Apple Inc. (NASDAQ: AAPL) announced its earnings this week and absolutely crushed the estimates. Apple reported $0.87 per share, while Wall Street expectations had ranged between $0.63 and $0.66 per share. The stock has moved up very nicely to around $100, but if one extrapolates the earnings momentum, which puts a $4.50 earnings number for 2008 and a PE multiple of 30 times (which Apple deserves), the stock should be right above $125 per share. Simple math, easy projection, so why is the stock only at $100?
Apple did indeed crush analysts estimates, but a huge part of the "extra earnings" are either not sustainable or predictable. Every company that trades in the public markets has a financial business model that the chief financial officer and research analysts work from. One dollar of revenues should equal how much profit on a pre-tax basis, or the operating profit margin. In the case of Apple, the financial model is for 27 to 30%, or 27 to 30 cents per dollar of revenue should be at the pre-tax profit line. That's Apple's model. So what happened?
This quarter Apple reported an operating profit margin of 35% -- a huge, huge increase. Reason to celebrate and uncork the champagne bottles? Not exactly. The reason Apple had a 35% operating margin was because of their enormous savings in semi-conductor chips and equipment. Every Mac and iPod is run by a set of integrated circuits that Apple outsources to various semi-conductor manufacturers. Apple was able to take advantage of an oversupply in the semi-conductor world driving down pricing, therefore generating the extra pre-tax operating margin. It may just be a one- or two-quarter pricing advantage, not something that can be taken for granted and made part of the permanent financial model.
All things being equal, had Apple just attained a normal operating margin of 30%, still a huge success, they would have reported about $0.72 in earnings per share, not the $0.87. Remember, Apple beat the revenue estimates by about $100 million at $5.26 billion. A strong and healthy number by any account.
Analysts did take their 2007/2008 earnings estimates higher, another success for Apple, but they did not get carried away by expanding the operating margin to the 35% range permanently. If semi-conductor pricing is still depressed and companies like Apple can take a long-term advantage, then that's another story. The Apple CFO was very quick to temper Wall Street excitement by saying that the semi-conductor pricing is only temporary. That is a fully acceptable explanation.
The great news is that shareholders still saw the value of Apple rise nearly $10 for the week. The stock should hit the range in the next 9 to 12 months, but it will do so with a normal operating margin.
Georges Yared is the CIO of Yared Investment Research where he explores more growth stock ideas.











Reader Comments (Page 1 of 1)
4-29-2007 @ 4:35AM
eddid said...
simple math you say. 4.50 a share with a pe of 30 is 135 not 125 per share. simple math indeed. i do agree with you that apple's pe should be at least 30 considering its growth rate. a 135 price would be very nice.
4-29-2007 @ 10:05PM
reinharden said...
And for good measure we should toss in another $13.77 a share in cash. So now we're add $148.77. ;-)
reinharden
4-30-2007 @ 4:17PM
Adam said...
I think Apple Stock will go up very soon. It just needs to wait until july inorder for its new iPhone to come out.
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4-30-2007 @ 4:19PM
Adam said...
When the iPhone comes out it will help sales even more.
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4-30-2007 @ 4:40PM
George Linder said...
What you failed to mention in your article about AAPL margins, is that the AAPL retail stores are more successful per square foot of space based on revenues than Best Buys and any other, not withstanding the fact that margins are double as to what they would be on the wholesale level. AAPL stores are expanding.