I love Apple. Not the stock, but the story. It broke all the rules. Business schools have forever taught students about the laws of large numbers – that large companies grow more slowly than small ones and therefore tend to make more boring investments. Apple has been neither slow nor boring. By definition, large companies cannot outgrow GDP forever, but Apple nonetheless broke most of the established rules. The largest company that the world has ever seen, by market capitalisation (at $658bn), still grew revenues in the fiscal year ended September 2012 by 44.5 per cent and earnings per share by 59.6 per cent. What is more, it did so with free cash flow of over $40bn over the past year and $121bn of net cash burning a hole in their pocket. The sheer magnitude of the numbers is phenomenal and requires great respect.
I also love the products. Before my first (of many) iPods, technology products were complicated. They came with large and highly user-unfriendly manuals written by techies for techies, packaged in large bland boxes padded with copious blocks of polystyrene. Then along came Apple, and technology products became consumer goods – small packaging, bright colours and no instructions. Just plug and play – a new massive growth market was born.
But what about the stock? The problem with technology and/or consumer goods stocks is that fat margins with accelerating sales can quickly turn into simultaneously collapsing margins and sales which decimate profitability. It might be instructive to look at Nokia as a case study, for example.
Nokia’s peak quarterly sales were in the fourth quarter of 2007. Its annualised revenue growth also peaked that quarter at 34 per cent, earnings grew at 55 per cent, and the company hit its peak market capitalisation at €105bn (also with net cash). Interestingly the operating margin peaked two quarters earlier 18.7 per cent. To complete the sorry story, market cap is now a mere €7.9bn, and operating margins are -8 per cent.
To compare with Apple, quarterly sales peaked in the final calendar quarter of 2011, sales growth back in early 2011, and the operating margin also in the first quarter of this year (at a much more impressive 39.3 per cent).
As a growth fund manager, I screen for attributes of quality, value and growth. With huge amounts of net cash and a return on equity of 42.8 per cent, there is no question that this is a high quality business. Trading on 11x expected 2013 earnings, the valuation does not seem stretched. But growth would clearly appear to be slowing and whilst it was leaps and bounds ahead of peers with the launch of the iPhone and iPad, that gap has systematically closed over time. Slowing growth may simply be in anticipation of new products, which will provide the next leg of growth. I am not in the business of guessing and hoping though, and with growth slowing, the data signals a warning that staying a $600bn company may be as difficult as getting there. History is littered with great brand names that have tripped. What is sure is that Apple will remain a much discussed case study for business schools for decades to come.
Mike Jennings is chief investment officer and manager of the Premier Global Strategic Growth Fund