Amazon (AMZN) vs. Apple (AAPL)

I changed radio channels from the morning news to Bloomberg Radio while I was in the car yesterday.  It was about 9am, so I figured I’d get some market news while avoiding the Today-like chitchat that begins on Bloomberg at 10am.

What I heard instead was an expression of disbelief about the relative valuation of AMZN and AAPL, with the former being inappropriately trading at 3x the price/free cash flow of the latter.   The senior talking head presented this as being so self-evidently true as to need no further discussion.

I’m not sure why this howler bothered me, but it it did.

Three points:

–Both companies were formed by visionary entrepreneurs who transformed the landscape of their industries.  However, Jeff Bezos is still innovating and AAPL hasn’t produced a big new product in the past five years.

AAPL is a high-end smartphone company.  Today, that’s a mature product that depends on replacement demand.  There are no new customers.  Network operators are trying to stretch out the replacement cycle as a way of lowering their costs.

In contrast, AMZN is all about web services, a business that’s in its infancy and growing like a weed.  And the world is increasingly shifting to online purchasing.

In other words, AAPL and AMZN are very different companies.

–The accounting principles AMZN uses are more conservative than AAPL’s.  What might appear on the AAPL income statement as $1 in profit might only be, say, $.75 on AMZN’s. That alone doesn’t explain why one should trade at 3x the other.  But the comparison is far from clean.  Dollars to donuts the talking head I heard had no idea.

–I don’t get why free cash flow generation is an appropriate metric to use in making the comparison in the first place.

Free cash flow is the money a firm generates from operations minus the capital it invests in building/maintaining the business (and, for me, minus any mandatory debt repayments, as well).  Free cash flow is the “extra” that can be used to pay dividends.  Good for income-oriented investors.  If it’s very large, free cash flow may even attract potential acquirers in related industries who have investment opportunities that are greater than their ability to fund.

At the same time, large free cash flow can signal that a business has no new investment opportunities.  So the large free cash flow may simply mean the company has gone ex growth.  That’s bad.  On the other hand, a firm may have little or no free cash flow because it has lots of new investment opportunities and huge capacity to grow.  A growth investor will pick the second over the first any day of the week.

Personally, I don’t have a strong opinion on AMZN vs. AAPL.  For years I’ve been bemused by the strength of AAPL shares despite the clear evidence that the smartphone market was nearing saturation.  I’ve also been surprised by how well AMZN shares have done.

My point is that there was a children-playing-with-matches aspect to the discussion I heard.  There was no recognition that AMZN and AAPL are very different kinds of companies and the comparison metric was, yes, a little more sophisticated than PE–but completely wrongly used.

Maybe CNBC isn’t so bad, after all.

 

when to analyze sales rather than earnings

I was listening to Bloomberg News on the radio the other day, when a stock market reporter began a segment of an afternoon show by mentioning a a study he’d received of US stock market valuation based on price to sales rather than PE.

“Why sales and not earnings?” asked the show host.

The reporter had no clue. (An aside: it’s not clear to me whether this host asks probing questions of this particular reporter despite the fact he never can answer them or because he can’t.  I also sometimes wonder how aware each party is of the dynamics of their interaction–showing I must have too much time on my hands.)

Anyway, I decided to write about using sales as an analytic tool.

First, I should be clear that I’m not normally a fan of price to sales.  That’s probably because I’m a growth stock investor and am most often seeking out situations where profits are going to expand faster than sales..

To answer the host’s question as best I can:

Some companies are highly cyclical, like American autos or semiconductor equipment makers.  In bad times, they still have sales but may be posting losses.  Yet nobody pays you to take the shares off their hands; the stock trade at a price greater than zero.  In other words, at market bottoms they trade on something (i.e., sales or assets) other than earnings.  Similarly, as the economy recovers and the profits of deep cyclicals begin to explode to the upside, the PE multiple they sport progressively contracts.  In many cases, profits continue to surge but the stock price stops going up–because investors are anticipating the next dip of the cyclical roller coaster.  Again, they’e not trading on earnings.

So, at market bottoms the losses from cyclicals reduce overall index earnings, making the market look more expensive than it arguably should be.  At market tops, the stingy multiples that investors apply to peak earnings can make the market look misleadingly cheap.

Both distortions are eliminated, or at lest mitigated, by using price/sales.

Also, one might maintain that price/sales allows a better comparison between past decades, when a large portion of the market consisted of deep cyclicals, and the present, when the cyclical content is much smaller.

More tomorrow.

more on Bloomberg radio

I’ve had a surprisingly large amount of interest in my previous post “The fading of Bloomberg Radio.”  Some comes from fans of Ken Prewitt, wondering where he might be and if he’s well.  Some is from others who have detected the same decline in substance at Bloomberg Radio that I have.

So I decided to write about a BR program I was listening to in my car last week.  It was the middle of the day, and the topic was immigration.

