Apple at $1Trillion: The Missing Theory

By Jean-Louis Gassée

Apple crossed the highly symbolic $1T market capitalization threshold and stayed slightly above it for the last two trading sessions. In his sober message to the troops (full text here), Apple CEO Tim Cook puts the big T in perspective:

“While we have much to be proud of in this achievement, it’s not the most important measure of our success. Financial returns are simply the result of Apple’s innovation, putting our products and customers first, and always staying true to our values.”

He’s right, of course. While Apple employees deserve to bask in the market’s recognition of their good work, the thing that really counts is “making a dent in the universe”, as Steve Jobs memorably said. To name but a few, the invention of products such as the Macintosh, the iPod, and the iPhone; the creation of attractive and lucrative platforms for app developers (who deserve their own recognition for helping Apple reach the big T); an unrivaled supply chain management system… These are the things that have propelled Apple, occasional warts included, to the top of the industry.

Nonetheless, symbols are important. For more than three years, serious tech and investing websites have turned the $1T tale into a race: 3 Companies That Could Beat Apple to a $1 Trillion Valuation [The Motley Fool], Amazon and the Race to Be the First $1 Trillion Company [Fortune], Apple? Google? Tesla? Which Will Be The First To Reach A $1 Trillion Market Cap? [Investopedia].

The pundits’ speculations have been entertaining but, as curmudgeonly Neil Postman would insist, they’re not to be confused with actual, useable information. For example, there’s the curious journey to the $1T number…

In theory, Market Cap (market capitalization) is the simple multiplication of the price of shares that day by the number of shares “out there”. But for Apple, the number of shares outstanding varies all the time. Since the beginning of the calendar year, Apple has bought back — taken out of “out there” — more than $40B worth of stock. You would think that buying back a substantial number of shares (more than 200M) would reduce Apple’s market cap — and it did, by roughly 4%. According to the WSJ, if it weren’t for buybacks, Apple Could’ve Been a Trillionaire Long Ago:

Buybacks and dividends have rewarded shareholders but probably cost the tech giant the distinction of already being the first company with 13 digits

On the other hand, by buying shares in the open market a company can stimulate demand and raise the share price, thus putting the market cap on a see-saw.

(Speaking of a stock see-saw, imagine how happy Apple’s CFO Luca Maestri was when a blogger started a rumor earlier this quarter: The iPhone X is canceled. AAPL went down and Maestri gobbled up more shares at an attractive price.)

There’s another mystery twist, here: How did Apple get to $1T with such a poor price-to-earnings ratio (P/E)? As you no doubt already know, P/E is the result of dividing the share price by the earnings per share (EPS). The higher the ratio, the more willing investors are to pay a higher price for today’s shares, assured by the promise of substantially higher earnings (EPS) in the future.

This is where we get into some intriguing comparisons. Microsoft’s P/E is a solid 48 and Alphabet’s hovers around 50…but Apple’s is a meager 17. Caricaturing just a bit: “Apple still trades like a steel mill going out of business.” In more sober words, investor actions say Microsoft’s or Alphabet’s future earnings per share are safer than Apple’s, hence the premium they’re willing to pay. With a P/E of 50, Apple’s Market Cap would approach $3T…

The broad recognition accorded to last week’s milestone is a deserved mark of respect for Apple, a company that has so often been “misunderestimated” and given up for dead. So dead, in fact, that Michael Dell once recommended shutting down the company and giving the cash back to shareholders. Pundits and competitors constantly predict the death of the iPhone because “it’s the same closed system mistake as the Mac” or “modularity always wins!”. These death warrants were issued by prestigious academics and still carom around the blogosphere’s echo chamber.

Yet, years later, Apple continues to follow its heterodox path and to prosper as a result. There are two reactions to this annoying anomaly. One is to stick to one’s comfortable theories, books and speeches. “Just wait, Apple will meet its preordained fate. Sooner or later!”.

The other approach is to react the way physicists or mathematicians do when they see a crack in their theories. Can’t express the diagonal of certain squares as a ratio between two integers? Let’s invent irrational numbers. And so on to the square root of a negative number, or special relativity.

What I hope to see someday is a young academic writing a magnum opus explaining in lovely detail and rich historic comparisons what the Apple business model is made of, where its works and where it doesn’t — and why.

As much as I like psychologizing the study of businesses, looking for human strengths and foibles in a company’s successes and failures, I think there must be something hidden-but-discoverable in the structure of the Apple machine.

Any takers for building such a theory?

— JLG@mondaynote.com