(This is a guest post. The author’s views are entirely his or her own and may not always reflect the views of Old School Value.)
What You’ll Learn:
- A brief timeline of Apple’s entry into retail
- A qualitative look at why Apple is such a compelling investment
- How Apple passes Phil Fishers 15 point checklist
- Fundamental comparisons with other retailers that show the true strength of Apple
Quick Apple Retail History
Apple’s entrance into the brick and mortar retail space began on May 15, 2001 when the company announced that it would open 25 stores in 2001.
Then just four days after that announcement, it simultaneously opened its first two stores, on the same day, in Tysons Corner in McLean, Virginia, and the Glendale Galleria in Glendale, California.
About five months prior, Apple was already planning a major move into the E-commerce space when it launched its iTunes Software on January 9, 2001 and laid the foundation for its iTunes Music Store, which it launched on April 28, 2003.
By the time Apple launched its App store in 2008, its iTunes Music Store had surpassed Wal-Mart to become the number one music retailer in the US.
Apple celebrated this fact by releasing the following statement at the time
With over 50 million customers, iTunes has sold over four billion songs and features the world’s largest music catalog of over six million songs.
And with it most recent launch of iTunes into China on September 30, 2015 Apple has announced that it now has over 800 million iTunes customers. It’s only a matter of time until the company reaches its one billionth user for iTunes.
I consider Apple’s retail operations to consist of the following:
- E-commerce Apple.com website
- its brick and mortar stores
- the iTunes Store
- the App Store
- the Mac App Store
- the iBooks Store
- licensing and other services
In his last TV appearance in 2011, Steve Jobs said that “Apple is growing like weeds”.
He clearly saw the future as here are the most recent Retail Sales results from Apple’s latest 10-K Annual Report filing with the SEC.
- The iTunes Store generated a total of $10.2 billion in net sales during 2014 compared to $9.3 billion during 2013.
- The growth in Retail segment net sales in 2014 was primarily driven by increases in net sales and unit sales of iPhone and Mac, partially offset by declines in net sales and unit sales of iPad and iPod. With an average of 424 and 403 open stores during 2014 and 2013, respectively, average revenue per store increased to $50.6 million in 2014 with Net Sales of $21.46 Billion.
- Including revenue from the iTunes Store, the App Store, the Mac App Store, the iBooks Store, AppleCare, licensing and other services = $18.063 billion
Apple’s retail operations clearly exploded since Steve Jobs introduced the store concept in 2001, where he also first introduced the “Genius Bar” store concept.
Why Analyzing Retailers with Fisher’s 15 Point Checklist Works
Analyzing retailers is a complicated operation.
Just as Benjamin Graham is widely considered to be the Father of Quantitative Analysis, Phil Fisher, in his own right, is considered to be the father of Qualitative Analysis and growth investing.
Qualitative Analysis for those who do not know is the art of analyzing a company based on the quality of its operations, quality of management and finally by the level of superior performance over time as measured by consistency of operations.
The most important point in Fisher’s work besides consistency, was;
A) getting “The Story” right
B) not overpaying for what people envision as a very promising future.
Many investors make the mistake of buying shares of a company that makes a product or provides a service they believe is a game changer. That is, they get emotional about it. This leads to an automatic assumption that if they just buy shares of the company (no matter what the price), they will get rich.
It’s happened… In some rare cases. Unfortunately, it doesn’t work like that.
Many have high hopes for companies, like Tesla, but the current numbers do not back up “The Story”.
The Fisher “15 Point” analysis is a way to take emotion out of an analysis.
It’s possible because Phil Fisher’s methodology objectively analyzes a company’s operations looking for consistency over time in the real world. It’s not focused on one year or one quarter results.
This method also forces you to examine the financial statements of the firm and make sure you don’t overpay for the company’s growth prospects.
Apple’s 15 Point Analysis
Apple creates its product and services to run on what is now known as the Apple “eco-system”.
Besides being works of art in design and very appealing to the eye and touch, each of its products, along with its services are also very user friendly and once purchased tend to become an essential part of one’s life, which most Apple customers cannot live without.
The reason for this is that the eco-system links all of Apple’s products and services into one place.
e.g. You can purchase and store your music and then transfer it among all your devices. On top of that Apple is constantly innovating each product and thus continually causes its customer base to want the next upgrade.
It’s constant demand.
This demand is universal and worldwide as customers in China have a similar addiction to their iPhone as someone in Canada or Singapore would.
As Apple further expands its operations globally, its potential customer base is rather unlimited because of the power of Apple’s eco-system.
With Apple having about $200 billion in cash and cash equivalents on its balance sheet, expanding its store operations costs Apple pennies on the dollar in relation to total sales and is a no-brainer.
Fortunately for us, management is determined to do so as Apple now has anywhere from 424 to 437 stores now open and surely has the determination to continue opening more stores in Asia for example.
While expanding store operations, management is also just as determined to stock those retail stores with innovative products and drive even more customers to its stores.
Obviously with the massive amount of free cash flow that the company generates and its massive war chest of cash and cash equivalents, Apple’s R&D budget is rather conservative.
