Is $AAPL overvalued Part 2, or what does Mr Market know?

Almost exactly three weeks ago (April 5, 2012)  I did a comparative study on Apple versus other large technology companies. The answer was "no", and one of the key pieces of evidence was the following table:

Since then, all of the companies in the list have reported their earnings, and we have the situation as below:

What do we see? Apple had smashed expectations, and at this point its trailing and forward P/E is better than that of all of the other names, except Microsoft, which leads rather narrowly, and which has considerably dimmer growth prospects than Apple. Google has done a good deal better than expected (looking at the old and new P/E figures). Both of their stocks have gone down considerably over the last three weeks. Curiously, the best performer of the bunch (by far) is Amazon, which has a crazy earnings multiple, and worse growth prospects than Apple. What does it all mean? I don't know, but Apple looks even more attractive now.

An Unscientific observation on Apple

I was loitering (sorry, working) in the Princeton Market Fair Starbucks (not a university hangout,mostly local professional people from the nearby office buildings). When I walked in, five people were working on laptops -- all of them MacBooks. When I left, two people (different from the first five) were working on laptops -- both MacBooks. Yours truly had to be different with a Zenbook (I needed to run Bloomberg), but also an iPad to compensate.

I Love you do death II: Or, hugging the benchmark

In the last post I cast aspersions on Google leadership by comparing Google's performance with that of Apple. This could be viewed as not entirely fair, since Apple sets an extremely high standard, and maybe Google's management, while not in Apple's league, is still very strong? With this goal in mind, let us compare Google's performance with that of S&P 500 (with dividends reinvested) -- we use the SPY ETF as proxy (this will have the effect of making S&P 500 returns look very slightly worse than they really are). Let us see what would happen if our GOOG-r-us hedge fund constructed a dollar neutral portfolio, which was long GOOG and short SPY. Here is what our results would look like:

You see that our fund would have done very well in the first three years of its existence, but it would have floundered aimlessly for the last five years: since mid-2007 Google has been tracking the S&P 500, so its performance has been (in a technical sense) mediocre. To avoid cluttering this post, I will not include a beta-hedged chart, but the results look exactly the same (Google's beta vs the S&P 500 is 0.8, which is good, but hardly a spectacular accomplishment for "the company of the future.")

• On the one hand, this bears out the contention in the last post that the skill set require to start a company is quite different from that required to keep it going, and it seems that Brin-Page-Schmidt have the former but not the latter.
• On the other hand, an even more cynical observer would remark that Google historical performance is exactly what you would see for a fund perpetrating the scan described in a recent post:: very impressive performance from inception, but hugging the benchmark for the last several years.

Either way, not a great argument for giving Google founders any more rope, er, voting power.

I love you to death, or: Monarchy vs Meritocracy

Yesterday, as part of their quarterly report, Google announced that it was going to do a weird stock split, whose main purpose appeared to be to consolidate power in the hands of the founders (Brin, Page, and Schmidt), who currently control 2/3 of the votes of Google. In a letter, the founders explained that they so loved the company that they felt they needed to keep shepherding it, without interference from pesky shareholders. This brings up the obvious question of how well they had been shepherding it, and since everything in this world is relative, who better to compare Google to than its tech rival Apple (whose shares tanked today out of solidarity with Google, demonstrating again the great efficiency of the stock market). It should be noted that through almost all of the period we will be looking at (Google's lifespan as a public company) Apple has been led by Steve Jobs, who had famously sold all of his founder's shares but one when he was fired from Apple, and while he had acquired a fair bit of stock during his second coming, he certainly did not have a measurable amount of voting stock. Same goes for his successor Tim Cook, who, when his options vest will have a princely 0.05% vote. So, how did the two companies do?

First, the obvious price chart:

You will see that GOOG started trading at $100 a share on its IPO day (8/19/2004). Its price doubled to $200 a share in two months, and it is now trading at a bit over $600 a share, considerably below its late 2007 all-time high. By contrast, AAPL was trading at $15 a share (adjusted price, there has been a split in the intervening period) on Google's IPO day, and it is now trading (by a curious coincidence) roughly for the same price as Google. For a total outperformance of 6.5x in the seven and a half years. 

This, however, is only the beginning of the story. First, let us look at Apple's annualized alpha vs Google:

(alpha charted is the simple six month regression alpha).

You will see that Apple has consistently outperformed Google. But wait, there is more. Let's look at the beta of Apple's returns vs Google (after all, if we believe in the Capital assets pricing model, Apple performance should be easily explain by the higher volatility of its returns:

(beta is the six month empirical regression beta, no GARCHes harmed...)

