Old School Value vs Wall Street


In response to my post on the valuation of AAPL, an opinionated user posted this reply on Google finance and so I responded. I don’t mind attacks if it is intelligent and knowledgeable, but if it is based on blind irrationality with no facts or logic other than sheep talk, then I will be hell bent on having lamb chops for breakfast.


In response to my post on the valuation of AAPL, an opinionated user posted this reply on Google finance and so I responded. I don’t mind attacks if it is intelligent and knowledgeable, but if it is based on blind irrationality with no facts or logic other than sheep talk, then I will be hell bent on having lamb chops for breakfast.

See below the for reply and response.
=======================================================
From: suzy.de…@gmail.com
Date:
Sun, Jan 27 2008 5:24 pm

First flaw in your calculation:
1) You use buffets’ 4-5 year running averages (for earnings)? Warren says that he doesn’t get tech stocks at all. So these are not-applicable to high growth companies, he tends to look at more established and lower growth companies. Averaging out earnings increases proves that. Evaluating Google by the techniques you’d use on say 3M or Ford, would mean their stocks would have an intrinsic value of what? $130 as well?

2) 1998-2004 is pretty irrelevant to stock performance from 2004-2008 and on to 2010 or so.

3) There’s many reasons why wall street doesn’t use CROIC, mainly because it only makes some sense in some areas. PE, FPE, EPS, all better indicators of a stocks past and probably future performance. In the end you used flawed variables, flawed methodology, and flawed logic to calculate a flawed result — your valuation for AAPL. And why is it flawed? Well, because those aren’t the numbers most people care about when investing in Apple, and it does absolutely nothing to factor in future shifts-in-market and so on.

Again, that makes sense if you’re buying a company that makes something, and is always going to make that same thing. Mining concern, a textile factory, insurance company, and so on. But it makes no sense in companies like Apple, which has remade itself a few times now. And will do so probably 3 more times before your 20 year calculation runs out. A few years ago, Apple was 80% about Mac Proprietary Hardware, 10%
about Mac software, 10% about peripherals. Now Apple is about 40% Mac Hardware (all practically off-the-shelf in better packaging), 10% about Mac Peripherals and software, 40% about iPod & iPhone hardware, and 10% about the software and peripherals and licensing support that. That’s a big move. Where will Apple be in a few years? I don’t know. I suspect the Mac will be far larger, and about 30% of their business. Probably 20% iPod’s, 20% iPhones, and that leaves a large chunk of other. I don’t know what that other is — but Steve Jobs / Apple has proven they are good at finding that. You did nothing to factor in the $18B that Apple has in cash, or what they might do with it. It is a flawed logic that drives forward by
watching the rear-view mirror. That’s what your valuation does. So if you’re buying Apple today for what they did 5 years ago (your averaging backwards valuation technique), then they’re not a good buy. But if you’re buying them for what they’re going to do, well then, they might just be a raging bargain.
================================================

From: Jae Jun
Date: Sun, Jan 27 2008 6:10 pm
Email: Jae Jun…@gmail.com

1) Buffett’s ‘earnings’ is not the earnings of wall street. Buffett specifically refers to earnings as ‘owner earnings’ which is the same as free cash flow. Plus the only reason Buffett does not invest in tech is due to his limited knowledge on technology. He doesn’t even use a computer except to play bridge online and read the Washington Post. If you also analyse Buffett’s holdings and companies, you will see that they are characterised as Large Cap GROWTH. Of course DCF methods can be applied to any company.

2) Sure 1998-2004 can be thought of as irrelevant but are you saying that the first launch of ipod in 2001 is irrelevent? I know the great things Steve Jobs has done so I even mentioned that I will only consider 5 years data. The look at the past 10 years is to see what the company has been doing, whether there was turnaround, why a few years where worse than the others etc.

3) There are many reasons why Wall Street doesnt use CROIC. Mainly because Wall Street only thinks 3 months at a time and only cares for EPS which can be totally manipulated even with GAAP. If you’re a Wall
Street lover by all means listen to everything they have to say, but I am analysing a BUSINESS for a long term investment in a value method. Sure I did predict the growth rate, but doesnt EVERYONE predict the 5yr growth rate? Look up yahoo, smartmoney etc and they will all have different growth rates. Some valid, some ridiculous. I dont agree with everything Wall Street has to say, so what?

Now, if you are trying to value a private company, where are you going to get the PE or EPS or FPE? Are you going to dismiss it because there is no such thing in the private realm? Those number just exist or cared for in the private businesses. They are just numbers that wall street loves. If you have looked at Enron’s PE or EPS during its run up, you would have thought the company had unlimited potential. Had you looked at owner earnings, you would have realised that something was up way before it happened. Boy was Wall Street wrong.

The reason why most people dont know about CROIC or the basics principles of investing is because people love to speculate and orgasm over the quick return. If you were able to think and question some of the things Wall Street says, you would be a very savvy investor. Following their every move is just another sheep in the making.

Immediately dismissing Discounted Cash Flow method that even wall street uses is completely ridiculous.
From your post, I assume you hold aapl shares and bought it over my calculated price of $130. Do I care?? Not one bit. If you made a calculated decision, good on you for acting on it. Just like you, I am making my own calculations. And I dont see the $18B in cash that AAPL holds. More like $10B. $10B in cash equivalents just means that the current stock price of $130 is made up of $11 cash. Therefore you can say the growth aspect of the stock price is really $119. Understand? If you think the sky is the limit for AAPL, just go about and do your thing. That euphoria feels good doesnt it? Until reality hits and you realise that price follows value.

