Wall Street Warms up to Apple, AAPL Valuation Update
Hello everyone.
Over at Above Avalon’s sibling site, Inside Orchard, my essay last week, "Big Tech Is Winning Over Wall Street," went over a Wall Street observation that has been on my mind for the past few weeks.
While NVIDIA was capturing many hearts and minds on Wall Street, a larger story was quietly unfolding in the background. Wall Street was turning decidedly more bullish on the broader Big Tech bucket (Microsoft, Apple, Alphabet, Amazon, Meta). The change in tone isn’t just attributable to AI either. That may come across as a shocking stance to hold - the Inside Orchard essay goes into more of my thinking.
For today, we will keep our focus specifically to how Wall Street is warming up to Apple. The discussion then turns to an examination of AAPL valuation metrics (forward P/E, EV/FCF, and free cash flow yield).
Wall Street Warms up to Apple
A few weeks back, we talked about the trading action seen in Apple shares following WWDC. The signs pointed to algorithm-driven program trading leading to a sudden move higher. It’s certainly possible that some market participants were swayed by other things like fundamentals, but the heavy trading volume suggests something more systematic. Another possibility that we did not explore was a pair trade involving
An Above Avalon membership is required to continue reading this update. Members can read the full update here. (Members: Daily Updates are accessible via the archive. If you haven’t logged into the archive before, fill out this form to receive an invite.)
Choose either a monthly or annual membership. Payment is hosted by MoonClerk and secured by Stripe. Apple Pay and other mobile payment options are accepted. After signup, use this link to update your payment information and membership status at any time. Contact me with any questions.
Contact me directly if you would like to purchase multiple subscriptions (five or more) for your team or company.
An audio version of the newsletter is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here. Special Inside Orchard bundle pricing is available for Above Avalon members. Additional membership customization is available via the Financial Models add-ons.
More on Apple Share Buyback vs. Market Cap, Thoughts on Apple and a $4 Trillion Market Cap, Thursday Q&A
There is one question that was carried over from last week’s Thursday Q&A that we will address today. What does the current Mac upgrade cycle look like? In addition, there were a few incoming questions regarding Apple’s market cap and buyback. We will tackle those questions first.
An Above Avalon membership is required to read this update. Members can read the full update here. (Members: Daily Updates are accessible via the archive. If you haven’t logged into the archive before, fill out this form to receive an invite.)
Payment is hosted by MoonClerk and secured by Stripe. Apple Pay and other mobile payment options are accepted. After signup, use this link to update your payment information and membership status at any time.
An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here. Special Inside Orchard bundle pricing is available for Above Avalon members. Additional membership customization is available via the Financial Models add-on.
AAPL Closes Above $3 Trillion for Second Time, Apple’s Recent Stock Price Strength, Apple Valuation Update
Today's update begins with Neil’s thoughts on Apple closing above a $3 trillion market capitalization for the second time. We then look at Apple’s recent stock price strength and what may be behind the move higher. The update concludes with an examination of AAPL valuation metrics (forward P/E, EV/FCF, and free cash flow yield).
An Above Avalon membership is required to read this update. Members can read the full update here. (Members: Daily Updates are accessible via the archive. If you haven’t logged into the archive before, fill out this form to receive an invite.)
Payment is hosted by MoonClerk and secured by Stripe. Apple Pay and other mobile payment options are accepted. After signup, use this link to update your payment information and membership status at any time.
An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here. Special Inside Orchard bundle pricing is available for Above Avalon members. Additional membership customization is available via the Financial Models add-on.
Apple's 3Q23 in Three Charts
Hello everyone. Welcome to Monday and a new week. We will continue our Apple 3Q23 review.
Given how the past few quarters for Apple have contained similar themes, we are going to try something different for this quarter's review. We will focus on three charts that sum up Apple's 3Q23. As we will see, there is quite a bit of consistency on display with each chart. (We will cover all of the granular takeaways from Apple's 3Q23 earnings call in tomorrow’s update.)
Before jumping into today’s update, one clarification regarding Friday’s update. When talking about Apple’s hardware margins, the commentary was garbled. That part of the update should have read:
Products (HW) gross margin: 35.4% (vs. my 35.7%). My iPhone gross margin estimate was a tad bit too optimistic. On a year-over-year basis, HW gross margins were up by 85 basis points.
