the news again, this time because a now former executive by the name of Greg Smith wrote a scathing resignation letter published in the New York Times titled Why I Am Leaving Goldman Sachs. In his article, Mr. Smith (who no doubt will be going to Washington when Congress calls for another investigation), accuses his former employer of putting its own interests ahead of its clients'. That may come as a shock to some people, but I would bet that most clients suspected as much anyway.

Mr. Smith says that Goldman's stock in trade for 143 years has been trust. However, he says that today a new culture has taken over, one which stresses "ripping eyeballs out" and "getting paid." Perhaps most interesting was Mr. Smith's claim that during the past 12 months he heard five different directors refer to their clients as "muppets."

Anyone familiar with the real Muppets would know that Misters Statler and Waldorf (pictured above) are the only ones who are wealthy enough to be Goldman clients. Interestingly (and this is no joke), Goldman Sachs has actually arranged financing deals for movie studios trying to raise money from hedge funds and private equity firms. I could find no evidence, however, that Goldman was involved in any of the Muppet movie deals.

In all seriousness, this is just another incident that tarnishes the reputation of Warren Buffett's favorite investment bank. Buffett, who has long been critical of investment bankers, has praised Goldman Sachs on a number of occasions. Berkshire Hathaway still holds a sizable financial interest in Goldman in the form of warrants, an investment that came about during the financial crisis when Buffett was approached by a former Goldman banker named Byron Trott.

One has to wonder what purpose Mr. Smith's public letter of resignation serves. He must have been very angry or fed up to do what he did. It certainly was one of the greatest displays of publicly burning ones bridges. His actions make it all but certain that no other bank will hire him. Yet Mr. Smith is probably wealthy enough to live comfortably for the rest of his life without having to work. I have no doubt, however, that a number of investment firms would be happy to have him on their staff. Yet criticizing Goldman so publicly for unethical behavior will also bring a certain degree of scrutiny on how exactly Mr. Smith has been earning his living over the past 12 years. Because he must know this, he must also be quite confident that he can withstand the scrutiny.

Tuesday, March 06, 2012

Earnings Guidance Revisted

Earnings guidance is one of the more controversial management practices. It is something I feel strongly about. I even devoted a whole chapter to defending this practice in my 2008 book, "Even Buffett Isn't Perfect." Those who would like to see an end to guidance are basically arguing that investors are better off having less information. In a day and age when regulators are trying to increase transparency, this makes no sense.

It was wonderful to see the recent Wall Street Journal article written by Professor Baruch Lev of New York University defending guidance. It reminded me of the excellent interview I had with Professor Lev several years ago when he was a guest on the MoneyMasters video program I used to host at Forbes. Click here to watch Professor Lev's excellent defense of earnings guidance.

Saturday, March 03, 2012

Stocks Ignore Economic Woes as Apple Drives the Indexes

The following commentary is derived from a Special Report distributed to subscribers of the Forbes Special Situation Survey on March 2.

So far, 2012 is turning out to be a great year for stocks. Through Friday, March 2, the NASDAQ Composite Index was up 14.2% year-to-date and the S&P 500 was up 8.9%. Of course, both indexes benefit greatly from their inclusion of Apple Inc., which is up 34.6% year-to-date. Apple, which has a market capitalization of more than $500 billion, is about one-fourth larger than Exxon Mobil, the second largest stock in the S&P 500. Because both the NASDAQ Composite and the S&P 500 are cap-weighted, they got a big boost from Apple's outstanding performance. On the other hand, the Dow Jones Industrial Average, which does not include Apple, is up just 6.2% year-to-date. This demonstrates just how influential Apple has been to the other two indexes.

For the most part, the corporate sector of the economy is doing well. Companies have benefited greatly from low interest rates and years of cost-cutting. Profits and balance sheets are strong. Many companies are using cash to increase dividends, repurchase shares, and pay down debt (or at least refinance existing debt with cheaper debt). Yet three critical legs of the economy remain troubled.

Employment – On the surface, there appear to be significant improvements in the employment market. The unemployment rate, which peaked at 10% in October 2009, has gradually declined to 8.3%. Weekly initial jobless claims improved from 659,000 in March 2009 to 351,000 for the week ending February 25, 2012. Nonfarm payrolls increased by 243,000 in January, marking the 16th consecutive month that the economy added jobs. There is no question that these trends are good. They certainly indicate that the jobs market is moving in the right direction. However, the improvement in the unemployment rate is largely an aberration because discouraged workers, who are many, are not counted. Furthermore, initial jobless claims are still higher than they should be in a recovery, and job creation is still much too anemic. Take a look at the employment participation rate to see just how troubled the jobs market remains. This figure is calculated by dividing the civilian labor force by the civilian non-institutional population. This critical measure, which hovered above 66% before the financial crisis of 2008, is now down to just 63.7%. In other words, a smaller proportion of the population is taking part in the labor force. If you think there isn't much difference between 66% and 63.7%, you will probably be shocked to learn that had the participation rate remained at 66%, the unemployment rate today would actually be 11.8% instead of 8.3%. As bad as it is, the unemployment rate looks better simply because fewer people are participating in the jobs market. Also, don't forget that if the jobs market truly strengthens, the unemployment rate should initially rise as more people begin to look for work.

Housing – Warren Buffett argues that the housing market is near bottom. He says that over the long term, the number of housing units must rise in line with the number of households. Today, household formation is outpacing the increase in housing units. That doesn't help the housing market in the short term because there is an oversupply of homes. In the long term, however, more houses will have to be built. Furthermore, because interest rates are low and housing prices are so depressed, the cost of buying a home looks extremely attractive compared to the cost of renting. Buffett is right that the housing market will eventually improve. Of course, the critical question is when? Unfortunately, the latest S&P/Case-Shiller numbers show that we aren't there yet. Housing prices are still falling. In fact, they are almost 35% below the 2006 peak. On average, homes today are worth what they were back in early 2003. Many people who purchased a house after that date are underwater.

Energy – According to the AAA Daily Fuel Gauge Report, the national average price of regular gasoline has reached $3.74 per gallon. In some parts of the country, it is well above $4.00 per gallon. Just one month ago, the national average price was $3.45 per gallon. This 8.4% increase in a month is largely due to the rise in crude oil prices. The oil market has been particularly sensitive to rumors. For example, any talk that Israel is about to attack Iran in order to destroy that nation’s nuclear capabilities causes prices to rally. A recent rumor that a pipeline in Saudi Arabia exploded caused another spike in oil prices. Interestingly, that rumor, which turned out to be false, appears to have originated in Iran. That may not be surprising, yet the reaction showed just how nervous oil traders are. Demand for gasoline, which has been depressed since the start of the financial crisis, was starting to pick up. Higher gasoline prices, however, are likely to reduce demand again, which is not a good development for the economy. Higher gasoline prices could also fuel inflation. One energy bright spot is natural gas, which is plentiful, cheap, and not imported. Maybe it's time to start thinking more seriously about alternative sources of energy, such as T. Boone Pickens' idea of converting long-haul trucks to natural gas.