That’s because its retail operations concept is running as smoothly as it can and the company does not need to change the concept, especially when you see results like these:
Here is what the company said about its R&D strategy.
The Company continues to believe that focused investments in R&D are critical to its future growth and competitive position in the marketplace and are directly related to timely development of new and enhanced products that are central to the Company’s core business strategy
If it ain’t broke, don’t fix it.
The key identifier of an above average sales organization is not only how a company’s operations perform in good times, but in how it performs in bad or difficult times.
Obviously China has experienced a slowdown over the last year. However the chart below helps you conclude that Apple is an elite sales organization.
Because Apple does not do much in the way of wholesale discounts to stores like Best Buy or Wal-Mart, it is able to maintain some of the best profit margins for its retail operations.
Stores like Best Buy and Wal-Mart thus are forced to offer Apple’s products as “Walk-In” items to draw traffic to each store.
The price you pay at your local Apple Store is consistent with prices from other retailers.
This is very unique in the retail industry.
One of the key roles that Tim Cook had prior to becoming CEO was to be in charge of overseeing Apple’s product production.
Having the CEO also be an expert in production obviously helps. Besides that, Apple also operates through “Economies of Scale” where it is able to reduce its cost per unit easily due to their market position and being one of the biggest players in the market.
If you want to see just how profitable Apple is compared to its competitor’s, then just look at the following chart.
Employee relations at retailers are always a difficult area to gauge, but for full time employees at Apple retail operations, benefits include:
- Medical and Dental Coverage.
- Special therapy coverage for those suffering from hard times.
- Stock buying program where retail employees can get a 15% discount on any Apple shares they buy.
- First on line for new product launches.
- Wear whatever they want to work as long as the Apple T-Shirt and nametag are worn while working.
When it comes to executive relations between CEO Tim Cook and Senior Vice President of Retail and Online Operations, Angela Ahrendts, things could not be better as in 2014 she earned total compensation of $83 million and was the highest paid female executive in the US.
Ahrendts told Fortune’s Adam Lashinsky, recalling her first meeting with Cook. “I did not expect to be moved by the man, and I left and I thought, ‘Ohhhhh! My life was perfect, Aaargh, why, why, why?”
“[nothing will] take him off of always doing the right thing. Not just for Apple, but for Apple’s people, for communities, for countries. The world needs more leaders like Tim.”
Apple has incredible depth to management with CEO Tim Cook and his team of executives.
But since this article is about Apple’s Retail and Online Operations we need to concentrate on Angela Ahrentds. Tim Cook persuaded her to join Apple from Burberry Group PLC, where she was a highly successful CEO from 2006-2014.
Here is a wonderful link to a video that explains a little about who she is and what she is doing for Apple, such as having successfully integrated the retail and online stores for the first time in the company’s history.
This is where Phil Fisher put on his quantitative analyst hat and ran through company’s financial statements to look for consistency over the years.
He did this by analyzing a company’s income and cash flow statements as well as its balance sheets.
Since I analyze a lot of companies each year and in order to save myself a lot of time, I spent a couple of decades designing a computer algorithm to assist me in my quantitative analysis.
I officially completed and launched this algorithm on May 1, 2015, which I named Friedrich.
Friedrich basically does 2500 calculations on ten years of financial statements using data from the Old School Value analyzer, for each company under analysis and then organizes the results into the 30+ original ratios that I created over the years.
As a result, in less than one minute, I am able to create the following Friedrich Data File for Apple (or any non-financial stock):
My work is based on free cash flow and what you see above is basically 30+ different ways of analyzing a company and doing so in a highly efficient and verifiable manner that is also lightning fast.
Friedrich basically does all my quantitative analysis for me and thus gives me the time to research the qualitative aspects, similar to what I am presenting here in this article.
To better understand the table above as well as view the ideal parameters to look for in each of my ratios, please go to the Legend Page (print it out). Here’s a detailed guide on how Friedrich works and how you can use him in your own analysis of stocks.
In this analysis what we are looking for is consistency in the results year on year (for a decade) because as an investor, I do not like surprises.
Thus if a company performs well over a ten year period under analysis, then obviously its cost controls and accounting controls are excellent.
In the Friedrich table above, all the results are GAAP results or “as reported”. They are not pro forma or adjusted for one time charges and other adjustments that are designed to make a company’s results look better than what they are.
Because Apple’s results are superior in quality, the company excels even without any adjustments.
For example using my FROIC Ratio = Free Cash Flow Return on Total Invested Capital, we have Apple’s results coming in above 20% for the last 8 years, which is excellent.
What FROIC basically tells us how much free cash flow the company generates for every $1 of invested capital (long term debt + shareholders equity) it employs. So Apple in the most recent “trailing twelve months” data returned 31 cents in free cash flow for every $1 the company invested on Main Street.
Friedrich is mostly based on the power of free cash flow in the investment process, which I verified by writing a proof after analyzing the Dow Jones Industrial Average from 1950-2009, which you can view by going HERE.
Since all companies are treated on an equal footing by Friedrich, here are two of the best pure retail operations that Friedrich has found for us. You can compare Apple in juxtaposition and see with your own eyes how powerful Apple really is.