Apple's 3Q23 in Three Charts
Gross Profit Resiliency
3Q23 results: $36B gross profit (up 1.5% from 3Q22)
There has been much attention placed on Apple’s gross margins (and rightly so). Gross margin is cost of goods subtracted from revenue. Based on management commentary, the company will come close to reporting a 11-year quarterly high for gross margin percentage 1Q24. Management provided a 44.0% to 45.0% range. Gross margin percentages don’t tell the full story though. Instead, we need to look at gross profit in absolute terms to obtain a cleaner assessment of Apple’s business.
An Above Avalon membership is required to continue reading this update. Members can read the full update here. An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here.
(Members: Daily Updates are always accessible by logging into Slack. If you haven’t logged into Slack before, fill out this form to receive an invite.)
Above Avalon Membership
Payment is processed and secured by Stripe. Apple Pay and other mobile payment options are accepted. Special Inside Orchard bundle pricing is available for Above Avalon members.
More information about Above Avalon membership, including the full list of benefits and privileges, is available here.
AAPL Valuation Metrics, Apple's Improving Valuation, Apple Close to $3 Trillion Market Cap (Again)
Hello everyone. The update kicks off with an examination of AAPL valuation metrics (forward P/E, EV/FCF, and free cash flow yield). We then go over Neil’s thoughts on why Apple’s valuation metrics have improved so dramatically in recent months. The discussion goes over Apple getting close to a $3 trillion market cap for the second time.
Let's jump into today's update.
AAPL Valuation Metrics
The AAPL roller coaster continues.
When we last talked about AAPL valuation at the beginning of the year, shares were on a down trend (-28% from all-time highs put in January 2022). Since that update was published, AAPL shares are up a whopping 45%. These are large, although not entirely unusual, moves for such a mega cap stock.
For today’s valuation exercise, it's prudent to run with a forward EPS estimate (earnings for the next 12 months) of approximately $6.00. With Apple shares trading at $189, the company’s forward price-to-earnings ratio (current stock price / forward EPS) is 32x. This is up significantly from the beginning of 2023 when shares were trading at a 20x forward multiple. It’s not the easiest exercise to compare the current forward multiple to historical averages given that we are relying on forward estimates and not reported figures. With that said, a 32x forward multiple would be close to all-time highs for Apple in the modern era. Shares had gotten close to the level in the summer of 2020 as shares made a major move higher prior to significant EPS growth which subsequently brought forward multiples down.
To put the 32x forward multiple in context, we compare Apple to various sectors and the overall market using the S&P 500 as a proxy.
An Above Avalon membership is required to continue reading this update. Members can read the full update here. An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here.
(Members: Daily Updates are always accessible by logging into Slack. If you haven’t logged into Slack before, fill out this form to receive an invite.)
Above Avalon Membership
Payment is processed and secured by Stripe. Apple Pay and other mobile payment options are accepted. Special Inside Orchard bundle pricing is available for Above Avalon members.
More information about Above Avalon membership, including the full list of benefits and privileges, is available here.
Nikkei Asia Stokes Apple Demand Fears, AAPL Valuation Update, AAPL Stress Test Scenarios (Daily Update)
Hello everyone. In today's update, we will tackle additional questions that came in from members over break. The first topic is related to Nikkei Asia's article on Apple product demand. We will then turn to AAPL volatility. The discussion includes a broader examination of Apple’s current valuation metrics based on both earnings and free cash flow. We also go over various stress test scenarios involving different EPS and forward P/E multiples.
Let's jump right in.
Nikkei Asia Stokes Apple Demand Fears
In an article published on January 2nd, here's Nikkei Asia:
“China's tech supply chain is heading into the new year facing the twin challenges of slumping demand and staffing chaos caused by Beijing's abrupt U-turn on COVID controls.
In a sign of the gloomy outlook for consumer electronics, Apple has notified several suppliers to build fewer components for AirPods, the Apple Watch and MacBooks for the first quarter, citing weakening demand, according to Nikkei Asia's supply chain checks with several component suppliers.
‘Apple has alerted us to lower orders for almost all product lines actually since the quarter ending December, partly because the demand is not that strong,’ a manager at an Apple supplier told Nikkei Asia. ‘The supply chain in China is still trying to cope with the latest abrupt policy turns, which brought a shortage of laborers because of the sharp COVID surges.’”
This article managed to travel quite far last week even though Wall Street was only starting to return to the office following the December break.
My initial impression reading the article was that there may have been something lost in translation. Having an unnamed source claim “demand [for all Apple product lines] is not that strong” isn’t exactly a compelling or convincing rumor.
An Above Avalon membership is required to continue reading this update. Members can read the full update here. An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here.
