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Author: RodgerRafter Big red star, 1000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 202101  
Subject: What you should know aobut The Books Date: 1/7/2001 11:53 PM
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A month and a half ago I did a post on what you should know about Apple's earnings:

http://boards.fool.com/Message.asp?mid=13583312

One basic point underlying that whole post was that corporate earings are fickle. A company's officers understate or overstate the company's earnings to suit their own short term objectives, and fluctuations in the economy can lead to wide swings in earnings from year to year. On top of that, deceptive accounting practices (especially when it comes to options grants) mean that the earnings of almost every company these days are grossly overstated.

To me, book value has always been much more important than earnings as the first step in trying to value a stock. The supposed purpose of accounting is to place an accurate value on a company in the form of shareholder equity (or book value), which is a company's assets minus its liabilities. Earnings just show how much shareholder equity has grown during a given quarter, but the real assets and liabilities are what matter over the long term.

Wall Street is mainly in the business of buying low (buy underwriting stock offerings or causing investor panic) and selling high (pumping and dumping when stocks are at their highs). Wall Street doesn't like to quote book value for two main reasons, IMO. First, book value is much less volatile than earnings, so it can't really be used to hype stocks at their peaks and panic them when stocks are at their bottoms.

Instead you usually see analysts touting models like P/E (bad), Price to Earnings Growth (twice as bad), Revenue Growth (sheesh!), and Return on Assets or Return on Equity (exactly backwards). With each step down that path, analysts get further away from a company's true value and deeper into the realm of obfuscation and deceit.

P/E is unreliable because corporate earings are unreliable (see the earlier post). Earnings growth is misleading because the growth rates rarely can be maintained. Newly and barely profitable companies often start showing tremendous earnings growth simply becase 2 cents vs. 1 cent equals 100% earnings growth. As for revenue growth:

http://www.ragingbull.altavista.com/mboard/boards.cgi?board=AAPL&read=31591

Let me add to that post the practice of companies like Lucent and Cisco, whereby they loan start ups and cash poor companies millions of dollars to buy their products. This allows LU and CSCO to report big revenues and profits now, even though they know that many of these loans will go bad in a couple of years. Typical customer of both LU and CSCO:

http://biz.yahoo.com/p/w/wcii.html

Lastly, RoA and RoE give exactly the wrong picture, because Assets and Equity are put in the denominator. A company that has a lot of assets (like cash) is solid financially, but suffers in this valuation model. Instead, a company that leases all of its property and equipment, and blows all of its cash on a stock buyback program has very little in the way of assets and shows a very high RoA. Likewise, a company buried under a mountain of debt has very low equity and can show a great RoE when the economy is good. When the economy goes bad, however, this company goes bankrupt. Companies short on assets often call up their investment bankers with a desperate need to raise cash, thus giving Wall Street reason to hype these kinds of stocks and create rationales for models like RoA. Give me book value as the first and most important step toward finding bargains in the stock market, and leave the other models to Wall Street and the suckers who buy the hype.

Well, that intro went a little longer than I expected... Now on to AAPL's books.

Recently, much has been made of Apple's Cash ($1.191B)and Short Term Investments ($2.836B). The $300 Million in Long Term Debt sometimes gets ignored, but that still leaves a net of $3.727 Billion that guarantees Apple will be able to survive any prolonged economic downturn. Best of all, it currently generates a net $62 million per quarter in interest income, no matter how well computer sales go. It doesn't, however, mean that Apple can't trade below $12 per share. Any stock can trade at any price. When Wall Street takes a stock down, there will invariably be more sellers than buyers because most people are stupid, and there will be more people who panic and take losses than there will who have the guts to buy at the bottom. Likewise there will always be plenty of suckers willing to buy a "hot" stock at the top.

I've always been against Apple's stock buyback program because I'd rather have the cash. Through September of 2000, Apple had spent $116 million to buy back 2.55 million shares at an average of $45.49 per share (ouch). Fortunately, Apple doesn't abuse the buyback like a lot of other companies. Dell spent several years spending every penny they earned on their stock buyback program and they only have $1.78 per share in cash as a result. Oracle is still doing that and has cash per share of $0.78. IBM has only $1.73 per share and has more than ten times that much in debt. All of them will see an especially big blow to their earnings when the economy slows. I only approve of share repurchases when a company is trading below book value.

