Wednesday, April 25, 2012

Missing the Point on AAPL

OK, so this is post number 3 on the same issue.  TRG has already made this case here and here, but now he feels the need spell it out, plain and simple.  AAPL stock is too cheap, and nobody seems to be noticing.  All the talk is about future iPhone competition, and margins that can not stay this high.  They are missing the point.  The stock will surely rise today, probably more then 10% based on pre-market activity.

IT WILL STILL BE TOO CHEAP!

Simple math will show it.  The current PE based on the April 25 close price of 560.28 and the announced earnings (past 12 months earnings are 41 dollars per share) is 13.66!  The current average PE for the S&P 500 is 22.5.  Based on this simple fact, 1 dollar earned at Apple is only worth 13.66/22.5 = .60 cents earned at any other company...  THAT'S STUPID CRAZY.

Apple is an exceptional company, and TRG would really like to believe that they deserve a commensurate valuation.  But lets be conservative and value them as an AVERAGE company:

41.02 X 22.5 = $922.95

There it is.  AAPL stock, with an average S&P valuation, should be trading at $923 per share.

Saturday, April 21, 2012

So, that life thing... what's it worth to ya?

Here's a question.  How much (in dollars) is a human life worth?  Priceless?  Hardly.  Given the impact on the earth's limited resources, it could be argued that there's a net benefit to one less person (resulting in a negative value for a life).  However, in social, and economic terms, a life certainly has a (positive) value.  This isn't just a philosophical question, there are a lot of situations where we really need to know.  It's time to come to have a responsible discussion and come up with a reasonable, consistent number.

Society puts a value on life all the time.  Courts, insurance companies, even municipalities deciding whether to make road safety improvements are putting a dollar value on your life every day.  The problem with modern society is that we are inconsistent, unjust, and unequal in our assessment.   For example, if you are killed by an American State, you are probably worth around $100 to 300K (regardless of weather it was an accented or not).  If you die because a doctor misdiagnosed you then it's a jackpot!  This woman hadn't even died yet.  Of course, that's medical malpractice in the United States, in other parts of the world, it's not so much a jackpot as a joke (in Europe, it can be a real challenge to raise a malpractice claim at all).  If a US military soldier barges into your house and kills your whole family (for no apparent reason) you are likely to receive a paltry sum.  If you are homeless and you die because no one will give you a warm place to sleep, then the value is probably $0, and if the state can find heirs, they may charge them for the disposal.

Wouldn't it be a little more equitable if we as a society came up with a single number, and applied it consistently?  This is not a new or original idea, in the 5th century the 'Barbarian Code' (an ironic appellation considering that, on this topic, the code was more sophisticated then our current system) contains the concept of 'WereGild'.  According to Philip Grierson the Barbarian Code itself was quite a complex list of values and equivalences, such that if the responsible party did not have actual cash money (which was not in common circulation) then an equivalent number of say chickens could be supplied.  So there you go, modern law does not even give you a value in dollars, let alone chickens.  outrageous!

If life had a price, it would set a useful benchmark for all sorts of other compensation issues too.  For example, lose an eye, or a limb on the job, and the compensation should work out to be some proportion of the compensation due for a life.  Naturally, in cases where the injury (or loss of life) was caused by gross negligence, or intentional action, then the compensation award could be a multiple of the normal value.  This would immediately solve one of the major issues in American healthcare by reducing medical malpractice awards, and by extension malpractice insurance that doctors must pay.   There are other legal is issues that impact healthcare costs, but this would go a long way to fixing things.

Setting a value for life would allow us to plan our society in a much more consistent way.  Insurance liabilities could be estimated with much more accuracy.  Safety improvements could be more easily analyzed for their cost/benefit.  Fair, consistent settlements for wrongful death would be easily arranged, and could probably even avoid expensive court trials.  The benefits are obvious, what's the drawback?

