Archive for November, 2012

80% Price Probability for S&P 500 Next 3 Months

Wednesday, November 28th, 2012

Mobile OS Market Share 2009 Q3 vs 2012 Q3

Thursday, November 15th, 2012

Price vs Target Price Evolution for GOOG, AAPL & MSFT

Saturday, November 10th, 2012

The three key players in the competition to develop a mobile ecosystem are Apple, Microsoft and Google.

“Ecosystem” generally refers to a one company source for interoperable, mobile phones, tablets, laptop or desktop computers, operating systems, app stores, and cloud storage.

Google and Microsoft are imitating Apple’s success with an ecosystem, but each has their own twist.  Google is moving toward wearable computing and Microsoft is moving toward mobile productivity and corporate connectivity.

We think Google could become the next runaway success with the introduction of wearable mobile computing through Google Glass in 2014-2015.  When and how they will have calling connections through telecomm carriers is unclear at this point.  However, wearable mobile devices and freeing of the hands as is expected to eventually become the case with Google Glass would be a disruptive change that would challenge Apple’s domain.

Apple is the top dog now, and is growing well, with tremendous opportunity in China if they can get onto the China Mobile platform.

Microsoft, with the introduction of their Surface Pro tablets in 2013 will have the edge for those who want full productivity capability in a tablet for word processing and spreadsheets with a fold out keyboard.

This chart shows the evolution of the price of GOOG, AAPL and MSFT versus the average street analyst 1-year target price over the past 18 months.  The data is as of 2012-11-09, is from using data from ThomsonReuters.

Target prices for GOOG are rising, falling for AAPL and flat for MSFT.

For GOOG there are 42 analysts with a $798 average target price, which is about 20% above the current price (yield = 0%, EV/EBIDTA =11.43, PEG = 1.24).

For AAPL there are 57 analysts with a $764 average target price, which is about 40% above the current price (yield = 2.00%, EV/EBITDA = 8.30, PEG = 0.50).

For MSFT there are 38 analysts with a $35.40 average target price, which is about 23% above the current price (yield = 3.20%, EV/EBITDA = 6.56, PEG = 1.11).

The current ThomsonReuters StarMine analyst ratings for the three companies (rating scale 0-10, worst to best), and the S&P Stars Rating for year ahead price performance  (1-5 worst to best) / Fair Value Rating (1-5 worst to best) are as follows:

  • GOOG:  2.9;  3/5
  • AAPL: 7.4;  4/4
  • MSFT: 8.3;  5/5

The Beta for the three varies with Microsoft lowest and Apple highest:

  • GOOG: 1.09
  • AAPL: 1.22
  • MSFT: 1.01

The Put/Call Ratio shows the most concern about GOOG and the least about MSFT.  The 1-day  /  30-day Put/Call Ratios (as of Nov. 9, 2012) were:

  • GOOG: 1.2/1.0
  • AAPL: 0.8/0.6
  • MSFT: 0.5/0.6

The Put/Call Ratio for GOOG and APPL were higher than the 30-day average last Friday, while the ratio for MSFT was lower.

Just How Large Is Apple’s Growth Challenge

Saturday, November 10th, 2012

Apple (AAPL) faces a monumental continuing growth challenge. It is so large that in order to continue growing at its recent pace, it has to create revenue and market-cap each year equal to the entire revenue or market-cap of major companies.

This chart from shows that Apple increased its market-cap by nearly 38% in the last 12 months, and its revenue by about 22%.

(click to enlarge)

In light of that growth data, let’s see, denominated in companies, what would be entailed for Apple to increase its market-cap and revenue by 20% to 25% in the next 12 months.

At about $515 billion in market-cap and about $157 billion in revenue, they would need to increase market-cap by $103 billion to about $129 billion; and increase revenue by $31 billion to about $39 billion.

That means they would have to add market-cap about the size of one of these companies in just 1 year (and do better than that in each subsequent year):

  • Amazon ($103 B)
  • Bank of America ($102 B)
  • Intel ($104 B)
  • Unilever ($102 B)

Alternatively, that means they would have to add revenue about the size of one of these companies in just 1 year (and do better than that in each subsequent year):

  • Aetna ($35 B)
  • Allstate ($33 B)
  • American Express ($29 B)
  • DuPont ($39 B)
  • General Dynamics ($33 B)
  • Goldman Sachs ($31 B)
  • Honeywell ($38 B)
  • Oracle ($37 B)
  • Plains All American ($37 B)

They may well do it, but when the size of the growth hurdle is denominated in the named other large company equivalents, it is simply amazing.