Much has also been made of Apple's drive to bring down inventory levels, but this is misleading for a couple of reasons. Inventories dropped from $437 million at the end of Fiscal 1997 to $33 million at the end of Fiscal 2000. It's true that Apple did have a big problem with stale inventory back in 1997, but making a big deal out of current low inventories is a mistake. The whole idea of "inventory turns" was popular with analysts a couple of years ago. By dividing inventory by sales you were supposed to find out how efficient and quick a company was in turning out product. Of course it was all just nonsense concocted to help sell Dell stock at its highs. All it really showed was how much a company relied on outsourcing and how quickly product could be moved into the channel. As we painfully learned last quarter, it's how quickly a company can move product out of the channel that matters. Now that DELL and AAPL are at relative lows, you don't hear much about inventory turns.

Apple supposedly owns $313 million worth of Property, Plants and Equipment, but this is probably understated by a good deal, especially considering what has been happening to real estate prices in Cupertino. Similarly the "Intangible" assets aquired from NEXT and Power Computing are understated. Every quarter P,P & E items get depreciated and Intangibles get amortized (written down in value on the books and counted against earnings) so that Apple will have to pay less money in taxes. Therefore it makes sense to depreciate things as fast as possible, even though it brings down book value. All the NEXT and PC assets were amortized out of existance in 2 to 3 years, which theoretically means everything acquired from those companies (Web Objects, and the nuts and bolts of OS X) is now obsolete and worthless.

Such conservative accounting by Apple management is commendable. In contrast, Compaq is ammortizing items from the Digital aquisition over 5 to 20 year periods, thus enabling them to show much better short term profits. Apple's overly rapid depreciation and ammortization understates Apple's true worth. Apple also expenses about 5% of revenues on R&D every year. This builds up valuable intellectual property that doesn't show up on the books. For these reasons, Apple's true worth is much higher than its stated book value per share.

Another big "Intangible" is Apple's "brand," the customer loyalty and product recognition that has been builty up over the last 20+ years. The "installed base" of Apple customers has gotten a lot of attention. Advertising expenses count against earnings, but they build up mindshare that doesn't show on the books. Apple's customers are the most loyal in the industry.

I had to cringe last January, when Steve started boasting about how Quicktime had led Apple to invest in Akamai, and how the investment had grown to be worth over $1 Billion dollars. It was pretty obvious at the time that $2.14 Billion in "investments" was a temporary function of a Nasdaq in full frothiness. Now that apple has finished selling off its stake in ARM and now that the stock market has brought AKAM and ELNK back down to size, Investments have dropped to $776 Million. That's closer to being accurate, but still probably a couple hundred million too high. Still, if Apple can work with the Investment bankers like they did for ARM, we could still end up pulling out a few hundred million in profits on the deals. Only time will tell there.

Since Accounting isn't perfect, we have to make some crude estimates to find out what Apple is really worth. Starting with a book value per share of $4.1 Billion, I add $200 Million for P,P&E, but take it away because of the Investments. For Apple's Intangibles, I'll give a very crude $2.5 Billion based on all the Intellectual property, and accumulated customer loyalty. Valuing Apple at $6.1 Billion leads to $20.35 per basic share.

I don't use the diluted totals, because they represent shares that will eventully be purchased from Apple at prices ranging from the $6 something granted to employees during the repurchase all the way up to Steve's 20 million shares at $40+ (which will be ITM someday). The net result is a wash with regards to book value in my estimate.

Stocks tend to oscillate between being overpriced and underpriced. Apple was overpriced in 1995, underpriced in 1997, and overpriced again in 1999. It's now underpriced here in 2001 and a victim of Wall Street's wrath, but someday it will be enjoy another period of being overpriced and being a Wall Street darling. If you are into the whold LTB&H thing, you can buy anywhere below $20 and be confident that someday you'll get a chance to take a nice fat profit.

Rodg.
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Author: KarmiCommunist Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37743 of 202101
Subject: Re: What you should know aobut The Books Date: 1/8/2001 6:58 AM
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Great post!!!

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Author: Plato90s Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37745 of 202101
Subject: Re: What you should know aobut The Books Date: 1/8/2001 11:06 AM
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While I usually find myself in complete agreement with RodgerRafter, I'd have to disagree on some point here.