AAPL Sillyness

Following That Retired Guy's (TRG) last post on AAPL, the stock has not exactly moved in line with his predictions.  Probably it should be expected that when you stick your neck out with a public statement, fate is sure to prove you wrong.  TRG is not deterred, so he's going to tempt fate.  He's going to double down.  He's going to talk about how AAPL stock has become ridiculously cheap.

First, a graph of the recent activity:

AAPL Chart

AAPL data by YCharts

As you can see, from the close on April 9th (636.68) to yesterdays close (572.98) AAPL has plunged almost exactly 10%.  Even worse when you consider that the S&P 500 is nearly flat over the same period, and worse still when you acknowledge the fact that AAPL itself has a massive impact on the S&P's performance due to it's outsized market cap as this chart from the Wall Street Journal shows:


But as TRG pointed out, AAPL's stock price growth was already struggling to keep up with it's earnings.  Now the situation has become a little ridiculous.  Basted on AAPL's current close and trailing earnings, the stock has a PE Ratio of 16.32.  If anyone can argue that that PE makes sense for AAPL, please comment, TRG would love to know what he's missing.  Keep in mind that 16.32 is based on trailing earnings, and that AAPL's balance sheet cash translates to approximately $100 per share which technically should be removed before calculating PE (if you remove it, current PE is even lower).  Depending on who's estimate of future earnings you use, you are likely to come in with a number somewhere around 12!  Daniel Tello is respected as one of the most accurate independent Apple analysts (independent's are more accurate then pro's on Apple) and his forward looking PE is around 10.

TRG would sell Apple if it's earnings PE got much above 25 (that is, 25 trailing earnings, the TRG limit is 20 on forward earnings), but at 16, it seems a bargain.  PE for AAPL has been lower, but that tends to be only just after earnings are announced.  Since AAPL tends to beat all earnings estimates, the high earnings cause the PE to become deflated, but this situation is usually rectified within a few days of trading (by a rocketing stock price).  For example, see last April.

Price to Earnings (PE) is a crude measure, but it captures the general idea that a dollar earned different companies and sectors does not have the same impact on the company's/sector's value.  There are some good reasons for this.  For example, if the company high risk, or highly leveraged, or facing low growth prospects then the stock price should reflect this, and the resulting PE should also be lower.

In the case of AAPL, given that the first quarter earnings were so high (one quarter being as much as the whole first half of 2011) the fact that their PE has come down since last year (it was over 20 a year ago) is very hard to square.  Is this actually suggesting that the next 3 quarters will be LOWER then last year?  Certainly the analysts making estimates don't think so.

AAPL has no loans, and therefore, no leverage at all.  From this standpoint, it's a pretty low risk company.  Although earnings have been volatile, they tend to be volatile only to the positive side.
AAPL has not had negative earnings in recent history (you have to go back about 10 years), and even the worst Apple doomsters would never dare to suggest that Apple will have a quarterly loss this year (or next).

AAPL's PE at 16.32 has now come in below some companies in the technology sector.  For example TXN (Texas Instruments) has a PE of 17.32, a fact that should immediately seem a bit strange to any investor.  TRG could go on and on about why this situation is just crazy, but rather, he will just show a graph that says it all (make sure you pay close attention to the scale on this graph):

AAPL Earnings Per Share Chart


Wednesday, April 18, 2012

No, the crisis is not over

The Economist has a good article this week about the euro crisis.  This retired guy (TRG) has a real soft spot for the cartoon too:


No more sugary euro's in the Sarkozy dispenser, better try the Merkel one.

The New York Times is also on it, and so is Reuters.  Although it's a mistake to think that this is just an exclusively European problem.  There is too much debt EVERYWHERE.  The US has it particularly bad, Japan too, and things are really unlikely to get better until we admit a few things about debt, and take appropriate action.

There are a few principles of debt that have existed since time eternal.  These principles of debt existed long before we even called it 'debt'.  Ever since it has been possible to owe something (anything) to someone (anyone) these principles have been true, so it's surprising that we are forgetting them now.


