Financial markets have a primitive belief that corporate revenues and earnings should always go up, so that stock prices never fall. Anything else is failure. Apple perfectly demonstrates what is wrong with that view.
Last week Apple announced record results, but also said it expected iPhone revenues would soon start to fall. Having already given up a quarter of its value over the previous year, Apple’s stock price fell another 5% on the announcement. Maybe the price response was appropriate, but the tone of the financial commentary was apocalyptic. According to the FT’s Lex, ‘… it is backfiring… . Tim Cook and his team are not going to talk the stock out of its malaise … the pressure will be on to staunch the bleeding… .
When you are in the innovation business you win some and you lose some, and you sometimes have to bet the farm. Steve Jobs was famous for that. The iPhone is an extreme case of winning. It is perhaps the most profitable consumer product the world has ever seen, and has almost single-handedly driven Apple’s revenues from $32bn in 2008 to $234bn in 2015.
Apple has a financial model designed to protect it through feast and famine. Apple uses little or no balance sheet, so that every $1 of earnings becomes more or less $1 of free cash flow. During the recent years of iPhone plenty Apple has given all of that free cash flow right back to its stockholders, while still sitting on a cash pile of $200bn+ to keep it going through the lean years. As a result, Apple doesn’t need to worry about keeping the equity market happy.
It was inevitable that the extraordinary revenues from the iPhone would fall. Smartphone sales have plateaued in the US and Europe as people resist upgrading to a product that isn’t significantly better than the one they have already got. In the still unsaturated emerging markets, where incomes are much lower, Apple faces cheaper competitors like Samsung, Huawei, Xiaomi, Lenovo.
This is why Apple stock has been on a very modest multiple – 10x or so of last year’s earnings of around $50bn. There is no growth expectation in that multiple at all. The question now is how what Apple does next will match up to the runaway success of the iPhone. That is a question that no one, including Apple itself, knows the answer to, which is why companies like Apple are inherently hard to value.
The main reason investors like predictable earnings growth is that it makes companies easy to value, just like bonds. Do we really want Apple to turn itself into that sort of business? Do we want the investor tail to wag this dog? I think we want Apple to carry on doing exactly what it does. Tim Cook needs to face down Wall St, and he needs to educate the expectations of the people who happen to own its stock.