Apple: Low-hanging fruit

Financial times – Lex

Accelerating economies of scale suggests we have not seen peak profitability

This was not just another Apple blow-out quarter. The company has released plenty of earnings reports atomising both analysts’ estimates and internal projections, as it did again on Tuesday. And the eye-popping revenue growth rate (73 per cent) was not even the highest. But what occurred to Apple’s profitability was unprecedented. It added $20bn in quarterly sales compared with a year ago and nearly half of that went into operating profits. As a result, profits more than doubled to $17bn. Operating margins also expanded by 8 percentage points. That Apple can harvest accelerating economies of scale even at its current preposterous size suggests that we still have not seen peak profitability.This performance will breathe new life into the tired old question of why Apple’s stock is so cheap. The stock rose to nearly $453 (up just 8 per cent) in after-hours trading following the announcement, leaving the shares trading at a laughable 10 times trailing earnings, once the $100 in net cash per share is backed out. That share price suggests investors think they will never see the cash. Apple must prove them wrong with a big dividend or buy-back, or both.

But it is much more than the cash. A sub-market multiple implies scepticism about Apple’s ability to protect its share or its margins. A drop-off in margins is reasonable to expect in technology, given the industry’s history of quick declines. But worries about market share seem misplaced. Yes, Apple has an overwhelming position in the tablet market. But if the category grows as fast as analysts predict, Apple can lose share while selling lots more iPads than it does now. In smartphones, Apple has just 20-30 per cent share (depending on how you measure it), and even less than that in personal computers.

It is hard to know what to think about the valuation. But it is easy to know what to do: buy the shares.

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