My past 5 year analysis of AAPL allowed me to calculate a growth rate which I find conservative, so that I dont lose money. If that means my calculations will rule out 95% potential candidates, thats fine. Im
after the sure 100% bets. Im sure you have some valid comments but to disprove a DCF method that
has been used for over 60 years even by wall street analysts is absurd and requires that you try broadening your mind.

  • Shane

    Jae,

    Suzy raised a valid point – you are not adjusting discounted FCF’s i.e. aggregate/enterprise value by the cash which sits on AAPL. You need to add back the cash from enterprise value to get to an equity value!

  • JJun

    Do you mean the cash and equivalents that AAPL has in its balance sheet?
    The latest filing shows that AAPL has around $9 billion in cash and equivalent. As an example, if I do add that back in to your equity value, the share value comes out to be $140.92. Only 7% increase from the first $130.80. Now $9 billion, or the word billion sounds big but it didnt have that huge affect on the overall value.

    More importantly, why I don’t add current cash equivalents? Well cash & equivalent is a part of current assets. Shareholders equity is total assets – total liabilities which already takes into consideration cash and cash equivalents.

    I am buying a company where I am entitled to the cash as well as anything that can be converted to cash should the company be liquidated. Shareholder equity takes care of all this.

  • Shane

    Jae,
    Suzy raised a valid point – you are not adjusting discounted FCF’s i.e. aggregate/enterprise value by the cash which sits on AAPL. You need to add back the cash from enterprise value to get to an equity value!

  • Do you mean the cash and equivalents that AAPL has in its balance sheet?
    The latest filing shows that AAPL has around $9 billion in cash and equivalent. As an example, if I do add that back in to your equity value, the share value comes out to be $140.92. Only 7% increase from the first $130.80. Now $9 billion, or the word billion sounds big but it didnt have that huge affect on the overall value.
    More importantly, why I don’t add current cash equivalents? Well cash & equivalent is a part of current assets. Shareholders equity is total assets – total liabilities which already takes into consideration cash and cash equivalents.
    I am buying a company where I am entitled to the cash as well as anything that can be converted to cash should the company be liquidated. Shareholder equity takes care of all this.

  • Paul Ho Kang Sang

    I agree with Jae Jun. Apple being a tech company has stroke investor’s imagination. Judging from the past results, most people would have discounted APPLE as dead and moved on, only to miss one of the most dramatic business transformation.

    However such transformation is hard to value. In other words, it’s a little bit like lottery. Creative destruction/renewal hits like a typhoon leaving no one unhurt, either for the benefit of the company or the demise of it.

    Therefore to be on the safe side, there are stewardship grading, innovation grading which can to some extend give a guide on what the company is capable of dreaming up and executing successfully.

    One should never discount what APPLE can do to create entirely new businesses or industries making them huge profits. On the other hand, it should also be moderated with safety margin by looking at it’s ability to generate FCF from it’s existing businesses in a sustainable and growing manner in which to fund future projects.

    Price to book, P/E, FCF as well as wide economic moat are key having good protection from losing money.

    At the end of the day, Vision are in the future, facts are still facts, i.e. how much you earn and how much you have in the bank.

    In other words, safety margins needs to be considered, perhaps in the case of Tech visionary companies, the margin of safely can be loosened a little in view of the ability of the company to come up with HITS after HITS (which cannot be estimated or valued accurately).

    Morningstar values AAPL at 160, apply Graham’s discount of 50% according to you would value the company at $80 a share. At $80, that is still some >4 times Book value, while I would buy it and have bought it, that is because that in investing, you cannot ignore Market sentiment and behaviour.

    Some companies can be overvalued and stay over valued for long periods of time. There are more sheeps out there than Eagle eyed investors. And when sheeps move in numbers, there is nothing the eagles can do.

    paul ho
    http://paulhokangsang.blogspot.com

  • JJun

    Thanks for the insight Paul

  • I agree with Jae Jun. Apple being a tech company has stroke investor’s imagination. Judging from the past results, most people would have discounted APPLE as dead and moved on, only to miss one of the most dramatic business transformation.
    However such transformation is hard to value. In other words, it’s a little bit like lottery. Creative destruction/renewal hits like a typhoon leaving no one unhurt, either for the benefit of the company or the demise of it.
    Therefore to be on the safe side, there are stewardship grading, innovation grading which can to some extend give a guide on what the company is capable of dreaming up and executing successfully.
    One should never discount what APPLE can do to create entirely new businesses or industries making them huge profits. On the other hand, it should also be moderated with safety margin by looking at it’s ability to generate FCF from it’s existing businesses in a sustainable and growing manner in which to fund future projects.
    Price to book, P/E, FCF as well as wide economic moat are key having good protection from losing money.
    At the end of the day, Vision are in the future, facts are still facts, i.e. how much you earn and how much you have in the bank.
    In other words, safety margins needs to be considered, perhaps in the case of Tech visionary companies, the margin of safely can be loosened a little in view of the ability of the company to come up with HITS after HITS (which cannot be estimated or valued accurately).
    Morningstar values AAPL at 160, apply Graham’s discount of 50% according to you would value the company at $80 a share. At $80, that is still some >4 times Book value, while I would buy it and have bought it, that is because that in investing, you cannot ignore Market sentiment and behaviour.
    Some companies can be overvalued and stay over valued for long periods of time. There are more sheeps out there than Eagle eyed investors. And when sheeps move in numbers, there is nothing the eagles can do.

[checklist-collection]
[checklist-collection]