First of all, I disagree that book value is more important than earnings. Earnings, as reported to Wall Street, is indeed a number which can be twisted like a pretzel, which is why I prefer to look at a narrow definition : operating income or free cash flow. Operating income tells us how well the company is executing on its business and free cash flow tells us what the company is doing with its cash.

Book value is useful only as a way to guage the long term effects of a company's operations. Logically, a consistently profitably company would have ever-increasing book value. In fact, that is not the case. With a greater and greater percentage of assets being in the form of equity, book value will now be changed by the stock market. As the case of AKAM and ELNK demonstrates, book value can evaporate faster than you can earn money to replace it. Apple also spent ~$150M of cash to purchase 3.7 million shares of AAPL, which is now worth less than $65M. That's another $85M of book value which has vanished. But once the stock price rebounds, it will re-appear.

So my conclusion is that book value is really not the best method to evaluate a company, since it's about as volatile as any of the other numbers like P/E and EPS. I'd have to advocate the basics. Does the company make a profit? If so, how much money? This is where operating income and cash flow really comes into play, and both are areas I like to pay attention to.



--------------------------------------------

A few minor corrections as well.

When calculating the book value, you should also take into account the Account Payable vs. Account Receivable. For Apple, Accounts Payable is $200M greater than Receivable. That's $200M that Apple, Inc. owes somebody for which it will have to get cash from its own accounts to pay. It should be accounted for.

In addition, the number of outstanding AAPL shares is 321 million, not the 300 million shares that RodgerRafter used.

Regarding the $2.5B of intellectual property, I'm not sure how to respond to that. R&D investment doesn't always lead to returns, especially in Apple's case where many in-progress R&D projects were never completed. Does the work done on OpenDoc or Rhapsody really translate into IP of value? When the investment in R&D creates software like iMovie, which is given away for free, doesn't it imply that the value of the R&D is already reflected in hardware sales?

The classic example here is the Xerox PARC facility, which has helped to spawn some of the most basic inventions of the computer age. Xerox was unable to benefit from the results of their R&D investment, both due to lack of vision and lack of ability to follow through.


Getting back to the question of what AAPL is worth, I tend to agree with RodgerRafter that buying AAPL stock at <$20 is probably a decent bet. I wouldn't be confident of your ability to take a "nice fat profit" since AAPL did have an entire decade of mediocre returns. But at least you won't lose your shirt on it, which is about as good a recommendation as any stock can receive in this volatile market.

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Author: dsheehy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37751 of 202101
Subject: Re: What you should know aobut The Books Date: 1/8/2001 1:23 PM
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While I usually find myself in complete agreement with RodgerRafter, I'd have to disagree on some point here.

Hahahahaha! That's hilarious.

I normally agree with Roger, but this is Apple, and I must find any reason to bash it, whether logical or not.

I know Roger's post makes complete logical sense, but it has to be wrong, because Apple SUUUUUUX MAN, it ssssuuuuxxxx, MMMKay?



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Author: nigelh Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37755 of 202101
Subject: Re: What you should know aobut The Books Date: 1/8/2001 1:38 PM
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Rodg:

...someday it [AAPL] will enjoy another period of being overpriced and being a Wall Street darling.

Very good post! No, GREAT post! And good analysis.

Just one point, from your words above - did you really say "another period of being ..... a Wall Street darling"?

So, when was Apple EVER one of those? ;-)

NigelH

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Author: TheAngryFerret Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37783 of 202101
Subject: Re: What you should know aobut The Books Date: 1/8/2001 6:05 PM
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RodgerRafter,

Great post, I'd like to debate a few points if you will indulge me.

On top of that, deceptive accounting practices (especially when it comes to options grants) mean that the earnings of almost every company these days are grossly overstated.

I absolutely agree, and I think its imperative that investors begin to understand the true financial risk of options, and just what an effect they have on overstating earnings. (incidentally, I wrote a paper of this at www.angryferret.net/i/home.htm)

To me, book value has always been much more important than earnings as the first step in trying to value a stock. The supposed purpose of accounting is to place an accurate value on a company in the form of shareholder equity (or book value), which is a company's assets minus its liabilities.