The FIRST Principle of Debt

The number one, critical, most important principle of debt, that every lender and borrower should understand intimately is this:

If you CAN'T pay a debt...  YOU DON'T.

It's that simple, really.  There are consequences to not paying, and they must be faced, but the simple fact is, if you can't pay, you don't.  You face the consequences.  You get on with it.  In fact, over time, as a society, we discovered that 'getting on with it' is the most important part.  The consequences themselves need to be focused on 'getting on with it', not on punishment, or retribution.  Think about it for a moment, take yourself back a few thousand years, it's not hard to imagine early societies where the consequence of default was DEATH.   In the more recent past, it was imprisonment (debtors prison).  However as a society, we moved away from these stern consequences, and not just because they were inhumane; we moved away from these consequences because they were unproductive.  If you kill or imprison some one for not paying debt then you have effectively GUARANTEED that you will recover exactly zero percent of the debt owed.  In our modern world, we have developed bankruptcy as an alternative.  Bankruptcy is a legal process whereby you pay what you can, and anything you can't pay, you don't.  You pay what you can, and then you get on with it.  How many successful entrepreneurs today were bankrupt at least once in the past?  Would be a shame if we had killed them for it!


The SECOND Principle of Debt

The second principal of debt (nearly as important as the first):

There are ALWAYS exactly TWO responsible parties for every default; the borrower AND the lender.

Whenever a loan goes bad, BOTH the lender and the borrower have failed.  It is easy to forget this, people who struggle to pay all their debts feel a natural resentment to those who don't pay, and the lenders (banks) feed this fire.  Banks want us to forget about the part they played, the lax loan standards, the unreasonable high interest rates, the complex structures, or the heavy handed marketing that entrapped people into more debt then they could reasonably pay.  Don't be fooled, when a loan fails, it's because the LENDER fucked up as much (sometimes more) then the borrower.  "But, what if the borrower never intended to pay?" you ask; that's not a loan, it's a fraud, and we DO have prison for that (China still has DEATH for fraud).

The second principle of debt explains why debts are erased in bankruptcy, it is not just because they CAN'T be paid, it's because the lender is partly responsible for them not being paid.  This is also why bankruptcy is final; even if the bankrupt party latter becomes rich, they don't have to pay debts that were erased in the bankruptcy process, those old debts go away, FOREVER.

Lawyers will go on at length about other principles of debt (pari passu for example) but these are legal principles that may or may not exist except in law.   The First and Second principle of debt ALWAYS exist, whenever there is a debt they exist, they have always have existed, and they always will.  The First principle cannot be ignored, the Second principle CAN be ignored (killing people for default is a good example), but it shouldn't.

The situation we find ourselves in today is not new or unique.  The world has too much debt, everywhere.  This has happened before, (see this book) in fact, you could argue that it happens every time we as a society forget the First and Second principle.  Unfortunately, history is littered with some very nasty consequences to times like these, for example, the great depression played a significant part in setting the stage for World War II.

Two years ago, it became clear to TRG that sooner or latter, Greece would default.  TRG was correct in guessing that that does not necessarily mean that Greece would leave the Euro, but it was clear that they would definitely default.  Greece has now defaulted on the private part of their debts, and they are not done, the public part (loans from the EFSF) will come latter.

Most governments have two ways of defaulting, they can stop paying (direct default) or they can create inflation (effective default).  Inflation (effective default) will likely be the path of the US, although some of the debts (Social Security for example) will likely get the direct kind of default.  There is no such thing as a bankruptcy process for governments, they have a really clean way of defaulting, they just change the law.  For example, when the US want's to default on it's Social Security payouts (probably sometime in the next 5 to 10 years) it will just change the law to reduce them.  Greece did a little fiddling with the law in their recent default too.

