NEW YORK - OCTOBER 14
Currently surfacing are analysts’ music sheets rationalizing Apple as a $900 piece of paper. I’ve seen one $1,100 number, but reasoning is flimsy. Apple’s market cap may approach $900 billion. Then, it accounts for nearly double Exxon Mobil’s 3.8 percent weighting in the index. 2G2BT?
What will Apple’s price-earnings ratio look like at $900 a share? With a strong sell through of iPhones and iPads next year I would expect to see consensus earnings projections for fiscal 2014 fix on approximately $60 a share. This would put Apple’s price-earnings ratio at 15 times, what the market sells for in a buoyant setting of low interest rates, modest inflation and high single-digit earnings growth for major multinational corporations.
A handful of tech stocks account for one-third of the market value of the top 25 names in the S&P 500 Index starting with Apple, now an unprecedented 5 percent weighting. In recent years Exxon Mobil dominated the index with a $400 billion market capitalization. Microsoft was numero uno long ago and far away.
The market is driven by these top 25 names. They comprise nearly 40 percent of the S&P 500 Index’s valuation. Technology, in turn, counts up to one-third of the top 25’s valuation. If Apple’s iPhone 5 is a hit next month along with its coming 7-inch iPad, the stock has $750 written all over it.
When I scroll down the list of big cap technology, I can’t find any names selling above 15 times forward 12-month earnings projections. Microsoft, Oracle and Intel coalesce closer to 10 times earnings. Qualcomm, pretty much tied to the unfolding smart phone story, is somewhat pricier, but still in the mid-teens valuation zone.
Amazon remains the sole iconic growthie selling as if it were the year 2000 when Internet properties got rationalized on the basis of pops, hits and multiples of revenues. Some of these doggies exceeded a 10-times revenue multiplier. Amazon, today with a market cap pushing $110 billion sells under 2 times estimated 2013 revenues and by 2014 probably at one times revenues and hopefully, $7.50 a share in earning power. As a $245 stock, Amazon’s price-earnings ratio is still a heady 33 times my 2014 estimate.
What am I doing with a serious position in Amazon at such an extended valuation? Well, growth stock investing boils down to how far out you need to go to justify your position. Obviously, I don’t believe the trajectory in Amazon’s revenue growth and therefore its coming profit margin explosion gets capped by 2014.
I see Amazon as the Wal-Mart of the Internet, employing balance sheet strength to locate warehouse and fulfillment centers in population clusters wherever someone else’s big box rests. Best Buy seems toast in its present format.
Retailers turn into the walking wounded or succumb. Amazon’s overhead is now a fraction of even Wal-Mart, which carries 2 million employees in over 10,000 retail outlets, worldwide. Wal-Mart is not known for overpaying its “associates,” either.
If I’m wrong on Amazon as the iconic, unfolding growth story, bar none, schmeiss the stock in half. I’ll lick my burnt fingers and soldier on. Everything else that I inventory excepting Qualcomm, is dirt cheap. My list includes Google, Apple and Microsoft, along with IBM.
Apple is the most curious case of all. By yearend 2014 its cash hoard could approach $200 billion. This is more capital than all but the top ten names in the S&P 500 Index sell for. Number 10 is Berkshire Hathaway and right above that comes AT&T.
And, yet, the market disdains Apple’s boodle. For sure, most of it rests abroad, un-taxed. So, unless Apple cares to raise debt to drive dividend paying capacity, don’t expect the payout ratio of earnings ever to move above 25 percent. On $60 a share for 2014, I project dividend paying capacity of $15, some 50 percent above the current dividend rate. Nothing to write home about, but I’ll take it. The S&P 500 Index currently yields under 2 percent which is probably where it will rest 18 months out.
At some point the yield on cash assets won’t be confiscatory. The long term trend line for LIBOR approximates 4 percent. Pre-tax earnings on $200 billion in liquidity would count up to $8 a share for Apple. A $100 billion strategic acquisition conceptually could double the return on capital.
Anyone who ciphers can figure this out. The critical, still unknowable variable in Apple’s stock price trajectory is when does the smart phone product sector peak out? After all, iPod reached saturation years ago. Is everyone on the planet going to carry a smart phone of some kind? Hardly.
Analysts deal gingerly with the issue of saturation for smart phones and tablets. Nobody wants to hear when the music stops. You can model the next two years, but that’s all. Thereafter, to expand the market, product prices must drop to the $100 to $200 range, not a wholesome scenario for profit margins. Cellular operators like Verizon and American Telephone won’t pay $200 to $300 subsidies for more than another year.
Samsung may have lost its patent case with Apple, but remains a formidable competitor and manufacturer of smart phones. This is a powerful South Korean conglomerate that sells at 8 times earnings. The market fears its cyclical history in semiconductors, display panels and television sets.
Samsung’s Galaxy 3 smart phones and newly introduced tablets gained favorable press reviews. Consumers followed through. Unlike Apple, Samsung is a fully integrated producer of smart phones and tablets. Its productive research and development programs have left Sony and other Far Eastern players in the backwaters.
If Apple’s impeccably advanced product lines top out some day, Samsung is the template for what happens to its valuation. Apple would drop to 8 times earning power with some credit for its cash hoard, but not a lot. The market wouldn’t bet on a high reinvestment rate in terms of acquisitions or start ups, either.
Conceptually, all this could happen a couple of years out. Assume recurrent earnings power might be no more than $40 a share. Look what happened to Nokia, the old leader in low cost cell phone production and sales. It’s close to moribund, unable to reinvent itself.
Apple as a stock could easily sell in the three hundred range, maybe as high as $400 considering its cash hoard. Microsoft for all its free cash flow sells at 10 times earnings because its reinvestment rate is shabby on acquisitions and it’s supporting its still-in-the-red MSN network.
All this finally gets me to Google where I see a prospectively high reinvestment rate, lasting hegemony on its internet network and the least cyclical variance in its businesses which are not reliant on annualized new product initiatives. Polaroid, once it ran out of new toys was bypassed by competing photography breakthroughs in photo finishing, Japanese 35 mm cameras and finally computerized photography, the stake in its heart.
Reasoning from historical analogy, Apple should never sell over the market’s multiplier of earnings, currently 14. At the first smell of fish, expect a 10 times valuation and if operations turn sour 8 times earnings. Pre the introduction of the iPod Apple sold in the thirties (with a double digits valuation only because it carried a lot of cash on the balance sheet).
Venerable operators like yours truly simultaneously are blessed and cursed by their historical memory of the life cycles for great growth companies. I could easily turn my back on Apple, but see nothing but blue sky right ahead. At 8 times earnings I’ve activated my research on Samsung.
Martin Sosnoff: mts@atalantasosnoff.com
Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, an investment management company with $6 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser. He was a columnist for many years at Forbes Magazine and for three years at The New York Post. Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Apple, Exxon Mobil, Microsoft, Qualcomm, Amazon and Google.
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