First published in The Globe and Mail on July 20, 2011
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Forget the fact that a single share of Apple Inc. costs more than a flight from Toronto to Los Angeles. At about 13 times earnings, for a company whose profit has multiplied ninefold over the past four years, Apple is not expensive. And if you adjust the price for the company’s $76-billion (U.S.) cash hoard, the price falls to about 10 times earnings – dirt cheap. At least, statistically speaking.
When you start thinking about it more carefully, however, you can see why the market values the company at only $330-billion (U.S.) or so.
There is, to begin with, the issue of CEO Steve Jobs’s health. But I don’t think that’s as much of a factor as some suggest. Yes, he’s the co-founder and the public face and the acknowledged saviour, but the truth is that he’s surrounded himself with some pretty bright people and seems to delegate well. The company, after all, keeps innovating despite his illness. He’s not the only nerd in the lab.
I think the miserly valuation has more to do with two related points: size and a certain flaw in the business model.
Apple earned $818-million in the third quarter of 2007. Four years later, it announced a profit of $7.31-billion, almost nine times higher. The annualized estimate for earnings is about $26-billion.
To continue compounding profits at that rate would mean coming up with a revolutionary idea (or more than one) that could add billions in earnings to the bottom line. That’s obviously not likely. In fact, just to increase profits by 10 per cent it needs a pretty good idea, once the growth in existing products reaches its natural limit.
Apple is in some ways like Big Pharma – the Pfizers and Mercks of the world – which have gotten so big they can’t consistently grow at above average rates any more.
But I would argue that Apple has another problem. While it consistently amazes consumers with the coolest and most useful computing things, it also has a reliable knack for damaging itself, to a point, every time it comes up with a new gadget.
Apple’s laptop sales grow briskly, but that growth has for years come at the expense of desktops, where sales are growing but obviously not as much as they would have. This is true of every computer maker. More and more people just use portables.
But this cannibalization is happening in other devices too. Apple sold more than 11 million iPods in the third quarter of 2008. It sold only 7.54 million in the third quarter announced yesterday – a drop of 20 per cent over the same period a year ago. In fact, on an annual basis, sales have been falling for a couple of years.
Where did these sales go? To iPhones, largely, but now to iPads as well. You don’t need an iPod Touch if you’re carrying an iPhone around. And by the same token, do you really need one if you’re toting an iPad? Not likely.
But that’s not the only example of redundancy in the lineup. If you use a Mac laptop and buy an iPad, will you buy another laptop when yours has run its useful course? I would guess that many customers won’t. The
iPad may be limited in function, but the fact is that most of us only use a fraction of the computing power of a modern laptop. You use it for e-mail, Web browsing, maybe a little word processing, watching shows and music (I’m speaking of consumers mostly, not business users). A modern laptop packs a lot more computing power than is required for those functions.
So when some analysts argue that Apple is cheap at 10 times earnings, I’m not sold, and I don’t think you should be either. It needs to create and sell blockbuster gadgets to really move the earnings needle, and it also needs to compensate for the cannibalization of its existing sales. If anyone can do it, you’d think Apple could. But at $330-billion, it’s tough. And furthermore, what will those products be?
The truth is Apple innovates, it doesn’t invent. RIM invented the smart phone. Sony invented the portable music player. Apple just did a better job at making and selling them (so far, anyway – don’t count out RIM just yet).
So if history is any guide, the inventory of potential products is in the marketplace already. Where is this blockbuster product that Apple will latch on to, improve and make billions from? It’s not obvious, at least to me.
Mining for quality shares backed by gold
Friday, July 29th, 2011This column first appeared in The Globe and Mail on July 27, 2011
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It’s hard to have a relationship with gold. You give it love, it gives you mood swings. You try to communicate, it sits there in cold silence.
Still, it’s worth working through those differences, in my view. Being a simple person, I have a simple view on the prospects for gold and, more importantly, gold shares: Whatever appears to be making gold prices go up isn’t going away any time soon.
Gold bullion has done very well, gold shares not as well. In theory, gold shares should do better than the metal when the price rises. That hasn’t really happened, but when the companies start cranking out profits that investors find sustainable, gold stocks will go up.
First, the background: gold is going up, one would reason, because money is suspect in Greece, Spain, Ireland, the United States, Japan, and even Canada, where we pretend to be better than anyone while we rack up enormous deficits and household debt. There’s so much debt and so little that can be done about it that we’re left with two choices: not pay it back or print more money to pay it back.
You can’t count on economic growth to fix the problem. Will the Greeks suddenly start working harder? Will the Japanese stop being in denial about their demographic and debt problems? Will U.S. politicians abruptly stop using the public purse to buy votes from either the rich or special interests?
Obviously not. If anything, the debt crisis, at least 30 years in the making, has only revealed how weak and ineffective the “first-world” political system is. No one wants to address the burning problems. Europe seems to be most adept at producing politicians and bureaucrats. Wall Street still runs America. Japan is shrinking toward oblivion.
So, money is not going to get more valuable – it’s going to get more abundant. Investors are lemmings, it’s true, so when gold goes up as it has, thanks in large part to the gold-holding exchange-traded funds, it’s easy and probably wise to assume some froth.
But are investors dumb? Faced with a choice between, say, a government bond paying next to nothing (or paying a lot, but with great odds of default), are they suckers for buying gold?
The U.S. debt-ceiling “crisis” will pass, just as the Greek crisis passed. But the debt remains, and, in fact, grows faster than the economy almost everywhere.
Gold prices will undoubtedly whipsaw. As mentioned earlier, it’s a moody thing. But does it make sense that gold will plummet? I doubt it; and if you do, too, you have to think gold shares are attractive, at least some of them.
Take New Gold Inc. as an example. At current gold and copper prices, according to analysts, the company could produce cash flow of between $2.60 and $3 a share in five years. Using an average historical multiple of 15 times, for big producers, yields a stock price between $39 and $45 a share.
Where’s the stock today? About $10. Investors clearly aren’t interested in producers or they’re skeptical about the gold price. And some caution is warranted. Mining gold is a tough business, notwithstanding every yahoo who claims to have the mother lode and a mine plan.
If you like smaller plays, there’s Wesdome Gold Mines Ltd., with a mine in Quebec and another in Ontario. The company pays a (modest) dividend and has bought back stock – unheard of in the business.
Wesdome needs to find reserves, but higher gold prices help as more rock becomes economical, and it’s in very good areas for new discoveries. Again, the stock seems neglected at six times earnings, notwithstanding its challenges.
But investors always go where the cash is eventually, and at some point the market will take note of the cash that quality – and I can’t stress that word enough – gold companies are producing and bid up those shares aggressively.
I think this is true of producers and also of high-quality explorers. They are, of course, considerably riskier, but gold production is falling. The industry needs new deposits, and anyone who finds a quality one will likely get snapped up. In fact, New Gold bought one earlier this year.
So, don’t dump gold; make the relationship work by buying some quality shares that are backed by yellow metal, just like money used to be.
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