The guest–over the phone–came from the Cato Institute.  As one might expect from an organization founded by the Koch family, he had a strong libertarian, conservative bent.

He started off with a number of anodyne statements about illegal immigration, like that:

–the overwhelming majority of farm workers are illegal immigrants,

–a tightening of border controls has resulted in a shortage of farm laborers that, in some cases, is causing farmers not to plant as much as they might like.  They know they won’t be able to find workers to harvest the crops

–most jobs illegal immigrants take–farm work in particular–are ones American citizens don’t want.  They’re seasonal, and they’re hard physical labor.

At this point, the host groaned her disbelief and asked about the effect of the minimum wage on American interest in farm jobs.

The guest replied that the minimum wage is not an issue here, that, for example, some apple pickers in Oregon earn $28 an hour.  (The average for farm workers, according to the Wall Street Journal, is around $10.50/hour.  The guest didn’t say this; the host apparently had done no preparation for her work that day.)

The guest then said that the government was the main factor in Americans’ aversion to farm work.  To someone collecting unemployment insurance, he continued, relocating to take a farm job made no economic sense.  A little polemical, maybe, but a subject for discussion if one thought the opposite.

Not for our host, however.  She became audibly angry   …and then HUNG UP on the guest!

Wow!!

I have to admit that this isn’t the first time I’ve heard behavior like this.  Sometimes, on a long drive I’ll choose WFAN over Bloomberg.  I listen typically when Mike Francesa (formerly part of the “Mike and the Mad Dog” duo–but the MD went to satellite radio) is on the air.  It’s a staple of this broadcast form for the host to disconnect a rambling or ill-informed caller.  In fact, some of these shows are simulcast on TV, so you can actually see the host turning to switchboard and pressing the “off” button.  He continues to talk, however, as if the caller is still on the line–but awed into silence by the host’s discourse.

The twist, in my Bloomberg case, is that the guest was the coherent, polite and well-informed one–yet all that got him was a dial tone when the host showed herself to be the unarmed opponent in a duel of wits.

A new low, in my Bloomberg Radio experience.

the fading of Bloomberg Radio

first ESPN…

Over the Thanksgiving holiday my older son pointed out to me that family friend, John Koblin, had written a critical article for Deadspin on how ESPN has gradually lost its journalistic way as it chases television ratings.

The example John focusses on is the network’s apparent obsession with New York Jets football player, Tim Tebow–a legendary college football figure who appears to be the latest in the parade of Heisman Trophy quarterbacks not quite good enough to make it in the NFL.

How is Tebow a continuing story?  ESPN2’s unsuccessful morning show First Take switched format in late 2011.  The new look:  …a staged debate between two cartoonish figures who duel in vintage WWF fashion over some item of sports news.  Their favorite topic:  Tebow.

ESPN discovered that the new First Take was surprisingly popular, even taking audience share away from its mainline morning show, Sportscenter.  It reacted in two ways:

–more phony debates all over the network, complete with loud voices, exaggerated gestures and bombast, and

–Tim Tebow all the time, no matter what the ostensible topic of a given show.

I’m of two minds about this ESPN development.  As a holder of DIS shares I guess I should approve.  As a sports fan, I’ve got to find other sources of sports information and analysis.

…now Bloomberg

Yesterday I was on my way in the car to Delaware and turned on the Bloomberg Radio morning broadcast for the first time in a while.  Five years ago I used to listen every day, either live or through podcasts of important segments.  No longer.  As Bloomberg dialed down the information content and dialed up the reporter self-congratulation I began to look elsewhere.

Anyway, I caught the last part of The First Word, with Ken Prewitt, who strikes me as the only savvy professional journalist left on Bloomberg.  Then came Bloomberg Surveillance, which appears to have had a format tweaking since the last time I listened.  Mr. Prewitt is gone (…or maybe he was just taking a day off from the insanity).  What remains is a veritable First Take of loud voices and self-congratulatory glorification of trivia.

To my mind, this can’t be an accident.  The radio personalities must have been trained, à la ESPN, to speak louder, create fake “debate” and constantly tell the audience how important the topics–and the radio hosts themselves–are.

And, as with First Take, the quest for higher ratings is the most likely explanation, with Fox News and CNBC as the models.  It’s probably also cheaper to simply act as if you’re conveying relevant information rather than to do the research and analysis needed to create it.

The written Bloomberg news appears not to have been infected by this broadcast tendency.  I figure the investment professionals who pay $30,000 a year or more for Bloomberg terminals wouldn’t put up with the stuff that’s now on Bloomberg Radio.

Where is the real financial news today?  It’s in newspapers like the Financial Times  and the Wall Street Journal.  And, like sports, it’s in the blogosphere.

We may mourn the loss of Bloomberg Radio as an information source, and the fact that the search for relevant stock market information is somewhat more difficult without it.  But this also means that insights we may develop are that much more valuable–because they are less likely to have been fully disseminated into the market at the time we figure them out.