Now I have to disagree. Asset values in our accounting system totally misrepresent true value. The accounting system is designed more for bond holders than stock owners, as such it is way to conservative. Assets are recorded at the lower of cost or market. Under US GAAP, assets can't be written up to their true values. Its only on the books for what you paid for it, or you can take a charge if the asset is impaired. As such, book value dramatically understates true value. I do recognize that later you try to rectify this, but I still think it deserves to be pointed out.


P/E is unreliable because corporate earings are unreliable (see the earlier post). Earnings growth is misleading because the growth rates rarely can be maintained. Newly and barely profitable companies often start showing tremendous earnings growth simply becase 2 cents vs. 1 cent equals 100% earnings growth.

Yeah, people need to get over the PE. Every needs to just forget about it. It is a 100% useless metric. I could write a paper about how much damage the PE ratio has done to society by diverting resources towards failing businesses appearing as undervalued. PE does not account for a diffent capital stucture. Want a higher PE? Issue a bunch of debt because you would have relatively less equity. PE doesn't account for risk. PE doesn't account for earnings quality. I could go on... Sames goes for ROE and ROA.

Regarding AAPL's cash you wrote...

Best of all, it currently generates a net $62 million per quarter in interest income, no matter how well computer sales go.

But isn't there a better return that could be attained on that cash? Companies only create value when their return on capital exceeds their cost of capital. Say AAPL's cost of capital is 8%(very low). They aren't coming close to that with the money they make on their cash. I'd like to see them either invest it in their business, or give it back to the shareholders, through a dividend(not the best idea) or share repurchase(better, but not perfect, more tax efficient, phycholically less costly to them than a dividend). The cash balance may seem great, but us shareholders are getting cheated out value that could be created with that cash.

I only approve of share repurchases when a company is trading below book value.

That's a great idea. You make an excellent point.

The whole idea of "inventory turns" was popular with analysts a couple of years ago. By dividing inventory by sales you were supposed to find out how efficient and quick a company was in turning out product. Of course it was all just nonsense concocted to help sell Dell stock at its highs. All it really showed was how much a company relied on outsourcing and how quickly product could be moved into the channel. As we painfully learned last quarter, it's how quickly a company can move product out of the channel that matters. Now that DELL and AAPL are at relative lows, you don't hear much about inventory turns.

But lowering inventory turns does have value. It frees up working capital than can be invested back in the business, and earn more. Same argument as I made for the cash balance above. IF they lower their inventory balance by $x, that is $x dollars they can now invest elsewhere and earn a higher return than the zero they earn on inventory sitting around and getting obsolete.

Similarly the "Intangible" assets aquired from NEXT and Power Computing are understated. Every quarter P,P & E items get depreciated and Intangibles get amortized (written down in value on the books and counted against earnings) so that Apple will have to pay less money in taxes. Therefore it makes sense to depreciate things as fast as possible, even though it brings down book value. All the NEXT and PC assets were amortized out of existance in 2 to 3 years, which theoretically means everything acquired from those companies (Web Objects, and the nuts and bolts of OS X) is now obsolete and worthless.

True, I would add back the amortization when looking at something. The FASB's new rules on purchase accounting should help this, as amortization would only have to be occured on goodwill if it becomes impaired.

Since Accounting isn't perfect, we have to make some crude estimates to find out what Apple is really worth. Starting with a book value per share of $4.1 Billion, I add $200 Million for P,P&E, but take it away because of the Investments. For Apple's Intangibles, I'll give a very crude $2.5 Billion based on all the Intellectual property, and accumulated customer loyalty. Valuing Apple at $6.1 Billion leads to $20.35 per basic share.

I like your analysis, but it assumes that AAPL should trade at its adjusted book value. I'd argue that there should be some premium because I expect it to acheive returns in the future in excess of its cost of capital.

I don't use the diluted totals, because they represent shares that will eventully be purchased from Apple at prices ranging from the $6 something granted to employees during the repurchase all the way up to Steve's 20 million shares at $40+ (which will be ITM someday). The net result is a wash with regards to book value in my estimate.

I don't understand. These shares will be purchased from AAPL, but they will still be in the market. And since the diluted number only takes into account currently ITM options, they are pretty much certain to be exercized. Then think about what happens in the future when those OTM ore ITM. I don't think I am understanding something that you are saying.

Cool. I think people who have read this far are great!