Surprise: AAPL beta vs GOOG (except for literally a few days in 2007) has been much below 1. In other words, Apple's performance flies in the face of CAPM, since its risk-adjusted returns are truly phenomenal.

Those of us in money management business measure risk-adjusted returns by Sharpe Ratio (which is the ratio of mean return to the standard deviation of returns). Google's annualized Sharpe Ratio is a rather unremarkable (if solid) 0.69. Apple's is 1.27 -- essentially double Google's, and very good (given the long period marked by a major recession) for any hedge fund, and without the benefit of the diversification that a hedge fund would have.

So, Steve Jobs managed to run Apple very successfully while not having the ability to pick the board, and did it while enjoying complete control of the company, which the board was more than happy to give him. Jobs had famously said that he did not give a shit about the stock, and yet his bean-counting statistics are far superior. Not only was he allowed to run the company as he saw fit, but Cook is his hand-picked successor. Meritocracy works. But there is more: in 2004, Apple was very much an also-ran computer maker, who had just introducers the iPod. Google already had the monopoly share of internet search at the time of its IPO. In the intervening years, Search (or more precisely, selling advertising on search) remains Google's only serious money-making business. All of Google's other efforts have been attempts to disrupt other people's business at great cost to itself (examples: Google+ is an inferior version of Facebook, Android is an inferior copy of the iPhone, which has not hurt Apple, but destroyed Microsoft's phone business, and contributed to the destruction of RIM, Google apps is a poor attempt to compete with Office, Google Finance is a poor cousin to Yahoo! Finance, Google Play is an attempt to undermine iTunes and Amazon...) The one exception to this is YouTube,which is actually the leader in the field, but I don't know that it actually pays for itself (the amount of advertising is minimal, and the costs, given that video is very storage intensive, must be very high)

Bottom line: Brin, Page, and Schmidt started a great company, but starting and running a great company are, it seems two very different things (Jobs did both, but his second coming was twenty years after the founding of Apple -- he had apparently learned a couple of things in the meantime). So giving the founders control in perpetuity is a stupid idea, and I would not invest in any IPO which does it (that means you, Facebook).

More trading strategies, or "there is one born every minute"

In this post I discussed a model for how some hedge funds make money.A couple of weeks ago I was chatting about this with an acquaintance who runs a mid-size university endowment, and he said: NO! That's not how it is done! I was prepared to hear that hedge fund managers are caring nurturers, and would never do such a thing, but instead he continued: What you do is this: Let's say you have $25 million in start-up capital. You divide it into five piles of $5 and start up five funds with variations of your strategy (which might consist of throwing darts at the bloomberg terminal). At the end of a year or two, by sheer luck, one of the funds will have done really well, some will have done ok, and some will have tanked horribly. At this point, you shut down the underperforming funds, and publish the results of the overachieving fund (in, for example, the standard databases). The stellar performance will attract suckers investors, and then you continue running that one fund, but now you hug the benchmark closely. What happens then is that your recent results don't look so stellar, but your results from inception look great. It seems almost too easy (and does not work with sophisticated investors like my friend, but, sadly these are in the minority).

Is $AAPL overvalued?

There has been much hysteria lately about Apple, and its skyrocketing stock price. Many comparisons have been made to 1999 and the tech bubble. While some current tech IPOs do remind one of the good/bad old days, Apple seems a poster boy for sanity. Indeed, consider the following comparison:

You will see that Apple's valuation is quite reasonable (even more reasonable if you take into account the traditionally conservative forward looking statements), and if you believe that it can maintain its current growth rate, it is actually cheap compared to its tech rivals. Can it? Hard to say, of course, but they appear to have a successful plan, which includes:

• iPhone 5 (coming out either Summer or Fall of this year).
• new generation of (most likely) retina display MacBooks
• a disciplined software strategy which includes the convergence of iOS and OS X
• Apple TV

While all of this is happening, Apple is struggling to meet demand for its existing products. Observations during a recent trip indicate everyone in first class sporting iPhones. It seems clear that everyone in economy wants one (many people have them already), and the iPhone 3GS, from all reports, is a very hot seller (and a money machine for apple, since it costs very little to make). They are about to start making the iPad 2 in Brazil, which will open up the rapidly developing (and tariff protected) Brazilian market to yet another apple money machine (iPad 2, being last year's technology, is extremely profitable).  Apple is also making a lot of money from the very popular Android handsets. So far so good.

Things do not quite look so rosy for the competition. AMZN is operating a fairly mature bookstore business, and its Kindle hardware business is about to be killed by the new iPad, which gives a vastly improved reading experience.