They need to grow incrementally by amounts annually that are equal to or greater than the total lifetime accomplishments of major corporations.

It puts a different lens on the growth challenge, and gives rise to reasonable questions about the limits to growth — how much they can continue to add year upon year.


Apple Stock Price vs Key Product Release Dates Beginning 1983

Thursday, November 8th, 2012

We consider Apple (AAPL) to be a leading dividend growth opportunity (read our article about that), which we hold for both growth and income development.

We also sell short-term PUTs on Apple and other stocks at strike prices that we find attractive for additional share accumulation. That generates income on the cash we have in reserve to make those purchases if called upon to do so.

If we are assigned we are OK with the price for the additional shares, and if not assigned our cash earns reasonable income.  Selling options can be part of an income investing strategy.  Our current Apple PUT position is described at the end of this article.

Apple is currently suffering a double-whammy of broad market malaise and a bit of post-product release depression.   We believe they will recover, and while they are down the current yield and future gain potential is up.

Apples’ success has been driven by a series of new product releases, which seem to be coming more frequently.  There is, however, some concern about the new releases being more incremental than revolutionary, and that imitators are getting better.

We thought it would be interesting to see how the Apple stock price has reacted to product releases over a long period, such as about 30 years.

Key New Product Release Dates:

  • 01/24/1984 — MacIntosh
  • 01/xx/1998 — iMac
  • 11/10/2001 — iPod
  • 01/10/2006 — MacBook
  • 06/29/2007 — iPhone
  • 01/15/2008 — MacBook Air
  • 07/11/2008 — iPhone2
  • 06/08/2009 — iPhone3
  • 04/03/2010 — iPad
  • 03/11/2011 — iPad2
  • 05/11/2011 — iPhone 4
  • 03/07/2012 –iPad3
  • 09/12/2012 — iPhone5
  • 11/02/2012 — iPad4 and iPad Mini

Key Competitive Product Release Date:

  • 05/xx/1990 — Microsoft Windows

Historical Prices

The first thing you run into with long-term charts, particularly of highly successful companies is the difficulty comparing older periods to newer periods in a regular chart, as this Figure 1 chart of Apple from 1983 clearly shows.

Figure 1:  Apple Arithmetic Price Chart from 1983 Versus Key Product Release Dates

The product release dates are shown as vertical lines along the timeline.

It is more effective to compare old to recent periods with a semi-log price scale as in this Figure 2, so that the same percentage price change in an old period has the same vertical change as a percentage change in a recent period — regardless of price, any given percentage change in price has the same vertical size on the semi-log price scale.

Figure 2: Apple Semi-Log Price Chart Versus Key Product Release Dates

The product release dates are shown as vertical lines along the timeline.

The red line is a negative 20% offset from the trailing one-year high, and the tan line is the 200-day exponential moving average.

You can see that Apple stock was declining before the release of the MacIntosh in 1984 (“A” on the chart) and didn’t really catch on in terms of stock price until 1985, then went flat until 1990.  At that time (“X” on the chart), Microsoft introduced its Windows operating system designed to challenge the Apple user interface.

Apple stock then effectively languished with a downward drift until 1998, when it introduced the iMac (“B” on the chart).  It took off nicely from there, but got whacked in the dotcom bust.

In 2001 (“C” on the chart), Apple introduced the iPod, which decimated demand for the Sony Walkman product , but that was not enough to overcome the gravitational pull of the bear market in stocks.

After the 2003 bottom in stocks, Apple climbed very nicely to new highs.  The high before the dotcom bust was about $37.  The low after the bust was about $6 (an 84% drop); and the high reached before the next key product release in 2006 was about $86 (about 14 times the low price).

In 2006 (“D” on the chart), Apple released the first MacBook.  The price subsequently declined about 45% before then approximately rising by factor of 3 to a level more than 45% above the prior high when the MacBook was released.

The big news then came in 2007 (“E” on the chart) when the first iPhone came out, revolutionizing smart phones the way the iPod revolutionized mobile music.  Apple stock rose about 20% from there over a couple of months, before dropping nearly 25% , and then rising more than 80% from there to a 2007, pre-market crash high.