TAF
www.angryferret.net

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Author: BeenFooled Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37840 of 202101
Subject: Re: What you should know aobut The Books Date: 1/9/2001 10:18 AM
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Thoughtful posts like Rodger's are always a pleasure to read. And hopefully flattery will get me somewhere, namely to the answer of a question that's nagged me for a little while. When we look at:

"Apple's Cash ($1.191B)and Short Term Investments ($2.836B)"

how is the value of those investments priced? In my limited knowledge, Apple owns some chunk of ARMHY and Akamai. The price of both of these has fluctuated pretty wildly over time:

http://quote.fool.com/chart/chart.asp?time=8&uf=0&compidx=aaaaa%3A0&comptick=akam&freq=1dy&maval=0&type=128&symbols=ARMHY%2CAKAM&currticker=ARMHY&submit1=Draw+Chart

Should not that have a major effect on he Short Term Investment figure? I mean, when one quotes that figure "in these markets", should it not be referred to a particular date?

Thanks,
BeenFooled



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Author: allocatorx Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 37998 of 202101
Subject: Re: What you should know aobut The Books Date: 1/9/2001 9:55 PM
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Interesting analysis. I own a little bit of CMC (Commercial Metals). Their stock is selling at almost $10.00 below book value, and they are planning a stock buyback.

The company is cyclical and does have some difficulties, but it has done well throughout its history.

I just thought I'd mention this situation since it illustrates your point.

Regards,

allocatorx

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Author: tomhyland Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38041 of 202101
Subject: Re: What you should know aobut The Books Date: 1/10/2001 10:09 AM
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RodgerRafter writes in his article on AAPL:

"Similarly the "Intangible" assets aquired from NEXT and Power Computing are understated. Every quarter ... Intangibles get amortized (written down in value on the books and counted against earnings) so that Apple will have to pay less money in taxes."

Huh? Last time I looked at the tax code intangible were not deductible for tax purposes.

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Author: dlatkinson Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38072 of 202101
Subject: Re: What you should know aobut The Books Date: 1/10/2001 12:57 PM
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tomhyland writes:

"Huh? Last time I looked at the tax code intangible were not deductible for tax purposes."

You better look again.

From IRS Pub 4562 (Depreciation and Amoritization):

"Amortization is similar to the straight line method of depreciation in that an annual deduction is allowed to recover certain costs over a fixed time period. You can
amortize such items as the costs of starting a business, goodwill and certain other intangibles, reforestation, and pollution control facilities. For additional information, see Pub.535,Business Expenses."

Dave

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Author: pshaffer One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38201 of 202101
Subject: Re: What you should know aobut The Books Date: 1/11/2001 3:43 PM
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Rodger:
I very much appreciate your psot and your perspective on the stock valuation. It has caused me to rethink some material I have been reading. I have some observations/question that I would like to throw out for you (and all others) to respond to.

You make the point that ROE, growth in earnings, etc are not proper methods for valuing a stock, that book value should be the primary method. That is sensible, given that there is some major room for obfuscation in earnings reports. I am not sure if it is more or less wiggle room than is available for determining the book value of, say, intellectual property. Which determination is more imprecise?

All of us invest to make money. We want to sell our stock higher than we bought it. Almost always, we buy our stock at some value greater than the book value and wish to sell it for more, again more than book value. The premium above the book value is what I am concerned about. The way that premium is determined by those wishing to buy my stock is what I would like to be able to determine precisely.

It appears that your argument is that the premium should be determined by the book value itself. My observation is that the willingness of an investor to pay more than the book value per share is a result of reports of increasing margins, increasing profits, and of course, some intangilble sparkle that a stock like MSFT, or Celera has had. IN short, investors are looking for some reason that the company will look even more attractive to other investors in following quarters and he can unload the stock to someone else at even higher premiums. While it would be reasonalbe for investors to attach a book value to the stock, that is not the way buyers of stock do it.

I guess another way to put this is that we do not buy stock primarily to buy a chunk of book value. I would usually be paying 3 or 4 dollars to get one in that construction of the situation. The market seems to be more interested in paying a premium for companies with rising profits even if those profits never make it to the investor directly (in the case of many companies which pay no dividends). Being someone who wants to sell my stock higher than I purchased it, I MUST pay attention to what criteria the potential purchasers of my stock are using to attach a value to it. It does not appear to be book value.

