What will we pay for a company with flat earnings growth and a good balance sheet that also has a decent yield and can buy back a huge amount of stock and increase its dividend? What multiple can we put on a company's earnings stream where we worry that its products might be saturated and it doesn't have any new game-changing product on the horizon for perhaps several quarters, and we aren't even sure of that?
Why would you own shares in a company that is largely international, with 60% of its business overseas, especially when we have learned its biggest growth market, China, is slowing? And what's a stock worth when the company behind it might have a down quarter, year-over-year, in part because of currency but in part because the world is slowing, nobody needs a new one of its wares and it has nothing else that can make a big difference?
I know, you are thinking I am talking about Apple (AAPL), which is being hammered today for all of the reasons above. But what I am actually talking about is pretty much every international company out there. In fact, many companies fit the bill -- the most obvious being the car companies, with far flung enterprises and where we simply don't need a lot more of their product than we have right now.
That's really the dilemma with Apple, isn't it? What the heck do you pay for this monster?
First, we have to eliminate some of the extremes and make the exercise less emotional.
Apple, an Action Alerts PLUS holding, is not General Motors (GM) -- and I say that not only because it yields 2% not 5%. It's not GM because it is far more dominant and the other players its its space aren't nipping at its heels. Plus, it has far greater gross margins and a balance sheet that's more than 40% cash.
But let's belabor the analogy, because the professionals, despite professing love for Apple have had one foot out the door since the peak last July.
If you use a General Motors multiple on Apple, you get a $60 a share price. Therefore you would want to sell Apple's stock now in the $90s and avoid that $30 decline.
What's wrong with the comparison? First, Apple is perceived as a much better widget than a GM widget, with continual sharetake and much better gross margins -- that are rising, not falling. If you ex out the cash, you would be paying $20 for a company with $10 in earnings power. I don't think Apple deserves a two P/E, do you? Even if we are sure that iPhone sales could drop 20%, as it was alluded to on the conference call, would you possibly just pay 2X earnings, ex cash for this stock? After all, this isn't Yahoo! (YHOO) ex-Alibaba (BABA).
So the analogy is flawed, but the methodology isn't, because if you back up and look at Apple as a company, you see a producer of products that many people feel are saturated, namely cellphones, with no hope on the horizon of changing that.
But the GM metaphor, as insulting as it is, works on some level -- because of that product saturation and the slowdown occurring in its biggest market, China. But it fails on another level -- because Apple does have other things it can make that can mitigate the possible saturation, but they aren't big enough to offset the core product slowdown.
Why go to such an extreme? Because of how confused the current market is about Apple. Think of it like this. The average company in the S&P 500 so far has shown a slight decline in earnings year-over-year so far in this reporting period -- minus 6%, according to data from FactSet.
Apple earned $3.05 this time last year versus $3.28 in the quarter just reported. That's far better than the average stock. But, at this very moment the market is paying 15x the forward earnings of the average stock. That would put Apple at $150 -- and one thing we know, that's not any more in the realm of where Apple's stock is going than General Motors.
In fact, oddly, the price of Apple's stock actually splits the difference between GM and the average S&P 500 stock, which also seems a little ridiculous.
So if we aren't going to give it an S&P multiple, even as it is performing better than the average stock, (in part because we don't think it can continue to perform better - or at least that 's the talk I heard, last night), then what is the compare?
How about if we give it the same multiple as the average that its suppliers, Skyworks (SWKS), Qorvo (QRVO), Cirrus Logic (CRUS), NXP Semi (NXPI) and Avago (AVGO) get? That's intriguing, right? I mean it's not going to do much worse than they do and arguably it could be doing better even as NXPI and Avago have done their best to diversify away from Apple and become more of an Internet of all thing play?
Guess what? The average multiple here is 11.5x earnings. That would put Apple at about $100. I think a lot of people are clustered around that concept. But I have a problem with it. Can Apple really be as beholden to its suppliers as they are to it? Can we really just damn Apple like that? Two of these customers, NXPI and Avago, actually have multiples that would put Apple at about $130 -- but they do have streams away from Apple that could give them lift. Still, if Apple can't do the new numbers, there is no way that these companies can, either. Let's just keep this one in mind as a better bear case than General Motors.
I regard the analogy as inconclusive.
Now, we know we can't give Apple a FANG multiple, whatever the heck that is. But how about if we give it the multiple of another company trying to break free of what might be a secular slowdown and saturation of its main product, that is also beholden to worldwide growth: Intel (INTC)? I expect its earnings to be up only slightly this year, because of its tight correlation with the personal computer -- which is in a vicious secular decline. We know that when Macbooks are declining in sales, there's no way the rest of the PC world is going to do better. I think the analogy bears up. Again, though, using that analogy, you would get a $130 stock. Cisco's (CSCO) growth is just as challenged as Apple's, in many ways. But you put its forward multiple on Apple and you can see the stock trading at $105.
Should we use a blended average between those two slower-growing techs? Call in $115. That seems reasonable, if Apple can just do the posted numbers, but too high if it actually fails to do so.
Do you want to go way down the food chain in tech, to those companies that we KNOW are going to have down numbers? Do you want to go to the disk drive companies? Do you want to give it a something between a Seagate Technology (STX) and Western Digital (WDC) P/E multiple? This is the dregs of the dregs, but what the heck, anything's possible. There, you get an $80 stock for Apple. But those companies have challenged balance sheets and dividends that are too large versus the cash flow and have no differentiating characteristics. That is too harsh.
So let's leave the realm of tech altogether. Let's say that Apple is a consumer-packaged-goods stock with a company that, if it weren't selling into weaker currencies and had a difficult macro environment, would be doing much better. That's the tone, certainly, of last night's call. Where does it put Apple? Let's use Procter & Gamble (PG), which showed 2% organic growth but was whacked by currency. Whoopsie! That gets you to $200. Hey, I could have picked Clorox (CLX), which would put it at $230 - but bleach seems to be more highly valued than cellphones, right now. Talk about one commodity now trumping another.
Which leads me to what I think, ultimately might be the best analogy: big pharma. We think the futures of these companies aren't as bright as their pasts. We know they have patent cliffs that make it so their earnings could fall off, like Apple. For some, the pipeline is thinner than others, but they have good balance sheets and can buy back a lot of stock and have a lot of optionality. That's Apple, too.
Let's say Apple is, well, Pfizer (PFE), Well, guess what? If that's the case, Pfizer, with patent cliffs and real worries about growth -- such big worries that it is merging with Allergan to invert and get access to its overseas capital, something Apple wants to do but could never be allowed to -- might be the key to valuing Apple. It doesn't have the growth right now, but it could with new products coming from the merger.
What would you get for Apple on a Pfizer multiple? You would be paying about $130 a share.
I like that, because, like Pfizer, there's hope for a new set of "drugs" so to speak, namely the iPhone 7 later this year. And while it is absolutely true that many of Pfizer's drugs are peaking, it can still buy or create others to offset its concentrated portfolio, like Apple can. And if Apple could just develop one other recurring revenue stream, like buying Harman for a little more than 7% of its current cash hoard and getting the hammerlock on the other mobile recurring market, the auto, I think the Pfizer multiple would hold up. And here's the pièce de résistance: Pfizer had a down year in 2015, as people think Apple will, too.
Hmm, $130 for a company growing faster than Pfizer with many of the same characteristics, none of the political risk and a far smaller patent cliff with a blockbuster second half new drug coming? I wouldn't trade that stock, I would own it.