Both Icahn and Apple, the company, seem to think so.
Billions of dollars have been invested and divested in Apple stock since their earnings release on January 27th and two parties on the buy-side have gone public.
Mr. Carl Icahn, who I affectionately call Uncle Carl because of his crazy unshaven look these days, tweeted this on January 23rd, the Thursday before the Apple’s earnings release on Monday night, the 27th.
From Twitter @Carl_C_Icahn
The day after Apple’s earnings release and with Apple stock down 8% (and having a negative transit of EBV+5 that I will get to later in the blog), Uncle Carl tweeted this.
From Twitter @Carl_C_Icahn
Hope you’re with me so far?
Then on Thursday night, February 6th, 2014, Mr. Tim Cook, Apple’s CEO announced through the Wall Street Journal – not Twitter thank goodness – that Apple, the company, purchased $14 billion of its own stock or 3% of the company subsequent to its earnings release on the 27th.
Folks, this is business history occurring here. Rarely, if ever, have I seen two major buy side buyers making very public comments on what they were doing – spending (investing) billions and telling everyone what they are doing. This is unprecedented and real-time disclosure.
If this couldn’t get any better Uncle Carl writes two more tweets on Friday afternoon, February 7th, 2014 stating:
From Twitter @Carl_C_Icahn
In the old days of the stock broking business it was not uncommon that someone out of the blue or a casual acquaintance would telephone you and whisper about a penny mine company had hit the mother lode of one precious metal or another (diamonds were popular once) that was not publicly known. We called these men – they were never women – touts. Well-funded touts opened brokerage accounts with you and purchased a hand full of shares to give you the feeling of being authentic. The goal for the tout was to get you and your clients purchasing the stock creating demand thus driving up the stock price. Yes, almost like a chain letter. The early participants were rewarded the others suffered financial losses.
I’m sure the act of touting still thrives in some dark corners of the equity markets but Uncle Carl takes touting to a whole new level calling his investment in Apple a ‘no brainer’!
So what do we make of this activity? Billions of dollars are flying around with unprecedented disclosure by buy-side participants. Both parties, Uncle Carl and Apple, are not only making claims as to the valuation of the company but also backing their claims or assumptions with cold hard cash that each controls.
The Greatest Spectator Sport There Is!
This is where I have the most fun asking myself questions:
Did Apple make the right decision for shareholders by being so aggressive with its stock purchases? Is Uncle Carl’s assertion correct that an investment in Apple is simply a ‘no brainer’ for every investor/trader? Apple, being the most valuable company on the planet, can afford the best finance brains in the world in making this buy back decision. Who did they consult and what was their logic? Uncle Carl makes an assertion that if Apple had the same P/E ratio as Google, now the second most valuable company on the planet, as of Friday, that Apple would be worth $1,245 per share. Is this assertion correct? Who is going to argue with Uncle Carl’s analysis? Are both parties using the same analysis that Apple shares are undervalued and if so what is this analysis?
And most importantly can financial math solve any of these questions?
So many questions, so little time.
Model Price To The Rescue!
Our goal and business idea was to have a unique service where financial participants could readily observe what we consider model price or fair market value of the public company in question. We have created a database of companies that inputs selected pieces of financial information and calculates, through our algorithms, robust and unbiased – no matter the company or industry it participates – fair market value for each company. This is a service we call Model Price.
Critics will charge that such a calculation is not possible with the current state and knowledge of finance. We agree. We had to create and acquire new financial concepts that are not known nor written about in finance textbooks. For skeptics we have included these new financial concepts under our ‘Key Concepts’ tab, above.
Back to Apple
Let’s start with our model price chart on Apple, Inc.
Apple, Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)
What’s the fair market value of Apple? We have calculated Apple’s fair market value or what we call model price at $596.42 on Friday, February 7th, 2014. Friday’s market close on Apple was $519.68, representing an upside potential of 14.8% for investors. Nice upside, but would I mortgage the house on this upside potential, no.
As users of Model Price know we provide two pieces of original financial information for users. The first is our calculation of model price as I have mentioned. The second is our calculation of parallel lines we call EBV’s or Economic Book Value lines. These parallel lines come from the balance sheet of the company. By charting a company’s stock price along with our EBV lines gives users of model price unique perspective on how the fundamentals of the company interact with the publicly quoted stock price.
When Apple reported their earnings on January 27th, Apple had a negative transit for EBV+5 or our yellow EBV Line. (See arrow on chart above)
What does this negative transit mean?
This is not the first time Apple has had a negative transit of EBV+5. I noted the first time here in a blog and explained its significance. In summary, the significance of this negative transit is the fundamentals of Apple are deteriorating.
Here is a more thorough analysis of Apple earnings and its calculated Theoretical Earnings (TE) value. (For more on Theoretical Earnings and what TE means see Key Concepts.)
For ease of analysis we calculated a ratio between EPS and Theoretical EPS.
Apple has been a massively profitable company in the past. With the invention of the iPhone and especially the iPad you can clearly see in this chart how profitable Apple has been. Much of these past profits reside on Apple’s balance sheet in the form of cash – $158.8 billion as at the end of Apple’s 1st quarter. The critical question that nobody knows, probably including Tim Cook and his management team, is what products can Apple invent or produce in the future that will produce as much earnings as the iPhone and iPad have produced in past years.
Well, unbelievably, we do have an answer to this question. Apple, the stock price, had a negative transit of EBV+5 after its 1st quarter earnings release. The market is taking away valuation and a negative transit of an important EBV level are signs that the collective wisdom of the market says we have seen peak earnings from this company probably for the foreseeable future.
