MorningWord: 2/17/12: I am in Southern California this morning, and frankly very happy to be away from what I perceived to be a fairly goofy week for US equity markets. Wednesday’s reversal in AAPL and thus the market had the feeling of a short term top, but it was not to be……Yesterday marked a new closing high for the SPX since July and seemingly appears to be breaking out…..I will go back to the Bloomberg new high composite index and suggest that yesterday’s reading of 324 is fairly weak with the SPX at 1358, but last May’s highs are clearly in striking distance and it appears we will break them with or without broad market participation.
I know, I know I sound like a broken record, but here is the thing, I can only tell you guys what the inputs are that I am using to make my investing/trading decisions. And in this case I have clearly been wrong, so from an investment standpoint I sit in a lot of cash, and from a trading standpoint I lean short both unprofitable positions to be in at the moment.
ALso this morning, Bloomberg columnist Jonathan Weil suggests, “Apple’s Stock May Not Be As Cheap As it Looks”.
Throughout the extraordinary surge in Apple Inc. (AAPL)’s share price, a persistent question has lingered: Why is the stock still so cheap? One overlooked answer may be that Apple’s accounting isn’t as conservative as it used to be.
After topping $500 a share this week, the iPhone and iPad maker now has a $468 billion market capitalization. Yet Apple trades for only 14.3 times its earnings for the previous four quarters — about the same as the Standard & Poor’s 500 Index’s price-earnings ratio — in spite of growth that’s far above average. Revenue last quarter rose 73 percent to $46.3 billion, while earnings more than doubled to $13.1 billion.
Many theories have been floated for why such a rapidly expanding company with such loyal customers would trade for so little. Perhaps investors believe Apple will cling to its $97.6 billion hoard of cash and marketable securities, rather than pay a fat dividend. Others have suggested a lack of confidence about the future. It’s a consumer-electronics company, after all, and competition is brutal.
While each of those points has merit, here’s an explanation that hasn’t gotten enough attention: Thanks to an accounting- rule change for which it lobbied, Apple gets to book revenue from sales of bundled products such as iPhones — which include hardware, software, services and upgrade rights — more quickly than it used to. In short, one reason Apple’s earnings have been so high is accounting inflation, and the market realizes this.
The easiest way to see the rule change’s impact is to look back at the two sets of numbers Apple reported for fiscal 2009. Originally, the company said it had $5.7 billion of net income for the year on $36.5 billion of revenue. Then in January 2010 Apple retroactively adopted the new accounting principles and restated its previous numbers. The restatement boosted Apple’s fiscal 2009 net income 44 percent to $8.2 billion. Revenue was revised to $42.9 billion, 17 percent higher than originally reported.
Nothing changed economically, of course. Only the accounting did. On the surface, though, Apple’s valuation looked cheaper under the new reporting regime than under the old one.
On Dec. 31, 2009, for instance, Apple had a market capitalization of about $191 billion. Using the fiscal 2009 earnings that Apple initially reported, its price-earnings ratio that day was about 33. Using its restated numbers, the ratio would have been about 23. My guess is a similar effect is occurring today: Had it not been for the rule change, Apple’s P/E ratio would be higher, because the “E” would be lower.
“It would appear that the market continues to consider a significant component of Apple’s revenues and gross profit to be presently unearned and not deserving of a normal market multiple,” said Charles Mulford, an accounting professor and director of the Financial Reporting and Analysis Lab at Georgia Institute of Technology in Atlanta.
Apple was one of a handful of companies that lobbied the Financial Accounting Standards Board for the new rules in 2009. The impact for Apple seems to have been greater than for most others, probably because of the nature of its products. Dell Inc. (DELL) said the rule switch had no material impact on its results. Microsoft Corp. (MSFT) and Oracle Corp. (ORCL) said the same. Hewlett-Packard Co. (HPQ)’s earnings got a slight boost.
The FASB rule change had two main parts. One related to so- called multiple-deliverable arrangements, while another covered software sales. When Apple sells an iPhone, for example, the hardware and software are delivered at the time of sale. Other deliverables include the rights to future software upgrades and other features.
The old accounting rules required Apple to defer large chunks of its revenue and recognize the amounts gradually over each product’s economic life. While the details are complicated, the gist under the new rules is that Apple is allowed to record more revenue upfront.
What’s unknowable is how much different Apple’s latest results would have looked had the FASB not amended its standards. There’s no way to tell from the company’s disclosures. Plus, Apple adopted the new accounting principles right before it introduced the iPad. An Apple spokeswoman, Kristin Huguet, didn’t return phone calls seeking comment.
