Maybe a Pine Tree

Ahknaten doesn't like AAPL

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Sell Apple.

Using eVal, I created a DCF model of AAPL. For sales growth assumptions going forward for the next two years, I used the sales growth estimates from analysts of 64.8% (this year) and 17.9% (year after). Surprisingly, by taking just the defaults in eVal and using those growth estimates, and a cost of capital of 8%, I was able to get EPS estimates of $3.73 and $4.41 for the next two years that were very close to the analyst estimates of $3.74 and $4.41, but there were obvious problems with that valuation model. Although it produced a stock price estimate of $160, which would indicate that AAPL was undervalued, the terminal ROE in the model was at 20%. I really doubt that AAPL will be able to sustain a ROE of 20% forever. So, I made some more modifications to the model. My thought was that perhaps some analysts were doing very simple valuations like the one I had just done, and in my opinion... that method was too optimistic and faulty. I reworked the numbers to adjust my terminal ROE, by increasing the COGS/sales, R&D/sales and SG&A/Sales just a bit so that a terminal ROE of 8% was reached. The terminal sales growth was kept at 5% so that it could reflect the long-term GDP growth rate. After I did that, the earnings estimates for this year and the next year fell, but I was hoping that I could at least match that of the analysts. So, for this year and next year I lowered the COGS/sales, R&D/sales, SG&A sales and even the tax rate to 5 year historical low levels. I was unable to get an EPS estimate that matched that of the analysts. Maybe I just screwed up. Who knows? But after doing all of that, my estimated price/share was only $75. In other words, I think it's possible that they will not meet estimates and the stock is overpriced.

There were some other 'negative' factors that I found interesting. There was some insider selling lately. The last time I could find any insider buying was back in May-July '06 and those insiders timed it nicely. I found it interesting that AAPL had consistently beat earnings and although that's usually a good thing, I had to wonder... will they take a 'big bath' soon? I don't know. It's just something that I think about. I noticed it had a high price/book, high price/cash flow and a high PE and although it had high growth, I had to think... could it really sustain that? I dislike high PE, price/book and 'hot' growth stocks, so these numbers bothered me.

Here's the thing about AAPL. You'll see these blogs and newsletters talk about AAPL, but do you also notice that they start talking about it after the stock rose 180% in two years? Doesn't it make you wonder if folks are just trying to ride on the momentum? That momentum strategy can work sometimes, but sometimes I think folks are just a bit too late to the party. I held AAPL in my virtual technology fund, I bought it in Jan '04 at $11 and then I sold the holdings in Nov. '06 at $79. Alright, so I never made it to the current level of $140, but I was into this long ago and made some returns and bought some other stuff. Ever wonder what institutions are doing? Take a look at block-trades and lets assume that block trades are a proxy for institutional buying. What do you think they've done in the past few months? Are they lower? Now, look at non-block trades and presume that the average investor buys those, are they higher in the last month? Are they higher? Could it be an interesting guess to presume that more institutions might be selling the stock than buying? Just a guess. And could it be reasonable to assume that perhaps that those institutions hope this momentum continues so they can unload their shares?

Watch out for AAPL. I do not think it's a good buy at these levels. You're going to see a lot of hype and blogs talking about AAPL as if they're pitching a product and not a stock. Sure, the iPods are great and fun and cool, and perhaps that's a good reason to buy the stock. I dunno. But, I'm not confident with it and although some in this competition hold it, I wouldn't hold it. So that's my contrarian viewpoint. Sell AAPL and buy something else like GIB, CSC, XRX, NOK, CHT or TMX.

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Ahknaten Likes AAPL Tables -- Apple Part Two

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I love my IPod. I seriously love it. I won two of them and I love each one. I love the AAPL store. I love the store's layout. I love the furniture in the store. If you happen to know who makes the nice wooden tables in the stores, let me know. I especially love the tables. I don't love the stock. I could spin a positive story to an investor looking for a stock. The story could go like this:

"You like the IPod eh? Well, check out that nice stock graph. Sweet eh? Ever walk into an AAPL store and see all the people and the cool toys? Awesome. See all the people buying the cool toys? Sweet. I-Tunes is awesome. I use it. I love my I-Pods. Just imagine if they sent this stuff all over the world. See the growth? Wow. Cool toys for the world. Don't all your friends either have one or want something from AAPL? Don't you think that Microsoft/Intel think that the AAPL advertisements must be creative? Sweet advertisements, sweet product, sweet store, and a sweet stock."

Here's the thing. I don't buy that argument and as I look at the stock more, I dislike it more. I have some experience with AAPL. It's not much, but it's some. I walked into an AAPL store this weekend and noticed a lot of folks buying a lot of things. It was nice to see. But, I also noticed how the mall I was walking in was opening a series of other stores by other wireless competitors. One only needs to look at Porter's Five Forces to realize the "threat of substitutes", making it's way into the market. If AAPL can do it and have great margins, certainly expect the competitors to join in. I love I-Tunes and I used to buy a lot of videos from that website, but then something came along... Facebook and from there I learned that I could link free movies from Yahoo. Free videos? Yes. I could log on, view a video and listen to some music. That seemed to be a much better deal than paying some money to I-Tunes when I could see something for free on Yahoo. Isn't that a "Threat of Substitute"? Sure, AAPL will keep reinventing things, but those reinventions only last for a little while, and it's not long before the others will catch up, margins will drop and innovation will need to move forward. People might be very optimistic for AAPL that it's creating a world-wide network of media, and perhaps it is, but I think those views are a bit too optimistic. Aren't views like this best viewed by looking at the past at other world-wide 'hot phenomenon's'? Microsoft? The internet?