Google's search business is alive and well, but, near as anyone can tell, its many other efforts have produced a string of duds, at least from the business perspective. Android, while popular, generates far more revenue for Apple, Microsoft, and Qualcomm than it does for Google. Google+ has been forced down the throats of the public, which still prefers Facebook by a huge margin. Chrome and YouTube are popular in their spaces, but neither is a big revenue generator. Google seems to lack a coherent strategy -- thank God for search.

Microsoft has an Office money machine, which will continue to crank for quite a while, Windows, and a considerably less lucrative Xbox franchise. Windows and Xbox are being seriously threatened by tablets, and while Windows 8 is an attempt to combat this, it seems to combine the not-quite-ready-for-primetime aspect of Android with the closed programming model, heavily encumbered by compatibility concerns. Not a recipe for wider adoption than the current Office-user user base (I have a Windows laptop just so I can run bloomberg terminal and excel together). Windows phone has been (so far) a failure. No risk of MSFT being the next RIM, but no particularly bright prospects either.

IBM is well-managed and profitable, but not exactly nimble. It is a mature company which seems to have few prospects for (or even interest in) rapid growth. Its R&D is stellar, and it will continue to make money  for the foreseeable future, so I don't think any fund managers will be fired for buying IBM, but it is not clearly a better investment than Apple.

To summarize: I would not be at all surprised to see AAPL hit $800 after the next quarterly report (in less than three weeks),  especially as I think that the new iPad is an unqualified success, and for those not willing to take a naked technology bet, going long AAPL and short GOOG and AMZN would seem to be a wise strategy (as it has been for quite a while).

Update on Market Efficiency

Our last post on the curious behavior of the AAPL stock price was a little over three weeks ago, and since it is now (approximately) two months since Apple's last quarterly report, and since some "forward looking statements" were made in the last report, AND since in the intervening period Apple has

• Announced the new iPad
• Sold a bunch of them
• Announced a dividend (for the first time since 1995) and a stock buyback.

Curiously, the stock price (at this point the run-up has been sufficient to mandate using a log plot) has been increasing almost mechanically log-linearly:

For those who care about such things, the (annualized) Sharpe ratio of an investment in Apple over this period is very close to 9(!)

What to make of this? Apparently the process of gigantic mutual funds loading up on AAPL is continuing, and its speed depends in part on the decision-making speed of the appropriate committee, and partly by the reluctance of said committees to move the market to much, so that the buy orders to their brokers are spread over weeks (of course, we all know that the market is efficient, trends do not exist, and you can only hurt yourself by acting quickly. Why, you might pull something...)

A brief update on gold

There have been considerable conniptions, consternation, wailing, and gnashing of teeth over the price of gold in recent times. Here is a quick look at reality. Below is the graph of the natural logarithm of the price of gold (measured by its proxy GLD) from its inceptions in 2004 to present day:

You will note that the graph hugs its trend line very closely, and has not really deviated much from its appointed rounds. You do see a wiggle at the very end, but a quick check will reveal that over the entire history, GLD has been gaining 7.2 basis points a day on average, with standard deviation of 13.5 basis points a day (so Sharpe ratio of 0.85), while over the last twelve months, the average return has been 6.8 basis points a day, with standard deviation of 13.4 basis points, for Sharpe ratio of 0.81, so yes, the risk adjusted returns have dropped, but not hugely. Notice also that the graph (at least in the date range shown) shows no indications of a bubble (you can see a mini-bubble in early 2008, followed by the mini-crash in late 2008 -- presumably the mini-bubble was caused by the contemporaneous, and much more substantial,  oil price spike, while the crash was caused by the general panic of the crash of 2008, but not again that the crash was much more mild than the crash in the oil prices (factor of six, peak to trough), and the stock market (close to a factor of two).

Efficient markets?

On January 24 2012, Apple came out with its quarterly data, which completely obliterated analysts projections. AAPL was trading at a P/E multiple of around 12 at the time (already quite low for a company with Apple's growth). Following the earnings report, we saw the following price movement (presumably not over, unless Apple really screws up the iPad 3 badly):

In other words, after a relatively modest 4% jump on the day following the earnings announcement, the stock has been going up linearly. No significant news has come out since the earnings report (there have been reports of the coming iPad 3 for several months, and since, in the post-Steve Jobs era, Apple secrecy is not what it used to be, the rumors have been detailed and consistent. Much has been said of the considerable Apple cash hoard, but that, again, is not news. The question is: since all the relevant information has been available for over a month, why such a slow reaction time, which flies in the face of the efficient markets hypothesis. The only explanation I can come up with is that Apple is large enough that to significantly move the price, very large pension funds and mutual funds have to decide to buy, and whatever these guys are, quick on the uptake is not it. The morals of the story seem to be: not all opportunity lies in $10 cap micro stocks, and those of us with money in (for example) TIAA-CREF should be very sad.