Let me be clear: I’m not opining on whether Apple is overvalued or undervalued, and I’m certainly not making any predictions about its stock price. The point here is that it makes sense for Apple’s earnings multiple to have declined significantly once you consider how the company’s accounting has changed.
The bottom line: Not all iEarnings are created equal.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
MorningWord: 2/16/12: Over the past week my trading strategy had become fairly myopic, fairly undisciplined and overly concentrated in an almost unhealthy way. I had become almost obsessed with shorting AAPL, and desperately looking for ways to play for a near term spike in vol and an outright short for the broad market. Well things sort of crescendo’d yesterday right about at noon……I swear I was this close to pulling the plug on my Feb AAPL puts (even said so in 2 different posts, should have been a great contra indicator) that were becoming increasingly less likely to be in the money with 2 1/2 days to expiration, but I did a fairly undisciplined thing with the stock up 3%!, I bought more…..now this is generally not a sound strategy, especially given the way that I had been trading in the name since last Tuesday, But I was less in survival mode and more in “F this” mode, I did not write about this yesterday as this is not the sort of behavior that I would want any reader to try to replicate, and to be frank I got pretty lucky, it could have very easily gone the other way…….
IN a more disciplined manner though, and as posted on the site, I continued to look for other ways to get short exposure to AAPL without adding to my concentrated single stock bet and bought Puts in the XLK, an etf where AAPL had recently come to make up almost 18% of its weighting……Basically I went all in. But, and there is a big BUT, not a single time over the last week or so, was I naked short AAPL common stock, even while being undisciplined as it relates to cutting my losses or adding risk at the exact wrong times, I was always able to define my risk, and that is the key……To be very honest, the stock could have gone to $550 for absolutely no good reason, and it probably will after a little bit of a pullback, but I was only exposed to the premium that I owned, and that helped me get my losses back of the previous week when the turn eventually came. I am still long the March Put FLY and now actually really love the strikes and will look to close remaining Feb puts today or tomorrow morning.
As for the Vol spike, the VIX continues to act like we will be in a fairly different volatility environment for the next few weeks, now that the bulk of S&P earnings are behind us and the markets have to digest a host of geo-political risks, rising oil and the potential for a Greek default. As far as the VIX Mar Call Fly I bought last week, I am increasingly liking the structure but most specifically liking the risk reward as I only paid .27 for a $5 wide fly that is now in striking distance of being fairly profitable.
As for today, I would like to see AAPL make an attempt to get through $500 and then fail and I think you could see a stock settle in over the next few trading days btwn 490 and 480….this would be healthy and a signal that the fever has in fact broken…….
Also yesterday I mentioned I was keeping a close eye on the banks and this will be important again today…..BAC is now off about 6.5% from last weeks highs and I am hearing that the company’s buyback of their own shares for employee comp ends tomorrow and that once employees receive their shares next week and the company no longer supporting the stock you could see the stock pull back a bit, possibly back to about 7.20 which was support and where it broke out from earlier in the month. Moody’s put some banks on watch today and this should obviously not help sentiment in the space.
Bit of a bonus….saw Guns N Roses last night at Webster Hall, Axl looks a bit roughed up these days, but he still has his voice, all in I give him a ton of credit for playing small venues without his original band mates……giving the people a least a bit of what they want…..
MorningWord: 2/15/12: China to the rescue……after hemming and hawing about their participation in Euro-zone bailout, overnight Premier Wen Jiabao and People’s Bank of China Governor Zhou Xiaochuan suggested that they will be “more involved in resolving the debt crisis”. The DAX is up about 75 bps on the news, but about 75bps off of the morning highs….
AAPL continues to drive the train here, and during CEO Tim Cook’s talk at Goldman’s Tech Conf yesterday, the stock rallied about 1% in the last hour of the day to close at a new all time high, dragging the SPX up with it. Obviously this is getting a bit over done near term, and it is not even borderline frenzy activity, it is all out mania….I am gonna throw in my hat on all Feb Puts that I own, But will keep on March Put Fly. The price action causes me to ask myself once an hour, “Who the Hell is buying this stock at these levels?”, which reminds me of a classic line in one of my favorite movies, Butch Cassidy and the Sundance Kid, when Butch routinely asks Sundance, “who are those guys?” The Buying is relentless and while I feel it is unsustainable there doesn’t appear to be any end in site!