I had already mentioned about the PE, price/book and insider selling, but perhaps there were some other stats that bothered me as well? How about asset turnovers? Aren't they declining? Isn't that a bad thing? So perhaps the asset turnover was declining and they're trying to build these stores to increase turnover? But, if they build new stores, then won't that hurt margins? Does it mean that they need to compete much more aggressively because other stores and companies are modifying their product lines as well? The accruals are high. Academically it's been shown that high accruals are a bad thing. Hmmm... Seems like a red flag to me.

So perhaps my AAPL story could go like this:
"You like the IPod eh? Cool. Maybe you should buy your IPhone and IPod and love your store and your cool looking AAPL computer, and perhaps you should short the stock as well? Perhaps? I dunno. It's just that it smells like a 'hot stock' right now. The valuations are rich, there is some insider selling, I see it's had some decreasing asset turnovers and high accruals. I notice that I can't seem to justify the valuations and I wonder if they can really keep up with beating analyst estimates by 0.10 to 0.36 cents each month. You do realize that next quarter, if they don't beat by 0.10 cents, then it might look bad, right? Sure, it's a growth story, but can growth really continue so much? Don't you think that other competitors will kick in? Hmm... I see you made a valuation and it looks undervalued, may I ask you... oh dear analyst... what were your terminal ratios in your valuation? Or did you just take the PE and multiply it by the EPS? But wait, you love the momentum. And I would argue that momentum is a factor in the market. But as you like it then is it a good guess to presume that perhaps some funds are bailing out of the stock now? It's just a thought. If you do love the volume and returns, you must certainly not only like AAPL, but do you like RIMM, RIO, JNPR, AMZN, FCX, CROX, VIP, NOV and GMST as well? If not, then why not? Those seem like 'hot' stocks to me. They might even do well for momentum-based trading games. They have nice charts, don't they?" So perhaps I'm a bit cynical and perhaps I'm a contrarian and perhaps I have no idea what I'm talking about. I don't know. But, as I look at this stock a bit more carefully, I seem to see more negative aspects than positive ones and for that reason I cannot in good conscious recommend it as a buy (unless it's for risk/diversity purposes) and for the time being it sure seems like a short to me. But then again, remember to do your own due diligence.

And if you know who makes those AAPL tables, please let me know. I want an AAPL table

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Master-ahknaten-Card and Momentum

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I'm sad when I see that folks seem to pick stocks based primarily on momentum. Along with size and value, momentum is certainly a factor in the market, but it seems to me that in stock picking competitions, the best way to win at times is by picking these momentum plays. As Mastercard was held since the start of the competition, then it would appear that it was such a holding.

For fun, I made a paper portfolio of stocks that had nice momentum as of the end of July. That portfolio had TBSI, LPHI, CROX, SIF, EXM, DRYS, RCCC, ZNH, SNCR, CFSG, CEA, INNO, TNH, CF and MA. The two month return of that portfolio was 24%! Much higher than my virtual competition portfolio. Out of those stocks, CEA went up 96%, SIF fell -30% and the standard deviation was 36%! Now, many of those stocks were small, but guess which one had the highest marketcap? Mastercard. So, Mastercard makes for a great blog. Find a stock that many would hold, and those folks probably hold it for some momentum reason. Now, ask those folks to comment on their pick and why they love the stock. Some will talk about how great the company is, and perhaps it is great, but I'd be willing to guess that many picked it just because of the chart.

So, let's assume what I said above is true, and I'll make a paper portfolio with 20 stocks based purely on momentum -- ACH ZNH CEA CROX DRYS TBSI EXM BCSI SNCR CALM FTK CRNT JRJC NWK BPHX CFSG APPY HEM ASTI CORT. Now, I'm not saying these are bad (or good), I'm just saying that they look like momentum plays, and I bet there is a high probability that someone holds a few of these in the competition, and perhaps... in a few weeks we'll get a question that asks: Why do you hold ACH, ZNH, CEA, CROX or DRYS? Someone will come up with some sort of smart response, when in reality they held it for the momentum.

Here's my non-momentum based take on Mastercard. I see a high short interest, high price/book and high accruals. That concerns me. When I value the stock and make a DCF model on eVal, I get a value that is less than $100. (DCF is picky on the tax rate you choose for this one). Then, I look at the earnings history and I notice that it usually beats by 0.10-0.40 cents and I have to stop and ask myself... if it doesn't beat by 0.10 cents next time, what happens? This is a stock that I would sell/short at this point. Some may give the argument that as rates fall, folks will use their cards more. Some will give the argument that as Christmas approaches then everyone will go out shopping. I think it's overvalued, it was a momentum pick and it's due for a correction soon.

By the way, in the Apple blog (part two), I had sarcastically listed some other momentum stocks -- RIMM RIO JNPR AMZN FCX CROX VIP NOV and GMST. On average those stocks went up 6% last week. It's not master stock picking, it's just momentum.

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