why Apple (AAPL) is a growth stock anomoly

Although AAPL is one of the most important growth stocks of the past decade, its price action doesn’t fit my description of “typical” growth stock behavior.

Although AAPL’s earnings per share rose by 500% between 2009 and 2012, the price earnings ratio of AAPL, which experience says should have expanded a lot during this period, actually contracted.  More than that, it shrank during a period when the PE of the overall S&P 500 was expanding.  So, relatively speaking, its PE behavior was considerably worse than appears at first glance.

In addition, by 2013-14, there was, in my view, ample evidence that the best days for the iPhone would soon begin to be visible only in the rear view mirror.  Yet, after a slump in 2013, the shares recovered their upward momentum in 2014 and carried on their strong performance through most of 2015.  In other words, there wasn’t, as I read the stock price, the usual performance falloff in anticipation of the end to super-normal growth.

How did these things occur?

no PE expansion

On the first point, I don’t have a great answer.  As I wrote while this was happening (or, actually, not happening), I’d never seen this behavior elsewhere in 20+ years of buying growth stocks in the US and around the rest of the world (I was a value investor early in my career).

The only thing I can come up with is that AAPL changed from a very conservative method of accounting for its iPhone profits to a more aggressive one in late 2009.  The change added between 50% and 100% to near-term reported profits.

Professionals typically applaud companies whose accounting is conservative, and disapprove of those who sail closer to the wind.  In AAPL’s case the more flattering figures had been routinely included in notes to the financial statements, where anyone who cared could look at them. So although the move may have been calculated by AAPL management to give the stock a boost, the change didn’t provide any new positive information.  It only created the impression that AAPL was more concerned with flashy optics than operations.

(The issue was how to account for sales of iPhones by AT&T on two-year contracts where AAPL shared in the revenues AT&T collected over the contract life.  AAPL’s initial stance was to recognize the revenue over the two years.  The change was to credit everything up front, at the time of sale.)

no anticipation, no PE contraction

This is a lot easier.  The main factors:

The PE never went up in the way the multiple of growth stocks typically does.

As is the case with many successful growth stocks, AAPL started out with a retail investment base.  Then came hedge funds.  Traditional long only professionals bet against AAPL early on, in my view, and came to the party only after suffering considerable underperformance, either from not owning the name at all or from owning a less-than-market-weight position.  AAPL’s earnings growth was so powerful and so long-lasting that the safest position for skeptics became to establish, kicking and screaming, a market-weight position.  That allowed them to forget about AAPL and look for outperformance elsewhere.  In a sense, the stock’s upward momentum fed on itself.  But it also meant steady accumulation of the name.

In 2013 Carl Icahn convinced AAPL to begin using financial engineering–borrowing to fund large scale stock buybacks and dividend increases–to boost the stock price.  Maybe he didn’t put it quite that way, but between the end of the company’s fiscal 2012 and its fiscal 2015, AAPL shrank the number of its outstanding shares by 15%, despite issuance of new stock to employees.  That’s enough to change the psychology of buyers, as well as to relieve potential selling pressure and give a mild boost to eps.

Mr. Icahn has recently announced the sale of his AAPL holding.  Given that and recent negative earnings news, the stock has declined and the PE has contracted a bit.  However, the shares are now trading at about 2/3 the multiple of the typical US stock–mostly because the market PE has expanded while AAPL’s hasn’t.  All the damage has been in the relative PE, not the absolute.  At such a low relative PE today, I find it hard to argue that damage to the absolute PE multiple is in the cards.

3 responses

  1. Thanks for this series.

    One of my memories of investing was looking at my dad’s value line in around 1981 at Apple and having him yell at me that IBM was a better buy. Bigger. meaner, etc. Not sure who is right.

    In terms of the 2009 accounting switch, I find that really a minor revenue stream. Apple got something like 10% back from AT&T on the original iphone sales on a two year basis. That is when the iphone was only sold on ATT. Once they expanded that to multiple vendors, the 10% kickback disappeared.

    And I believe they still recognize the iphone sale revenue as a two year income stream. Or maybe just the software component. Haven’t looked in a while.

    In terms of growth and elevator pitches, have to agree with you. But on sentiment, it just looks as if Apple relies on a series of home runs and that have run out. The possibility of the iphone being a 10 to 15 year franchise seems somewhat discounted.

  2. Pingback: What stocks to invest in = why Apple (AAPL) is a growth stock anomoly « PRACTICAL STOCK INVESTING | Stock Investing

  3. Thanks for your comment. My impression of AAPL in the 1980s is that it had a far superior machine to the early PC. But the Mac was 3x the price of a PC for consumers and AAPL never developed a corporate sales force or the document/spreadsheet programs that business wanted.

    You’re right about the home runs. The huge size of the smartphone market has made it hard to conceive what AAPL might create as a new product that would be a quantum leap bigger than that.

    The 2009 accounting change was to go from spreading the profit from an iPhone sale over the two years of a smartphone contract to doing so all at once, on the date the contract was signed. Before it made the switch, AAPL was showing investors what overall company earnings would look like under the new standard. They were almost 2x as big.

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