I haven’t said this in a while, but I think with today’s opening above previous highs it will be interesting to see if the banks can hold any early gains….while AAPL is still on fire, it seems that the fever might have broken in the banking stocks as most have appeared to top out last week on declining volume…..yesterday’s downgrade of BAC at Citi was an interesting call and one that you don’t see often from fundamental analysts when they are trying to be pro-active.
Here were a few highlights from Citi’s downgrade call on BAC from yesterday:
We are downgrading BAC reflecting our view that at current levels the risk/reward trade off for BAC is relatively balanced in the near term. Longer term, we believe BAC still offers attractive value as the company addresses its legacy issues, which should drive down the perceived risk in the stock (reflected via its 3 year beta of 1.6, which is the highest in our universe) and its cost of equity. However, we believe legacy issues will take a while to play out, and our Neutral rating reflects a 1 year outlook. Raising target price to $8.50 (from $8) to reflect slightly lower cost of equity assumption on beta (now using 1.5).
Investor focus will shift to earnings… BAC’s recent outperformance reflects the market’s increased comfort with its capital position, but at these levels we believe investor focus will shift to earnings, which have been weak. Core PTPP was at $10.2 bil in 1Q11, but has fallen to $3.7 bil in 4Q11. Note that our 2012 EPS estimate already embeds a healthy rebound in core PTPP to $6 bil/qtr, which assumes better
capital markets, realization of cost savings and modestly lower legacy servicing cost…yet our estimates still remain well below consensus.
…And we believe consensus EPS estimates are too high. Our 2012 EPS estimate remains $0.50 vs consensus of $0.71, and our 2013 EPS estimate of $0.70 is also well below consensus of $1.09. Note that our $1.00 EPS est. for 2014 assumes core PTPP of $8 bil/qtr with the benefit of lower legacy asset servicing expenses, slightly improved capital markets and execution on internal cost initiatives. It also
assumes another $650 mil ($0.15 impact to annual EPS run rate/share) reduction in the credit costs. Our EPS ests reflect the forward curve, and thus we are not looking for higher short term rates which would be a positive for BAC.
We struggle to find value in the group. The recent move in the group has been driven by multiple expansion as the market has gotten more comfortable with US economic outlook and is less concerned about Europe, but we think at these levels one needs to see positive EPS revisions to get the stocks to work. Given a prolonged low rate environment, we see more downside than upside to forward EPS estimates. Our only remaining Buys are JPM and GS.
ALso yesterday’s new high reading was unimpressive at 253, which not surprising on a down day but still weak when you consider the SPX is still at ~1350.
MorningWord: 2/14/12: Late yesterday we posted a chart showing Bloomberg’s Composite New High Index as of Friday’s close vs the SPX which was clearly showing narrowing breadth of the market. As of yesterday’s 4pm close this reading improved a bit from Friday’s dismally low reading of 183, but as we appear to be trading in a narrower and narrower range, readings that are less than 50% of those a week ago are just not gonna cut it.
It appears that a lot of traders (including myself) are waiting desperately for a pullback, while the dumb money, I mean mutual funds just keep buying the same few names at all time highs…..I don’t get this one bit.
How Do You Like Them APPLES?
OK, now for our daily installment of our AAPL rant………The 18% rally since the company reported it’s Fq1 on Jan 24th, is obviously jaw dropping when measured in market cap, which has gained about $100 billion since the start of the year. The chart below tells 2 stories, the first 8% or so following earnings shows the gap on better than expected results (very fair considering the magnitude of the beat) and then a very healthy consolidation at all time highs….the second period, the 10% rally since Feb 2nd ( a period the SPX was up less than 2.5%) shows something entirely different……..Some of you out there think that the “markets” are a “rigged game” for those in the know. I believe this chart (below) could be exhibit A for the above rigged game theory, especially if on Feb 23rd at AAPL’s annual shareholder meeting the company does in fact announce a dividend.
I think it is very interesting that since the fall of 2009 we have seen numerous perp walks of hedge fund baddies busted for insider trading ranging from hundreds of thousands to no more than tens of millions of dollars in ill gotten winnings, but if the mutual fund community did get the “wink wink, nod nod” that AAPL was going to introduce a dividend (either a regular or special) then this could be the largest instance of insider trading by seemingly respectable institutions ever known.
I know, I know, I sound a bit bitter as I have been losing money trying to short the stock since last Tuesday, but losing money shorting stocks, happens, and trust me it wasn’t the first time and certainly won’t be the last, but this situation stinks, and if the mutual funds got the early call, and drilled the shorts by design, then I hope the feds will use the same fervor to investigate this price action as they have with the “villains of the hedge fund industry.”