All three companies have unique retail operations and are all extremely profitable operations based on company’s FROIC results.
Each company also operates mainly through organic growth, instead of buying out the competition and trying to grow operations that way. In an era of Federal Reserve inspired zero interest rates, it is refreshing to see three companies that grow organically without having to submit to the easy fix of borrowing hand over fist, just because such an option is available.
Apple is run on a culture that was built by the genius Steve Jobs.
To give you just one example of Steve Jobs’ genius, he saw early on that Music was something that everyone on the planet loves. At the time there was no way for people to enjoy all their music anytime they wanted, no matter where they were (home, beach, at the gym, etc..) and he also noticed that even the world’s largest record stores could not even hold 20% of all the music that had been previously recorded.
So he had his team develop iTunes and from there created the iPod to store 1,000 or more songs, where people could then listen to those songs anywhere they wanted.
From there his team developed the iTunes Music Store where you could buy songs for 99 cents each or whole albums.
It also did wonders for the music industry as it allowed record labels to sell the 80% of the inventory that they had on file, because traditional record stores didn’t have space to sell it all.
By creating an eco-system, Steve Jobs freed his customers and opened up a massive database of music for sale, while at the same time destroyed services like Napster that threatened to destroy the music industry. That is just one example of why innovation is built into the culture at Apple and thus makes it a unique company.
Steve Jobs used to operate with a three year outlook for new product concepts going forward and at most would go out five years.
He did so, because in the technology field innovation moves so quickly that to stay ahead of the curve the outlook had to remain 3-5 years. As an organization Apple has barely scratched the surface as to its potential, even though they have grown to be one of the largest companies on earth. They have barely scratched the surface as citizens of India and China are only now just coming on board as customers by entering the Apple eco-system.
With almost 3 billion people in just those two countries alone, the future for Apple indeed looks very bright.
Apple will most certainly be successful as the secret to its success is that it refuses to bring a product to market unless it can make a certain profit margin on each unit sold. Steve Jobs learned this strategy from observing the mistakes made by Nokia, who was a pioneer in cellphone and smartphone technology and was the king of that industry some seven years before Apple first launched its iPhone.
Nokia totally dominated and had the largest market share in its industry. Where Nokia failed (and where Apple succeeded) is that Nokia went for market share instead of profit margins and destroyed its wireless division as a result, finally selling that division to Microsoft for pennies on the dollar of what that division used to be worth in the year 2000.
So Apple will always be profitable, as long as management continues to concentrate on profit per unit sold and not market share. That is the secret to success for all businesses in my opinion, but a model that is rarely practiced.
Apple’s biggest problem is what to do with all the cash it is generating. Of the 15 points under analysis this one causes zero concern.
Apple, unlike most firms, does not freely discuss what it is doing with investors except when it launches product presentations and through various select press releases.
Apple does not do so as Steve Jobs was very secretive and was not a very trusting soul after getting forced out of Apple in the old days. But Apple does not need to be very public as it is the most widely talked about and covered company in history by the press and bloggers.
You can find almost 100 articles written about the company on any given day. When there are problems with its products, Apple management acknowledges them and then goes about quietly to correct those problems immediately, which is all you can ever expect from any company.
Senior Vice President of Retail and Online Operations Angela Ahrendts, told Fortune (in the article I linked under Fisher point #8 above) the following about CEO Tim Cook.
[nothing will] take him off of always doing the right thing. Not just for Apple, but for Apple’s people, for communities, for countries. The world needs more leaders like Tim.
It has been my long experience, that when the CEO operates through honesty and integrity, that the rest of management usually follows suit, simply because in most cases the CEO hired them as Tim Cook did with Angela Ahrendts.
There you have it.
A complete Fisher “15 point” qualitative analysis of Apple, along with a complete Friedrich quantitative analysis.
Apple is one of my clients largest holdings and will be so for a long time to come as it is nowhere close to my sell price.
Going forward I believe Apple is only in the early innings (2-3) of a nine inning game in reference to its future growth prospects. The potential customer base in India and China are just daunting. Few product manufacturers can achieve success in opening retail operations, but no product manufacturer has ever achieved the success that Apple has.
Success in retail is not only measured by how many people visit a company’s store, but is also measured by how much money each spends when they get there.
I am very happy that Apple management understands that it is very important for the company to make a profit on each sale and not operate like Amazon , which barely generates a profit at all, because they sell everything at cost, just to increase sales. We saw from the Nokia example above how such a strategy usually ends.
Each time I go to the mall, I am constantly overwhelmed by the number of customers that I see at my local Apple Store. With Apple generating $4,551 in sales per square foot of retail space, it clearly shows that their customer base loves the experience of shopping at an Apple store, but also spends money when they visit.
That is why Apple is my top retail pick and one of the largest holdings in my client portfolios.
The author is long AAPL.
Old School Value is long AAPL.
About the Author
Peter George Psaras is CEO at Conservative Equity Investment Advisors, a registered investment advisor based in New York. He is also the creator of Ask Friedrich, a uniquie blend of algorithm to analyze stocks focusing on free cash flow.