(Members: Daily Updates are always accessible by logging into Slack. If you haven’t logged into Slack before, fill out this form to receive an invite.)
Above Avalon Membership
Payment is processed and secured by Stripe. Apple Pay and other mobile payment options are accepted. Special Inside Orchard bundle pricing is available for Above Avalon members.
More information about Above Avalon membership, including the full list of benefits and privileges, is available here.
Apple's $500 Billion Year on Wall Street
Since the start of 2019, Apple’s market capitalization has increased by $500 billion or roughly the equivalent of Facebook’s market cap. For the first time with Tim Cook as CEO, Apple shares are trading at a premium to the overall market. Something has clearly changed when it comes to the way Wall Street is treating AAPL. However, the items that analysts, pundits, and the media positioned as catalysts for this dramatic change (Apple Services, iPhone sales rebound, 5G, improving U.S. / China trade sentiment) likely have little to nothing to do with Apple’s share price outperformance in 2019. Instead, changing behavior as it relates to passive versus active investing may be creating a type of perfect storm for AAPL shares.
Outperformance
It’s difficult to put a $500 billion market capitalization increase in context. Here are a few attempts:
Disney ($262B), Netflix ($146B), and three Spotifys ($78B) combined.
AT&T ($282B), Comcast ($196B), and a Spotify ($26B) combined.
Nearly two ExxonMobils ($588B).
Three Boeings ($558B).
Six Goldman Sachs ($498B).
Sixteen percent of the entire energy sector.
The market caps of the bottom 12% of the companies in the S&P 500 (60 companies in total).
When looking back over the past ten years of stock price performance, 2019 is on track to be the best one for Apple this decade (barring a stock market implosion in the next two weeks). Apple shares are up a whooping 77% in 2019. Comparing the S&P 500’s performance with that of AAPL, we reach Apple’s outperformance / underperformance relative to the broader market:
2010: 40%
2011: 26%
2012: 19%
2013: -22%
2014: 29%
2015: -2%
2016: 3%
2017: 29%
2018: 1%
2019: 50%
Apple shares have outperformed the market by 50% in 2019. For a company of Apple’s size, such outperformance is noteworthy.
Valuation
On a forward P/E multiple basis, Apple shares now trade at a 20% premium to the S&P 500. My preferred valuation metric for Apple is free cash flow yield, or the amount of free cash flow relative to enterprise value. Free cash flow is the amount of cash left over after management has paid all of the bills and maintained / funded capital investments. Enterprise value is market capitalization minus net cash (debt - cash).
In FY2019, Apple reported $58 billion of free cash flow. Apple is a free cash flow machine given its capex light business model. (More information on Apple’s free cash flow advantage is found in the Above Avalon daily update from March 13th available here.) While Apple’s free cash flow will fluctuate given the various moving parts, the combination of a stabilizing iPhone business and no major change in capex spending supports the idea of similar levels of free cash flow over the next 12 to 24 months. Accordingly, we can use $60 billion of free cash flow and Apple’s current enterprise value of $1.1 trillion. Apple is currently trading at a 5.2% free cash flow yield. The higher the yield, the lower the stock valuation.
One way of interpreting a 5.2% free cash flow yield is to compare it to other instruments such as government bonds and high-yield corporates. With those yields closer to 2.5%, a 5.2% yield suggests that Apple is still fairly attractive from a free cash flow yield basis. However, the days of Apple trading like a steel mill with just a few years left of operations are in the rear-view mirror. As recently as 2016, Apple was trading at a 17% free cash flow yield. For discussion purposes, AAPL would need to trade at $100 per share for free cash flow yield to once again be at a 17% yield.
What’s Driving AAPL?
Longtime Above Avalon readers and listeners will be familiar with my consistent stance on how to determine what is behind a stock price’s move. Unless every market participant is interviewed, we are unable to know the exact reason why a stock price behaves the way it does. Given the sheer difficulty found with such an exercise, the task of determining specific reasons behind a stock price move is ultimately a fool’s errand. The activity is nothing more than an attempt to add manufactured clarity to what is ultimately a lot of unknown. It is humans’ discomfort with the unknown that plays a role in the financial press’ never-ending quest to come up with exact reasons behind stock price moves.
When it comes to Apple, the list of “reasons” that analysts and reporters claim are behind the stock’s 77% move in 2019 continues to grow:
A stabilizing iPhone business.
Stronger services growth.
Apple management successfully navigating a tumultuous geopolitical landscape in both the U.S. and China.
Wearables momentum.