Inflation (effective default) has some real benefits over the direct kind.  The main one is the ALL debtors benefit  (and ALL lenders suffer).  When there's too much debt everywhere this is a GOOD thing.  It may be the best answer to our current dilemma.  One of the difficulties for Greece is that ONLY the government defaulted.  Greeks who had loaned the government money lost, but there own debts remain.  If Greece had been able to use inflation, the impact of losses on loans would have been slightly offset with gains on debts for everyone.

Countries in the Euro don't have inflation as an option (not individually at least).  But inflation is an attractive option, and that is why the Euro may be doomed.

Why buy Apple stock?

That Retired Guy (TRG) doesn't usually invest in single stocks, and he avoids investments that have a lot of hype around them, so AAPL would seem to be the anti-TRG stock.  Even so, a small number of shares were purchased into the TRG portfolio at the end of February.

TRG likes Apple products, but great products don't necessarily mean the stock is a good investment, and TRG is not a 'fan boy' for Apple;  he's never waited outside a store for a product release.

What got TRG's interest was Apples first quarter earnings release on January 24 (Apple's fiscal year runs October 1st to September 30th, so the first quarter was October 1st to December 31st and was released on January 24).   Apple's first quarter earnings for the 2012 fiscal year were unbelievable.  More the 100% over the year earlier period, and more the 70% over the previous quarter.  By all accounts, it was amazing, and the press said so.  Apples stock surged.  It was up about 20% within a few weeks, a big increase, but the fact is that Apple is making a lot of money, and a lot more every day.  After a little analysis, TRG came to the conclusion that as fast as the stock is moving, earnings are still going up a lot FASTER.

The graph below shows EPS vs Apple share price in percent terms for the past 5 years.  Yes, earnings are up 1,410% in 5 years!  Amazing.   The stock price is up (only) 415% in that period.  It can be argued that if investors were predicting this earnings rise, then the stock price would have gone up earlier to reflect the expectation.  TRG finds that explanation a little short simply because nobody thought it possible for Apple (or any company) to make this much money back in 2007, and certainly not in 2008-2009 during the financial crisis.

AAPL Earnings Per Share Chart


The other possible argument is that the first quarter was a one off and the future will see more 'normal' earnings numbers.  There's some truth to this, the first quarter included Christmas, so the quarter results may not be replicated in the second quarter.  Still they did release a new IPad in February, and a new IPhone is expected later this year, so it seems likely that they will do reasonably well.  Most estimates are that Apple will earn $8 to $10 billion in the second quarter...  We will know in a few days (second quarter earnings for apple will be released on April 24).  Just looking at the chart above, you can see that when earnings have taken a step back it's usually not a big step, and within a few quarters new highs persist.  Someday this trend will end, but is that day today?

Steve Jobs is of course gone, and there is naturally some concern that Tim Cook does not have the same genius for innovating new products.  TRG calls this the "Gerry's dead, Fish suck, get a job" argument.  In the short term (next year) it doesn't seem like an issue.  The products in the pipe now are still children of Steve, the real challenge will come a year or two down the road.  There is no way of knowing, but personally, TRG has a feeling that the design team at Apple is still healthy, there have been no big headline departures from Apple's design department, and there does not seem to be any determinable tension with Tim Cook as CEO.  If we get to the end of next year and all we have is marginally updated IPads and IPhones, then it's time to worry, for the moment, Tim Cook deserves the benefit of the doubt.  Roomers about IPhone 5 suggest that it will be a major release, TRG will have a close look at it when it comes out.

Yet another argument is that Apple's earnings come on the back of unusually high profit margins on it's products, and as the competition catches up with Apple, these margins are sure to shrink.  This is true, but at the moment, the competition is pretty far behind.  Ultimately, this is a similar argument that Apple without Jobs can't continue.  Without new products, Apple might start to loose it's shine towards the end of next year.  It's worth watching closely, but at the moment new products seem to be ever on the way, and as always they have been impressive.  Furthermore, the competition still seems miles off.  When the new Apple products stop impressing, and the android phones/tablets start making waves, then TRG is selling the stock.