So, I am left thinking that while your views on "book value as gold standard" are very reasonable, they don't seem to give me a guide to what stocks to purchase. Is there some study that would show that the long term appreciation of a stock is more closely tied to its book value than to its earnings accleration?


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Author: RodgerRafter Big red star, 1000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 38579 of 202101
Subject: Re: What you should know aobut The Books Date: 1/15/2001 3:34 PM
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In response to the other posters, in order:

KC...
I don't read your posts because you are in my penalty box. I found your posts amusing back in 1998, when you first started on the yahoo board, but their repetitive nature got old fast. Now I save myself a lot of time by skipping all of them. Sorry if that offends.

Plato...

Thanks for bringing up some interesting topics. We share a lot of ideas, however, I'll save time by just responding to the differences.

First of all, I disagree that book value is more important than earnings... I prefer to look at a narrow definition : operating income or free cash flow.

Cash flows and EBITDA are getting a lot of hype from analysts for a few reasons. First, all of the overvalued, stock based aquisitions of the 90s have left companies with a ton of goodwill on their books. This gets amortized and counts against earnings, but not against cash flows. If an analyst wants to sell these kinds of stocks, the analyst should quote cash flows, rather than earnings. Second, companies that are buried in debt and pay a lot in interest, are the most likely to need to do new underwritings. EBITDA conveniently ignores the tremendous debt burden that a great many companies are laboring under. Many future bankruptcies are now boasting about recently going EBITDA positive. Third, coming from an analyst on TV, quoting cash flows and EBITDA sounds sophisticated and important to a naive investing public. I intend to finish the series with a "What you should know about Apple's cash flows" post after the next 10-Q comes out.

My main point is that book value is supposed to measure what a company is currently worth, so for me it is the best place to start in finding the value of a company. Of course there are inaccuracies in the accounting, and my next step is to try and come up with a more accurate current value of the company, by attempting to correct these inaccuracies.

Apple also spent ~$150M of cash to purchase 3.7 million shares of AAPL, which is now worth less than $65M. That's another $85M of book value which has vanished. But once the stock price rebounds, it will re-appear.

It doesn't work like that. When the stock is repurchased, it essentially disappears, and so does the cash. Whatever happens to the stock price after that has no effect on book value. On a related note, if a company trading below book value buys back shares, book value per share increases. If a company trading above book value buys back stock, book value per share decreases.

When calculating the book value, you should also take into account the Account Payable vs. Account Receivable.

These are already accounted for in book value. Fluctuations in these can be used to distort cash flows, however.

In addition, the number of outstanding AAPL shares is 321 million, not the 300 million shares that RodgerRafter used.

I used 324,568,000, from the 10-K, although 326 Million probably would have been more accurate. My typo ($6.1B, instead of $6.6B) probably threw you off.

R&D investment doesn't always lead to returns...

Of course some projects will flop, but on average, investments in R&D will more than pay for themselves. A lot of companies capitalize some of their software development costs. By recording them on their balance sheets as an asset instead of expensing them on their books they are probably creating a more accurate picture of the worth of their companies while also helping themselves show higher earnings. Apple's conservative accounting leads to understated book value and understated earnings, as well as a lower tax bill.

dsheehy...

No Comment.

nigelh...

Just one point, from your words above - did you really say "another period of being ..... a Wall Street darling"?

I'd say we were a darling back in August of '98, and again in January 2000. We've never had all of Wall Street behind us at one time, and I've got some conspiracy theories to explain that, but we still ride the hype/panic cycle like everyone else.

TheAngryFerret...

Welcome to the board. I hope you stick around. There's not much to debate because we agree on almost everything.

I think its imperative that investors begin to understand the true financial risk of options, and just what an effect they have on overstating earnings. (incidentally, I wrote a paper of this...)

Well written paper. I enjoyed the Bushisms, too. The Black-Scholes model for valuing options grants would be an improvement over the current method. However, I still have some problems with it, the main one being these grants usually occur at relative price lows on a stock, and end up being exercised ITM far more often than publicly traded options.

But isn't there a better return that could be attained on that cash? I'd like to see them either invest it in their business, or give it back to the shareholders, through a dividend(not the best idea) or share repurchase.