Was Tim Cook’s purchase of Apple’s shares a wise move?
There are two issues here that need to be separated when thinking of this question. First, what happens to the past profits accumulated by Apple? How are the spoils of past innovation and great products to be divided? Interested groups include shareholders, of course; future R&D (product innovation) and payment of past and future management. Apple initiated a dividend, the first in company history. Management also last year initiated a share buy back program, again rewarding shareholders. This latest news of Apple management spending $14 billion is by far the most aggressive share buyback to date. Mr. Icahn point is that shareholders of the company should get this cash as owners of the company. He does have a point.
The second issue is how Apple should be valued going forward based on future prospects, products and earnings. This again has been answered by the negative transit of EBV+5. This action, in my opinion, is the ultimate arbiter on the future prospects of the company. Collectively, through the buying and selling of Apple’s shares, the market is making its’ decision in taking away valuation of the company. Even with the buying power of both Apple and Mr. Icahn couldn’t help support Apple’s shares above EBV+5.
So what is the answer?
The answer from our perspective would be for management of Apple to achieve a stable and balanced EPS/Theoretical EPS ratio, if at all possible. If earnings do start to fall then Apple’s theoretical earnings should also fall in direct proportion thereby keeping the ratio stable and balanced. (This can be illustrated when we do an analysis on Google later in the blog.) Apple’s EPS/Theoretical EPS ratio has been very cyclical in the past 20 some years probably reflecting the inherent nature of the product life cycle of each for Apple’s very successful products. This ratio’s cyclicality probably ultimately reflects in the low simplistic Price/Earnings ratio market watchers comment on repeatedly.
Mr. Icahn compares Apple with Google
Finally, Mr. Icahn tweets that if Apple had a Price /Earnings multiple of Google (19x) Apple’s shares would be $1,245. This rather simplistic ratio, Price/Earnings, can and will get investors in trouble and can lead to massive investment losses. Hopefully and I truly believe Mr. Icahn, a veteran of many decades in the investment game, wouldn’t rely on this simplistic ratio to invest billions for himself and others in his hedge fund.
First, let’s look at our model price chart on Google, Inc.
Google Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)
As you can observe Google now trades at a substantial premium (35%) above its calculated model price. As discussed previously, Apple trades at a slight discount (15%) to its calculated model price. So does comparing Apple with Google with a very simplistic ratio relevant to anything valuation wise? Of course, Mr. Icahn assumes the market is valuing Google correctly and not Apple.
Again, this is why we invented our model price algorithm. We are comparing apples to apples (no pun intended) in terms of valuation. So comparing a slightly undervalued stock (Apple) with an overvalued one (Google) is a stretch.
For fun, let’s wave a magic wand and say Apple trades at Google’s P/E ratio as Mr. Icahn suggests, this would place Apple’s shares above EBV+7. (For readers to get this reference you have to go to our Facebook app and see where a stock price $1,245 would place Apple in terms of our EBV zones (link here).) Apple never traded close to these levels even when the company was delivering peak earnings back in 2012. Can Apple shares trade at $1,245? Absolutely! Markets can and will do anything. However Apple would trade around 50% above its fair market value.
For fun, and to finish this blog, let’s have a look at Google’s EPS and our calculated Theoretical Earnings since the company went public almost 10 years ago.
Ratio of the two variables
Hopefully the difference in the fundamentals of these two companies is illuminating. Google, Inc. provides a service – search. Google is a dominant player in this space (near monopoly) and provides shareholders with an ever-increasing earnings stream. Apple, in comparison, is mainly a product company highly dependent on new and high margin innovative products. Apple has a formidable challenge of revisiting past peak earnings with new products. Google, on the other hand, as yet to show any signs of peak earnings.
Compare these two companies for valuation reasons? Not a chance. Mr. Icahn probably knows better but a tout is always very cavalier with facts and figures, even though they seem to cite them for authenticity and credibility sake.
So where does all this analysis leaves us.
First, my main goal here is to talk about valuation. Implied and explicit claims and counter claims have been made both in the market reaction to Apple’s 1st quarter earnings report and two individuals response to this market reaction. If you’re interested in corporate maneuvering our Model Price App can help keep score in terms of actual valuation of the companies in question and the likely winners and losers.
Second, tens of billions have been flying around in the last two weeks surrounding Apple. Apple has become a battleground and with two of Apple’s biggest proponents going public in their actions is, as I said, unprecedented.
Mr. Icahn wants Apple’s cash. This is the ‘no brainer’ of which he talks about. Mr. Tim Cook was repurchasing shares of Apple at an accelerated pace over the last two weeks because he thinks he’s being opportunistic and appeasing Uncle Carl at the same time. This repurchase move was probably a good political strategy but not necessarily a financial one. (This strategy clearly worked because on Sunday night Proxy-advisory firm Institutional Shareholder Services (ISS) Inc. on Sunday recommended that Apple shareholders reject a proposal by Mr. Icahn that the company buy back $50 billion of its stock. Subsequent to this announcement by ISS Mr. Icahn dropped his proposal. Mr. Icahn said he also supported Apple’s recent move to repurchase $14 billion in shares within the last two weeks.)
For me, a past owner of Apple shares, the decision is straightforward. A negative transit of EBV+5 was my sell signal and I will wait on the sidelines until either Apple has a positive transit of EBV+5 (again) or probably more likely when Apple trades at support in its current zone or EBV+4.