Continued ecosystem momentum with ongoing growth in terms of new users and the number of devices.
There is a rather glaring problem found with the preceding list of factors: None are significant enough on their own to justify a $500 billion increase in market capitalization.
Using a conservative measure as to what the iPhone business was previously valued at, Apple’s market cap increase would represent the iPhone business seeing its valuation double in just 11 months. That is unrealistic for a mature business like the iPhone. Expectations would have had to move from Wall Street thinking the iPhone was dead with just a few years of sales remaining (which was never the case) to the business demonstrating some kind of free cash flow bonanza (also not the case).
As for the idea that Services is somehow behind Apple’s spectacular rise, I’m skeptical. The problem with that theory is that there continues to be a lack of consensus as to what that narrative may even be. Apple isn’t becoming a services company, and there remains quite a bit of hesitation around that idea in terms of buy-side investors.
My suspicion is that Apple’s stock price run isn’t driven by any single business-related item. The move is simply too large. Instead, a $500 billion market capitalization increase points to a wide variety of investors wanting greater Apple exposure. This increased interest results in higher stock prices since a stock price is nothing more than the spot where demand for shares equals the supply of those shares.
Why do these investors want more Apple exposure? Instead of looking at Apple’s business for potential answers, we have to look at the multifaceted dynamic found with passive versus active investing.
Passive investing (index funds) are on the rise as investors are becoming increasingly disenchanted with mutual funds and active funds charging for underperforming the market. As more funds are poured into passive investment vehicles, all of the Wall Street giants (Apple, Microsoft, Amazon, Alphabet) benefit. By accounting for 4% of the S&P 500, 4% of every dollar put in an S&P 500 index fund is allocated to Apple. While this mechanism doesn’t necessarily lead to Apple’s share of the overall market increasing over time, it can lead to sustained demand for shares regardless of business fundamentals. This is key as active investors, and their constantly swinging perspectives on stocks, lose power to sway stock prices. While passive investing on its own doesn’t explain a $500 billion increase in Apple market cap in 2019, it likely is a contributing factor to what may be happening.
In a scenario where active investors (hedge funds, mutual funds, pension funds, etc.) were running with historically low exposure to Apple for whatever reason, a scenario in which Apple began to materially outperform the market would place pressure on these active investors given how they are often graded against a market benchmark. Given how Apple represents 4.3% of the overall S&P 500, a 77% move in the stock will likely make or break an active investor’s year depending on whether or not they own the stock.
The most likely explanation for Apple’s run up - however simplistic it may sound - is that active investors have been desperately trying to increase their exposure. The stronger demand for shares leads to higher stock prices in order for demand to match supply.
A crucial piece of evidence for my theory is found with Microsoft. The company is up 52% in 2019 with market cap gains of approximately $400 billion. We know Microsoft shares aren’t up that much because of iPhone sales. Instead, Microsoft is likely experiencing the same situation as Apple. Having shares of the two largest companies go up by 77% and 52% respectively means that active investors need to be overly exposed to these companies or risk underperforming benchmarks. For those active investors late to the party, the need for exposure only intensifies. Some may call this situation FOMO (fear of missing out). Others may call this forced buying - the opposite of forced selling.
Warren Buffett
Warren Buffett ends up being a symbol of this development. Back in 2016, Buffett began building his Apple stake after one of his portfolio managers introduced him to the idea. Buffett has been uncharacteristically quiet about his Apple investment. However, the past few Berkshire annual reports provide enough clues to suggest he is ultimately attracted by Apple’s robust free cash flow and balance sheet strategy in which free cash flow is poured into share buyback and dividends. Buffett took advantage of active investors shunning Apple to increase his own exposure. Buffett’s Apple stake is now worth $70 billion, marking an unrealized profit of approximately $34 billion (not including dividends).
During the period when Buffett was acquiring his Apple stake, the two largest Apple buyers in the market were Apple (via stock buyback) and Buffett. In some quarters, the buying from Apple and Buffett alone totaled as much as 10% of shares traded. That is astounding. As Apple and Buffett were buying shares, many other market observers remained on the sidelines for likely a variety of reasons (unease surrounding Apple’s business model, Apple’s exposure to China, and the list goes on).
What Next?
As for how this situation will end, no one knows. If someone proclaims to know, caution is needed. We can have much more confidence in saying that valuations will matter, eventually. It is also safe to assume that passive investment momentum will continue, which will likely only exacerbate current trends (both to the upside and downside).
Listen to the corresponding Above Avalon podcast episode for this article here.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.