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June 2, 2000

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Subject:  Analysts and AAPL
Author:  GFPE

There are some valuable insights to be gleaned about the relationship of analysts to the market when you look at stock price, momentum and analyst comments over time. First of all, you have to remember that when these analysts make recommendations and comments and set price target, they are speaking after-the-fact. Their statements are not precursors of future market sentiment but rather the froth of existing market sentiment. Their firms have already positioned themselves when the comments are made public.

When analysts get exceptionally negative, this represents a peak in negativity usually rather than a harbinger of more. The same is true of excessive positive statements by influential analysts, which I think should be interpreted as a sell signal if you're trading because extremely bullish analysts comments are what helps lead to "pricing for perfection," at which point any slight negative news can take a stock down.

Since technology is so future-oriented, and the focus is on revenue growth rather than value, tech analysts focus on speculation about the future. And since technology is so rapidly changing and unpredictable, tech analysts ultimately prefer present leaders in very large markets, which is just to say that most are conservative and are often looking after their firms' interests in those big companies. Institutions with profitable relationships with or holdings in established companies want to preserve the status quo, and the analyst is partly a tool of this. If an analyst at an investment bank is very hard on a company that is an important client, the bank can lose that company's business. If a mutual fund has important holdings in a big company, its analysts are mindful of that. Also, if a mutual fund has become very heavy in one stock and is no longer sure of it, it often cannot sell all at once without crashing the price, so they may want to help prop up the price over a long period while they sell slowly and reposition.

All of this influences analysts, but ultimately the biggest reason why analysts are not always right is that they are fallible like everyone else and that they do not have the resources to look at every company really deeply. So they focus on the market leaders and often do not understand other companies nearly as well. They cannot look at SEC filings in great detail and visit and talk with the management of every company out there. Their institutions are heavily committed to the biggest companies, and so obviously that's where most of their attention is focused.

Apple is very easy to misunderstand if you are not really plugged into the company, as many of us are. The analyst is thinking in terms of market dominance and revenue growth over the next quarter, and even though they issue meaningless 12-month targets, they are not really focused on the long term. The 12-month target is just a silly proxy for communicating their public "bottom line" on the company. Never forget that they are employed by their institutions to make money as safely as possible for employer over the mid-term. They are focused on tangibles rather than intangibles, on gorillas rather than chimps and on profit for their institutions.

Not being the biggest boxmaker and falling outside of the Wintel world, which obviously dominates the corporate environment analysts work in, Apple is seen as more ephemeral than Dell or Compaq. Perceived as having value uniquely in the flashy products they create, Apple is held to a much higher standard of innovation by the analysts. They need to be hit over the head with a new Apple product every quarter or they start to think, Apple is a niche player anyway, if they are not always coming out with new things, what's the interest and where are the sales? Dan Niles was quoted as saying something to the effect of the iMac is not new and exciting anymore, so its sales are falling. That's essentially the analysis. No other computer company is expected by the analysts to come out with a radically new computer every year. No other computer company is evaluated almost exclusively in light of one of many products. No other computer company has whole sections of its business and potential basically ignored, as Apple is with QuickTime, digital video as a central new strategy, Apple's huge profits in professional lines (as aashby has been saying), etc. But that's the double standard Apple is put to by many analysts, and its mainly because these analysts just don't understand all of Apple. They may not even ultimately understand tech that well, especially how different technological initiatives support each other and can combine in the future to make whole new classes of products.

But when you think of the business, profits for the company, what is good for the company is not always what is good for the analysts. It would be terrible if Apple came out with new products before they realized full profits from existing ones. Then Apple would really just be a research and design lab rather than a business. Again, other companies are not held to the same standard of constant innovation and flashy impact, but the other companies in the industry we're thinking about here are bigger and more important to the analysts' firms to begin with. Since the analysts have more significant commitments to other companies, they want one big coup - like an instant Windows killer or an instant hit - rather than slow and steady progress toward long-term goals and increased profitability to grab their attention. Again, that's great, but not always great business. History is filled with awesome new insanely great products that hurt companies' bottom lines, like the Newton. And even if you focus on iMacs, whose sales have been slightly downward revised for next quarter, you can't say that this product is still not selling really well and no longer has legs. You just have to look at an iMac even today and you still get that sense that it's the most modern-looking and aesthetically pleasing computer out there. It still feels like the cutting edge. It would be folly to abandon further refinement of the design.

That said, Apple is a rule instigator, and here (from a different prospective) we agree with a lot of the distanced analysts since newness from Apple is what gets their attention. So Apple investors and Apple fans all want some new products, like some iAppliances, redesigned PowerBooks, etc. We expect more out of Apple too. We get impatient. We get nervous that Gateway and AOL seem to be doing the Internet appliance dance. But in the end, it's not hype or words, but sales. The iMac would have been a disaster if it had not sold well, even if it were just as cool. Duh. And so, we should hope that Apple comes out with the right product at the right time, rather than just something rushed out to placate the fans' or financial world's need to see Apple pushing buzzwords around. I think Apple is right on for the long-term, for instance, in delaying Mac OS X. The public beta due out this summer will probably be workable and equivalent to a final release of a new Windows. The final release of OS X half a year later will be really polished, after the broad beta testing by the public. That bodes well for the Mac OS, very well, even if the analysts are disappointed that profits from sales of OS X and possible increase in market share will be delayed a half a year. I'm not disappointed. I'll play with the beta and then get the final release as soon as its out, knowing that it'll be stable and polished and the best operating system ever created.

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