One last point, yes I have been wrong in the name for the last week, but as my posts show, in all instances I have defined my risk and cut losses at different instances, this is the only way to trade a situation like this. Very soon we will get a dramatic intra-day reversal, and the fever will break, but until then, I don’t think it makes sense to be naked short the stock, if it continues to consolidate in this $500 range it could easily make another move higher on the least bit of good news, although this will become increasingly more difficult as the market cap grows ever bigger and bigger, who the hell else will be left to buy the stock??
MorningWord: 2/13/12: Tomorrow is Valentine’s day and in a household of 4 with me being the only male, I decided to pile it on and have a cavity refilled on the same day that I will have to shower my family with hallmark crap flowers and sweets just to get to max pain. But lets talk about today, “AAPL Day”, this will be the day that the stock finally tops $500, and many of you will remember this day for a long time….I remember when CSCO topped MSFT to be the largest market cap company in the world in March 2000, and the question then was, “will CSCO be the first company to top $1 trillion in market cap?” By no means is the stock trading above that round number, but with calls this weekend for DOW 15K, many will wonder how much higher this thing can go…………
MorningWord: 2/9/12: In what has been a fairly uneventful week so far as it relates to news flow, the SPX continues its trends of putting its lows for the day in the morning and seemingly spending the afternoon rallying post the European close.
Obviously this is healthy looking action, but it appears that the breadth in the market is getting a bit narrower as we approach last years highs. Chart below makes this point pretty clearly, with the SPX at 1350 (or there abouts) we had 397 new 52 week highs yesterday vs the readings of over 100o last Feb, Apr and May when the SPX traded above 1300, and specifically the 1200 reading on the May 4th, 2011 52 week high.
MorningWord: 2/8/12: It is not often that the first story that I read in the morning from Bloomberg top stories makes me vomit a little in my mouth, but this one, “BlackRock’s Fink Says Investors Should Be 100% in Equities, Take More Risk” takes the cake. I think it is safe to say that Larry Fink, the co-founder of BlackRock which manages more than $3 trillion in assets (your assets), just won the first of what will likely be an ongoing series here at RiskReversal.com for the most Self-Serving A-Hole of the week.
If that doesn’t make you want to take some profits in stocks that you own I am not sure what will. Many of you have heard me say this on numerous occasions over the last year, but everyone and their mother want/need risk assets to go up, and most of the time those who have the most to gain from the investing public being “bullish” and calm will do their part to make sure they don’t send the wrong message and be a bit cautious while their still appears to be a whole host of risks out there. But you guys know me, I am just here to rain on everyone’s parade.
MorningWord: 2/7/12: Greek default fears spooked yesterday’s opening a tad, but as we have become used to in 2012, the opening tick was in fact the low for the day, and quite impressively we closed on the highs, nearly unchanged.
U.S. equities display amazing resilience even as they appear to be a bit overbought and approach last years highs. It is my strong opinion though, that our equity markets appear to be trading on fumes as yesterday’s NYSE volume was the lowest of the year so far and that is not a good sign for those looking for volume to display conviction of buyers.
MorningWord: 2/6/12: Call it a bit of a Super Bowl hangover if you will, but the liklihood that the SPX’s close on Friday (the highest close since July 21st) would be able to follow through on today’s opening wasn’t particularly great……Since briefly flirting with 1200 in the SPX on Dec 19th, the SPX has rocketed nearly 12% with out a pullback of more than 1.5%, I guess my point here is that equities feel a bit extended and maybe discounting a fair bit of good news at current levels. I know I know I sound a bit like a broken record here, but at this point I think it is fair to say that even if you are int he bull camp you would rather see the market consolidate up near last years highs and then make an attempt to meaningfully breakthrough.
Last week prior to QCOM‘s earnings I posted a long term chart that I thought was kind of interesting (below). The stock on a few occasions in the last 12 months had flirted with the $60 level, a level that it had not traded above since crashing below in June of 2000 during the tech wreck of that period.
While this is an amazingly bullish chart, last weeks breakout wasn’t exactly that convincing as the volume seemed fairly mediocre when you consider that the stock broke out of a 12 year range.
Volume for instance on Thursday (the day after their Q4 report) was about 35 million shares vs the 44 million shares the stock traded on November 3rd the day after the company beat their Q3 estimate. So i guess my point is we want to see break-outs that are confirmed by volume and in this instance while price action is fairly impressive, I am not sure this one sticks…..Much like my discussion above of the SPX, I think there is a good chance that QCOM will need to consolidate here before making a meaningful move higher…..