Anchoring Bias Impacting Wall Street's View on Apple
Predicting tech trends beyond 6-12 months is somewhat of a futile endeavor, but two groups of analysts attempt the feat: paid and non-paid. Paid analysts largely encompass sell-side analysts - think along the lines of Goldman Sachs and Piper Jaffray. Non-paid analysts include everyone else and seem to have acquired the “independent” nomenclature. There remains another group - buy-side (think hedge funds and mutual funds) - who don’t actually publish Apple forecasts, instead utilizing paid (and independent) analysts forecasts.
Modeling Apple’s business (and earnings) involves two parts:
1) Knowing how to model a company’s financials. This is the easy part. Setting up an excel sheet to model revenues, expenses, and earnings going forward. Financial modeling is essentially Finance 101 (ironically many students have no clue what they are doing when they take intro Finance classes since the field is so disorganized academically in primary and high school).
2) Knowing how to model a company’s performance. This is the hard part. This is the part of modeling that is more art than science. How many iPads will Apple sell next year? How about iPhones? Experience, intelligence, and a clear mind separate the amateurs from the professionals.
I’ve discovered that looking at someone’s forward Apple projections reveals a lot about what they think of Apple and this is where things get interesting. Sell-side consensus for Apple earnings per share currently stands at $32.35 for fiscal year 2012 and $36.94 for fiscal year 2013. From a stock valuation standpoint, these numbers are important, but converting these numbers into growth, Wall Street believes Apple will grow 18% in 2012 and 14% in 2013.
In order to put these numbers in context, I compare Apple’s projected earnings growth to other technology companies:
2012 2013
GOOG: 19% 17%
IBM: 11% 11%
MSFT: 6% 9%
HPQ: -1% 2%
RIMM: -20% 2%
DELL: 26% -2%
Average: 7% 7%
AAPL: 18% 14%
(consensus data from FactSet and current as of 9/10/11)
Now we are getting a better picture of how Wall Street views Apple. Tim Cook and company are expected to outperform the overall technology sector, growing earnings 14% in 2013, versus a peer average of 7%. However, Apple’s 14% projected growth in 2013 pails in comparison to current 70% growth. What is going on here?
Instead of sell-side analysts “not getting it” - as some independent Apple analysts say, I think anchoring bias is the main culprit.
I thought Wikipedia did a good job at trying to define anchoring in a few sentences:
Anchoring and adjustment is a psychological heuristic that influences the way people intuitively assess probabilities. According to this heuristic, people start with an implicitly suggested reference point (the “anchor”) and make adjustments to it to reach their estimate. A person begins with a first approximation (anchor) and then makes incremental adjustments based on additional information.
Sell-side analysts are comparing Apple to its peers too much. Although analysts still believe Apple will outperform, many are modeling Apple with a 5-10% technology industry growth rate in mind. Apple’s growth is then pegged above this range, albeit by only a small margin. Apple is being anchored to its peers and corresponding lower growth rates.
Sell-side analysts may think Apple will sell a ton of iPhone and iPads, but end up with much lower Apple growth rates because Apple’s peers are performing so poorly. To make matters worse, much of this comparing, and anchoring, is occurring on a subconscious level, making it that much harder to acknowledge and correct.
Meanwhile, independent Apple analysts aren’t subjected to anchoring bias since they are only modeling Apple. In a way, they are able to put Apple in a valuation bubble. If independent analysts began to model Apple peers on a regular basis, I would suspect anchoring would become a bigger issue among the group.
As an independent Apple analyst, how fast do I think Apple will grow earnings?
2012: 40%+
2013: 35%+
My 2012 earnings growth estimate is twice the pace of Wall Street’s 18% growth estimate.
RIMM’s troubles, HPQ’s reorganization, MSFT’s status quo, and GOOG’s continuing mystery are causing Wall Street to view Apple with a more conservative eye. What is the solution? Unfortunately, I don’t expect Wall Street’s anchoring bias to end anytime soon. Apple will continue reporting large quarterly earnings beats, while Wall Street continues to gush over Apple’s growth.