In Defense of the iEmpirehttp://www.fool.com/investing/general/2004/10/07/in-defense-of-the-iempire.aspx Tim Beyers
October 7, 2004
This week we're dueling over the prospects of one of our most popular stocks here at Fool.com: Apple Computer. Loved by many, hated by just as many, Apple separates Fool from Fool frequently in our discussion boards. We take the battle to the front page today with Fool contributor and Mac aficionado Tim Beyers defending the iEmpire while Fool Seth Jayson argues that Apple is rotten to the core. After you've read both sides, vote on which one has won your heart.
Let me acknowledge right up front that there is no way to justify Apple Computer's (Nasdaq: AAPL ) price tag using traditional valuation methods. There, I said it. Feel better, Seth? Well, don't get comfy, bucko. I'm not going into this duel with my PowerBook tied behind my back.
Still, it's hard to make an argument for Apple's stock when value investing guru Benjamin Graham wrote in The Intelligent Investor -- a book I prize -- that selecting a stock with the expectation of unlimited future growth is foolish (notice the small "f"). He's right. It's darn near impossible to properly value growth stocks because growth is never 100% predictable. Heck, it's often not even 50% predictable.
So, where does that leave Apple, the very definition of a growth stock in this market? With a big worm hole in its side if you use Graham's traditional yardsticks such as cheap multiples and deep discounts on book value. For example, Apple is trading at more than 70 times trailing earnings. That's more than twice the multiple of market leader and Motley Fool Stock Advisor pick Dell (Nasdaq: DELL ) and three times that of the S&P 500.A Rule Breaker if there ever was one
So why in the world would you want to be a part owner of Apple at that kind of premium? Because, dear Fool, the company is a classic Rule Breaker.
For the uninitiated, the core tenet of rule-breaking investing is to find companies that take a stick of dynamite to the conventional wisdom on the way to outsized economic gains and, thereby, investment returns. (You can learn more about Rule Breaking by taking a free trial to David Gardner's growth newsletter Motley Fool Rule Breakers, which not only explains the strategy but also takes subscribers through a monthly quest to find the ultimate growth stock.)
So, how does Apple measure up as a Rule Breaker? Well, let's break down some of the so-called conventional wisdom:You should never invest in a stock with a P/E higher than that of the overall market.
Really? Back in February, when I recommended Apple for the year ahead, the stock was trading for more than 60 times its trailing earnings. Eight months and +80% later, I'm blushing red for not following my own advice.
Apple can't make money charging premium prices for a commodity product.
Apple has been defying this maxim for years, ever since Steve Jobs returned as CEO and pulled the plug on lower-cost Mac clones. Back then, I thought Jobs was nuts. But he figured Apple's future would be secured by restoring its name as a premium brand. Guess who was right on that one? A recent report in BusinessWeek compared the slick new iMac G5 with a Dell Dimension 4600. When both are loaded with comparable features, the Dell sells for roughly $550 less. But the stylish Macs are the ones reportedly flying off the shelves, so much so that some on Wall Street are expecting the new iMac to grow Apple's measly 2% global PC market share.Windows is just as good as the Mac; there's no reason to get one anymore.
Sorry, wrong again. But this time I need only five words to prove it: no Mac OS X viruses. (Even the virus that hit my PowerBook was never able to execute. The damage created by deleting my e-mail in-box wasn't due to the bug but instead to an overzealous cleaning job performed by Symantec's (Nasdaq: SYMC ) Norton Anti-Virus.)
There's no money in digital music; Apple is dominating a meaningless market.
Apple's iTunes Music Store reports more than 125 million songs sold. It's now also making money. Probably not a lot, but even if Apple collects only two thin pennies from each 99-cent download, that's still $2.5 million in profit. And more money is on the way: Forrester Research (Nasdaq: FORR ) has reported the market for digital music will rise more than 700%, to better than $2 billion, in the next three years. Were Apple to somehow drop from 70% to only a 30% share of the digital music downloading market -- unlikely, to say the least -- that would still equal $600 million in sales. Last year, Apple's low-end portable, the iBook, netted $717 million in sales.
The Mac was a once-in-a-lifetime success; Apple can't create another cultural icon.
No Apple product since the original Mac has taken off as fast as the iPod. Indeed, in less than three years Apple has sold more than 3.7 million of the stylish little digital music players. More than 2.4 million of those sales have come this year, creating $769 million in revenue. That's more than any other Apple product save the Power Macintosh and PowerBook lines.
And don't expect demand to slow anytime soon. A recent survey of 600 teens in eight states conducted by researcher Piper Jaffray (NYSE: PJC ) showed 25% of respondents without an iPod said they would buy one by year's end. It also ranked fourth on the list of kids' most-wanted Christmas gifts behind -- get this -- clothes, money, and a new car.
It's too expensive to sell Macs in a retail store.
Apple now has 86 lavishly decorated stores. For the first nine months of the year, retail sales are up 89% over 2003, to $809 million. 'Nuff said.Invest like a venture capitalist
One of the great Rule Breaking maxims is that to break the rules you must learn to invest like a venture capitalist. Why? Because VCs embrace risk.
No, they aren't thrill seekers. They're disciplined investors who spe