Category: corporate profits

Apple math

Apple just issued a brutal warning for the quarter just ended Dec 31:

– revenues of $84 billion, -4.9% (vs. previous guidance of $91 billion, a 3.1% gain)

– gross margin of 38% (vs. 38.4%)

– operating margin of 27.6% (vs. 29.8%)

We’ve felt Apple bulls have been guilty of recency bias and extrapolation for some time, especially with regard to its fat profit margins.  Annual operating margin has slowly drifted lower over the past three years, from 30.3% to 26.0%.  Where does that settle out for a company heavily dependent on one product in a market that is saturated and losing market share to a slew of feisty competitors?  Our best guess is 15%.  Worse, what happens to sales, especially as we head into a global recession?  We think down 20% from the peak is a strong possibility.  That would take Apple’s revenues back to where they were just 3 1/2 years ago.

With these assumptions, Apple’s earnings per share drop to $5.50 ($5.00 if you assume they squander their remaining cash on pricey buybacks all the way down, a safe assumption considering CEO Tim Cook’s assurances).  According to Yahoo Finance, the 42 analysts who follow the company expect Apple to earn $13.29 this year and $14.64 next.

Assuming the analytical herd has it wrong, what would you be willing to pay for such a company?  10x earnings?  Perhaps 12x assuming a turnaround?  8x in a worse case?  At $5.00/share in earnings, that gives you a stock price of anywhere from $40 to $60, i.e. 58%-72% lower than the current $143.42.

The importance of Apple to the foundation of the everything bubble cannot be overstated.  257 U.S. ETFs own AAPL, the most of any stock.  At just 10.8 x illusory “forward earnings,” Apple’s inflated margins help support the narrative that “stocks are cheap at less than 15 x earnings.”  Lastly, how much has AAPL’s outperformance over the past 10 years helped foment a bubble in passive investing where $2.0 trillion flowed out of active funds and $2.5 trillion into passive funds?  Indexing leader Blackrock (BLK) is down less than 2% on a day when AAPL is -9%.  For now, investors are failing to connect the dots…


American corporate profits heading lower

Most US strategists predict corporate profits slowing yet still showing year over year gains of approximately 7%. But according to the latest from The Economist magazine the devil is in the details.

Optimists cite the relatively modest ratio of share prices to forecast profits as a reason for buying equities. That assumes the strength of profits will last. But, according to Chris Watling of Longview Economics, a consultancy, profits now comprise the highest share of American output since the 1960s. If profits revert to the mean, a pillar of the stock market will be removed.

Gerard Minack, a Morgan Stanley strategist, says American earnings per share are now 75% above the long-term trend, the biggest divergence recorded in the past 90 years. Most explanations for the recent strength of corporate profits have centred on the effects of globalisation; in particular, the impact of Asian workers on labour costs. But there is another possibility; the influence of the financial sector. According to Mr Watling, the sector now contributes around 27% of the profits made by companies in the S&P 500 index, up from 19% in 1996. He reckons financial companies are responsible for a third of all of the growth in American quoted-company profits over the past decade.

My comments: Inverted yield curve, contraction in credit and overall collateral declines will continue to negatively impact the Wall Street EPS machine. Houston we have a problem.

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