There has been some recent talk about network providers becoming more stingy about iPhones.  This may be true, but it would be a mistake to overestimate the impact.  On the conference call for Apple earnings, Tim Cook stated that sales of the iPhone 4S were limited because the company could not produce enough of them.  In the past, Apple handles high demand by slowing the roll out to new markets, so this quarter, anything that slows iPhone 4S adoption can probably be rectified by rolling it out to new markets (China got it in January/February).

TRG likes to look at this wikipedia list of larges corporate profits.  Notice that Apple's first quarter profits rank 4th in the quarterly list.  Impressive, especially when you note that every other company in this list is selling 'Oil and Gas'.  But here's the really amazing thing.  On the yearly profits list, Apple is at 17, and that was for the period ending October 26, 2011; so it does not include the $13.1 that was just earned.  If Apple can produce earnings over $10 billion in the next three quarters it stands a very good chance of being at the top of this list at the end of this October.  Keep in mind that this list is inflation adjusted, and includes all public corporations.  It's reasonable to expect that the largest public corporations are more profitable than any state owned or private companies, so it can be reasonably argued that topping this list will make Apple the most profitable company IN THE HISTORY OF COMPANIES...  EVER!

No guarantee it will get there this year, but TRG is rooting for Apple.

Monday, April 16, 2012

Is 'build it cheap' just a fad?

What if the crappy quality we see around us in so many things is not a function of the economics of manufacture, but a passing trend of consumerism?  What if it's a fad?  What if the pendulum of quality might inevitably swing in the other direction to a world where the things around us reflect a high level of design, thought and craftsmanship?  This idea came to me while looking at the antique architecture and construction in Portugal.  Beautiful buildings constructed almost entirely of stone...  When you consider the technology of the day, it is clear that these buildings were not built this way because it was easy, or cheap.  Two hundred years ago, these buildings required an army of skilled craftsman with a cavalry of workhorses and oxen.  Today, we have modern hydraulic machinery, electric hand tools, portable cranes, and networks of well surfaced roads to transport it all around easily.  The economic cost of construction to our overall society is a fraction of what it was...  there must be more to it.

That Retired Guy (TRG) lives in the company of quite a lot of old architecture.  The average age of the buildings on his street is probably about 175 years, and the average hides some wide variety.  The most recent stuff was finished a few years ago, and some of the old stuff is likely greater then 300 years old.

The contrast in building quality between the old and the new is dramatic, although the difference between the old and the very old is not so great.  Anything older then 75 years is generally constructed out of stone.  In this area, the local stone is granite, and the buildings here often contain MASSIVE blocks of this stone.  TRG is writing this from a bar, sitting next to a window which is framed in stone blocks about 1/2 a meter wide and more then a meter long.  The windows themselves are steel framed, and have an industrial look to them.  They appear original, and from this detail TRG is going to guess that this place is probably early 1900's because wood framed windows were much more common here before that, and steel like this was pretty much non-existent before the late 1800s.  According to wikipedia:

The modern era in steelmaking began with the introduction of Henry Bessemer's Bessemer process in 1858.

So, judging from the window frames, this building is probably turn of the century, which makes it pretty recent for the area, but old enough to have been built to the older standard.  

This building also has a feature characteristic of the older construction; the ceilings are very high.  Here it's about 4 meters, though it's not uncommon to see even taller ceilings in the more grand buildings.  The windows are large, and rise almost to the ceiling, and this gives the space a certain feeling that newer constructed buildings never have.  The large windows and high ceilings contrasted with the thick stone walls make the space feel both airy and permanent.  There's nothing special about this construction, Portugal has hundreds of thousands of buildings like it.  What is unique is that almost nothing built in the last 70 years shares these characteristics.  Modern construction comes in a multitude of forms, but high ceilings and thick walls are generally absent.

