Apple Research: 1 HOLD, 1 BUY
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EvaDimension uses its own Performance Risk Valuation investment technology in evaluating stocks.
In spite of the fact that Apple performed well on some measures, the total of their evaluation brought in the Hold recommendation.
- On performance they wrote:
AAPL's exceptionally strong return on capital and its outstanding EVA profit trend combine for a first rate, 99th percentile P score.
- Their Apple vs. Market score was also favorable.
On most other evaluations, however, Apple fared poorly
- Risk evaluation was particularly high
- Valuation Score was also negative:
AAPL's elevated market-to-book ratios are diluted by middling earnings and cash flow multiples, resulting in a high, 64th percentile V score. [lower is better]
- Combined evaluation metrics are combined to form their “PRVit Matrix”.
The PRVit Matrix depicts a company’s PRVit score by plotting its “intrinsic” value score – what PRVit rates the firm is truly worth based on its risk-adjusted performance, i.e., its comparative P-R score – against its actual valuation score – which reflects the company’s current trading multiples.
Plotting the matrix yields their recommendation of a Hold rating.
Oddly, their analysis of Google (NASDAQ: GOOG) revealed a very similar profile. The scores were extremely similar in the four areas indicated above. But the devil is in the details, and in the end the slight differences were enough to move the Search Engine and Android OS and Advertising behemoth into the BUY zone on their matrix.
The research company produced a very different profile for Microsoft (NASDAQ: MSFT) - also yielding a buy rating.
- The performance score was high, though not equal to Apple's:
MSFT's exceptionally strong return on capital, muted by a lackluster EVA profit trend, leads to a first rate, 85th percentile P score.
- Their MSFT vs. Market score was also favorable, even higher than Apple’s.
On the other evaluations, they greatly exceeded Apple.
- Risk evaluation was more moderate (59 vs. 71)
- Valuation Score was much stronger:
MSFT's elevated market-to-book ratios are balanced by very low earnings and cash flow multiples, resulting in a low, 28th percentile V. [lower is better]
On the other hand…
Meanwhile, Jefferies set a BUY rating and price target of $900 on Apple, basing it on expanding margins and a rise in its EPS projection to $16.
So, with Mr. Softie a Buy, and AAPL a Hold, let’s look at some other data.
Source: Yahoo Finance 14-Nov-2012
I think what we see here is that there are similarities and differences. Each stock has its strength and weakness relative to the other.
In the Price to Book ratio, MSFT has a clear advantage with Apple appearing very high. But in my mind P/B is typically not a good indicator of when to buy or sell. To me it is an important reality check to see if we have some extraordinary value here then we may want to be careful about what our other analysis is saying. But otherwise, it is too static an indicator and says almost nothing about the business itself. Perhaps it was a better indicator when manufacturers owned their own factories, but I believe it has less relevance in the case of MSFT and APPL, where the former produces software and the later contracts out all hardware.
On the other hand, Apple has a clear advantage in other measures, most significantly in the 5 year PEG ratio.
Investopedia explains Price/Earnings To Growth – (PEG Ratio) as a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.
Here, Apple’s (0.49) is absurdly low. Much of Apple’s stock price depends on perceived value of future earnings growth. This is part of the problem with the current price fall. People are questioning the future prospects.
So, what’s going on?
Why the huge difference in the analysis? I think that these algorithmically generated analysis tools, such as used by EvaDimension have their place. They can very quickly provide an analysis of any company given the data to work on. The problem is this, they are inflexible.
Every algorithm has its own, hardwired Weltanschauung – its world view - and this has no flexibility. The fact of any computer algorithm is that it does precisely what it is told to do; nothing more, nothing less. This Weltanschauung was designed into the algorithm by the designers who set a single set of evaluation priorities, and now these are adhered to strictly.
The benefit is that when you compare two companies you know that they are being compared with precisely the same criteria. But the real world is a lot more complex than all that, and there will always exist companies that have real valuations that are not best explained by the given model. In this case, it is Apple’s. In particular, Apple has a lot of value, as mentioned above, in growth and earnings.
Apple is dinged in the report for its Wealth Ratios which measures the firm's market-to-book ratios. Yet, as has been noted above, this may be the least important measure, particularly for Apple. The other negative was volatility. Again, something that comes with the Apple turf.
Finally, the model does not seem to have any weighting for PEG.
It is interesting how different evaluation methodologies can yield such differing results.
Personally, I see the Jefferies report as much more accurate, especially with the current depressed price. Apple continues to grow, even if the pace has slowed somewhat. EvaDimension’s heavy emphasis on risk, much of which is based on Apple’s volatility, has skewed the analysis away from reality. That said, if your investment style is very risk-averse, then perhaps Apple is not for you.
What do you think?
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Malcolm Manness has a Masters degree in Computer Science, and worked for 14 years in development, technical publications and software quality assurance. He has been investing for 20 years. Currently, he does writing, and FileMaker Pro programming on contract.
His short fiction can be found (under pseudonym J. Seunnasepp) at http://50centflash.com/.
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