Sometimes cash is the best place to be. With stock prices still too high (by my estimate) using it for acquisitions would be a mistake. The money that was spent on repurchases last year now looks like a mistake. Had it been given back to AAPL shareholders, most of them would have blown it on the market and taxes. I expect the money supply to contract, as bad debt comes home to roost in the economy. Having a large cash horde will allow Apple to make acuisitions and expand at bargain prices when the time comes.

But lowering inventory turns does have value. It frees up working capital than can be invested back in the business, and earn more.

Yes, but the concept was greatly overhyped and extrapolated well beyond the realm of reason back when everyone was pushing Dell stock. We also have to look at the reasons why inventory is low. A big shift to outsourcing and a well stuffed channel don't equal good inventory management.

The FASB's new rules on purchase accounting should help this, as amortization would only have to be occured on goodwill if it becomes impaired.

Interesting. This will help a lot of companies show better earnings going forward. I can almost smell the lobbying effort behind it.

I like your analysis, but it assumes that AAPL should trade at its adjusted book value. I'd argue that there should be some premium because I expect it to acheive returns in the future in excess of its cost of capital.

Any company can trade at any price at any time. There isn't any "should" from what I've observed in the stock market. I've noticed that many companies, including Apple, tend to oscillate between being overvalued and undervalued. I like to be a net buyer when they are undervalued and a net seller when they are overvalued, no matter how long the cycle takes.

I don't understand. These (diluted) shares will be purchased from AAPL, but they will still be in the market.

I estimate that the current diluted shares are a wash with respect to book value per share. Any difference between the average exercise price and book value per share is negligible for Apple at this time. I hope that explains my thinking better.

BeenFooled...

Apple owns some chunk of ARMHY and Akamai. The price of both of these has fluctuated pretty wildly over time... Should not that have a major effect on he Short Term Investment figure

These are included under "investments," and are not part of the Cash and STI totals. Eric Yang got that wrong. If you've been around long enough to remember his AppleInvestors site, that may be what confused you. Apple used to include these equity investments with "other assets," but made the switch beginning with the 1999 annual report. I liked it better when Apple was accounting for these high flying stock holdings at the original cost of investment.

allocatorx, tomhyland...

No comment.

dlatkinson...

Thanks for taking the time to back up your point.

pshaffer...

I very much appreciate your psot and your perspective on the stock valuation. It has caused me to rethink some material I have been reading.

Glad to hear it. Making people think is my whole objective in posting.

Which determination is more imprecise (book value or others)?

Book value, earnings, cash flow, they all are imprecise at measuring what they are supposed to measure, and we need to dig deeply to try and improve upon them. My point is that Book Value at least starts to measure the value of company. The other models are used interchangibly by analysts whenever one helps them sell a given stock.

Almost always, we buy our stock at some value greater than the book value and wish to sell it for more, again more than book value.

Not me. There is always a good supply of stocks trading below book value if you look for them. Just don't expect Wall Street to show them to you.

The premium above the book value is what I am concerned about. The way that premium is determined by those wishing to buy my stock is what I would like to be able to determine precisely.

In the short term, I don't think stock prices pay much attention to book value at all, so there isn't any way to measure such a premium. In the long run, however (at least from my experience) most undervalued stocks eventually become overvalued, and most overvalued stocks eventually become undervalued. The length of these cycles can vary greatly, of course.

IN short, investors are looking for some reason that the company will look even more attractive to other investors in following quarters and he can unload the stock to someone else at even higher premiums.

I'd say that most investors put less thought into valuation than you believe. Most investors these days just do what the talking heads on TV tell them to. My theory is that the masses, on average, buy high and sell low. Wall Street firms cause and feed their frenzy so that they can do the opposite.

Being someone who wants to sell my stock higher than I purchased it, I MUST pay attention to what criteria the potential purchasers of my stock are using to attach a value to it.

I've found that patience is very important, and in the long run I'll usually be right if I make my decisions based on value. As long as I don't expose myself too heavily to any given long or short position, I can just wait until the market's view of a stock changes and the buyers or sellers start coming to me.

Is there some study that would show that the long term appreciation of a stock is more closely tied to its book value than to its earnings accleration?

I can't help you here, other than to say it has held true during the time I've been watching the market.

Good luck all,

Rodg.

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