The reason most people give is that it is just too expensive to construct buildings this way now.  For example; structural reinforced concrete is cheaper then shaping and moving stone; not only because it is easier to bring to the location, but also because the laborers who install it can be lower skilled when compared to stonemasons.

Reinforced concrete was invented around the same time as modern steel (most reinforced concrete actually contains modern steel, although the reinforcement can be done with other materials).   According to about.com:

Reinforced concrete was invented (1849) by Joseph Monier, who received a patent in 1867.

It took some time for reinforced concrete to become common in construction, but ultimately it has become the principle material in nearly all but the tallest buildings.  It is not surprising that reinforced concrete replaced stone in construction, in fact, the material is so revolutionary that it actually changed the whole language of architecture.  The first architects to use it realized that the material had fantastic potential.  A quick look at this about.com page shows a list of early examples, and that list (surprisingly) excludes the work of Frank Llyod Wright.  Anyone who doubts what can be done with reinforced concrete should visit Wright's Solomon R. Guggenheim Museum in New York City:





Looking at these early examples of reinforced concrete show it's phenomenal abilities, and also raises the question:

What happened?

Today reinforced concrete is more often associated with buildings like this:



It's funny how buildings in this stage of construction all look the same.  Will this be social housing, or luxury flats?   The distinction will come from minor differences in the quality of interior fixtures, and or the location of the building.

Reinforced concrete can be used to create 4 meter ceilings nearly as easily as the 2 meter ceilings in the building pictured, more material is required, and a little structural thought, but it's not as hard as moving 1500 kg blocks of stone was 200 years ago.  With the materials and technology today, there's really no excusing the crap that we see around us.  We could build incredible things, but much of the modern construction today has only one redeeming quality;  it's temporary.  Buildings like the one pictured above can last for a long time, but will it still be desirable in 20, 30, or 50 years?   More likely it will be gone, and we will have the opportunity to build it right the next time.

Judging from the construction today, we must want disposable buildings, but will we always?  Maybe there were times past where construction was fast and cheap, as it is today.  There were always cheap ways of doing things, mud walls instead of stone for example, and even if stone was the only material, that still doesn't explain ceilings 4 meters high.  Maybe there were disposable buildings of these era's, but they have long sense been disposed, leaving only the grand permanent monuments we see now.  Maybe in ten or twenty years, we will desire houses that are built like stone even if stone itself is not the actual material.

Monday, April 9, 2012

Why Blog?

That Retired Guy (TRG) has lots of time for thinking (being retired and all) and sometimes, TRG even has ideas which seem to him to be at least a little original.  Sometimes a beach in Portugal provides a new and interesting perspective even if the idea itself is not new.  In these cases, a blog is a nice place to put these ideas.  A blog publicizes, but it also records, so even if nobody reads, at least its there, and is somebody wants to read some day, they can.

TRG would really like to believe that he has something unique and interesting to say and that the world wants to hear it.  Wouldn't that be great?  Naturally, it may not be the case.  Maybe (probably) nobody reads this thing.  Even so, the fact that this is a public forum means that the ideas need some extra thought and care.  Some say that you should 'dance like nobody's watching'.  In fact, TRG finds that this idea often promotes very bad dancing.  It would be a mistake to blog like nobody's watching...  in that case, a private diary is probably a better medium.   The fact that this blog is public means that the ideas in it might find an audience, and if they do, it would be a shame if the ideas are not properly formed and thought out.  For TRG this is a great reason to blog.  It forces discipline.

What sort of ideas will be on this blog?  TRG doesn't really want to talk about himself, and he's not really out to cause a big stir.  After studying and working for years in finance, TRG finds himself thinking about these topics a lot, so there will be a fare amount of finance here, but there will also be some culture, and general commentary on society.  Basically this blog is going to be about whatever some retired guy in Portugal decides he wants to say, but he promises to keep it interesting, and link to original sources where appropriate.

Hopefully someone will enjoy it.  Hopefully, they will leave comments so we can have a discussion.  Hopefully no one will call me 'that retarded guy'.