Over the last few days, many commentators, notably Daring Fireball’s John Gruber, have been frustrated at, other commentators’, but also the market’s reaction to Apple’s earning report. Basically, over the last quarter, Apple’s share price has fallen around 35%. This is the same quarter that got them record iPhone sales, record iPad sales, numerous product launches, and the fourth highest quarterly profits for any company in US history. Its price to earnings ratio is now half that of Amazon. So the market, to sustain its previous valuation, expected much much more than this. This prompted Dan Pallotta to write:
The critics that are screaming right now are intellectually lazy. They’re throwing temper tantrums instead of looking at the big picture. Like two-year-olds, they don’t really know what they want. And they’re not happy when they get it, anyway. Apple could unveil a new car and they’d say Apple’s days are over because it’s just bet its future on an industry it knows nothing about. Not unlike, say, Apple’s entrance into the mobile phone industry. I bet that if Apple did unveil a time machine, they’d claim it wasn’t fast enough.
Somehow this quote has spread to the notion that the market expected Apple to actually make a time machine; something I will return to below.
The thing is what everyone seems to forget is that share valuation is part fundamentals and part guess-work about the future. For share prices to rise very quickly and sustain that rise, people have to expect pretty much a bubble around them. A year ago, the share price was lower than it was today and then rose 40% in a matter of months. So a year ago, the market got it wrong too. But for some reason, there was euphoria. The euphoria was short-lived. But the euphoria was likely based on some ‘above expectations’ good news — like the iPad 3’s retina display that everyone thought was not technically possible. Right now, there is basis for steady growth but not that Apple will generate a new and significant source of revenue. And one reason for that is that compared with 2007 or 2010, Apple is at the top of the pile. To be sure, there is growth to be had in China but China, the last time I looked, does not have consumers with the disposable incomes of advanced economies. That is why the market appears to grade Apple more harshly and Amazon, Google or Microsoft. Those companies have some places to move. Apple does not. The top is the top. And you know who believes this? Apple. After all, there have been no announcements to use all their cash to buy back shares.
There are some issues that nag with Apple too. The Maps debacle is one but not worth hundreds of billions in value. The decline in Mac sales — albiet on the back of not actually having iMacs for two months of the quarter and having one less week in the quarter — is a symptom of cannibalisation from tablets. But that was Apple’s stated intention. Indeed, commentators are saying that the problem with Apple is that the iPhone 5 did not cannibalise the iPhone 4S or iPhone 4 enough! And the calls for a cheaper iPhone and iPad seem misplaced — Apple earns terrific margins while having unit sales outstripping any past expectations. A race to the bottom is not the greatest competitive strategy move. Finally, a huge share of Apple’s valuation is its cash reserves. But that surely is subject to the vagaries of international currency movements. In other words, when you buy Apple you are not just being a IT company but some sort of foreign exchange hedge fund. But while I am claiming that there may be some sense to the market valuation right now, I am not claiming there is much sense to commentators’ attempts to justify the decline. To repeat, we need to focus on justifying the rise first and that was a problem.
So, yes, the market needs to expect a time machine (or something similar like a self-driving car) to get Apple back to its share price highs. It doesn’t. One reason is because Apple already has a time machine and it isn’t that great. In addition, if Apple invented a time machine, what they would do with it is use it and go back and manipulate the share price so that they could earn a ton of profits when the time machine was released. That is, they would engage in trades that pushed the share price down so as to increase the jump afterwards. Like 35% in a quarter where they earned record profits …. oooh.