As the stock market was crashing, Apple released the MacBook Air (“F” on the chart), but gravity won that time.  The stock took more than a 40% dive, fought its way back to nearly the old high, then collapsed with the market to about $79, more than 60%, before the 2007 high.  They had introduced the iPhone2 during the crash but while it made lots of money for the company, the investment community paid no heed and continued to drop the stock price as the world seemed to be coming apart.

Then in April of 2009 (“G” on the chart), just after the stock market bottom, Apple released the iPad and both the market and Apple stock were off to the races.

Closer Look At the Period After Release Of The iPhone

This next Figure 2 presents the Apple chart from 2007 to make a more granular view of version releases of key products.

Figure 2: Apple Stock Versus Key Product Version Releases:

The first iPad release is shown at “E” in Figure 2.  The stock didn’t do much for while then rose nicely.  All the product releases since then have been version releases of pre-existing products (treating the Mini as a version of the iPad).  There have been five device version releases since the iPad came out.  Except for the iPhone4, each was preceded by a rise.  In each case, including the iPhone4, the release was followed by a price decline.

The current decline is more significant than the others.  It is below both the 200-day moving average and is below the 20% negative offset indicator.

Figure 3: Growth of Revenue, EBITDA and Free Cash Flow:

This chart shows that Apple’s revenue and EBITDA are growing well, but not quite as steeply as in 2010 and 2011.  Their free cash flow actually declined somewhat this year, as they had to put more into the business to push out all of the new software and hardware.

The critical Christmas shopping season is about to open, and that will be telling.

There are two important competitors lurking now that were effectively not there before, namely Microsoft and Google.  The Surface tablet from Microsoft and the Nexus phone from Google could be spoilers to some degree — we’ll have to see.

Both Microsoft and Google are committed now to a vertically integrated “ecosystem” consisting of devices, operating systems, application stores and cloud storage, as is Apple.

At the same time, both AT&T and Verizon have stated that they would like to see three “ecosystems” so as not to be beholding to a single source.

There are brewing questions about the implications of the top talent changes at Apple, and whether the WOW factor is as great for new versions of existing devices, as it was for them when they were totally new experiences.

Apple is a great company with super products, but growth rate maintenance gets harder and harder as company size increases; and it gets harder yet when well funded competitors decide it is a strategic necessity to imitate.

Apple and China Mobile (the dominant mobile carrier in China) continue to talk. If Apple can get on board with China Mobile and get a good market share, the next phase for Apple could be amazing.

However, the work is harder now and there is not as much broken field running potential as before, either in the US or in China.

Our Position: 

QVM is long some shares of AAPL and is short Dec ’12 475 PUTs on additional shares.

Discussion Of The Short PUTs:

The annualized credit premium on the assignment exposure of the PUTs with 43 days remaining is 8.67%.  If assigned, the yield on the new long shares at the current indicated dividend rate of AAPL is 2.23%.

The 475 strike price is just below the 10-year linear regression trendline for AAPL (see article on that).

We are happy to own more AAPL at 475, and if it doesn’t go there, we are happy to earn 8.67% on our assignment risk.

Apple Chart At Close Today (2012-11-08):

2013 Taxation of Investment Income With Historical Perspective

Monday, November 5th, 2012

Federal legislated, proposed and possible tax changes for 2013 may create difficult to predict changes in asset prices in 2013. The only relatively certain thing is that investment taxes for upper income investors will rise, but just how and how much is mostly uncertain.

If nothing is done legislatively, the long-term capital gains tax will rise from 15% to 20%, and qualified dividend taxes will rise from 15% to the ordinary tax rate (the top rate of which will be 39.6%). Additionally, a new Medicare investment income tax on upper income investors of 3.8% will be imposed.

The definition of upper income for the purposes of these taxes is $250,000 for couples and $200,000 for singles.

Speculation abounds about whether all of the taxes will be implemented as scheduled, and there are open questions about other “reforms” that will impact deductions and exemptions.

Vice President Biden in the debates was tagged with an error that may have actually been an unplanned leak. He referenced a $1 million income threshold for the higher investment income tax. That may indicate that the Obama administration is actively considering a higher threshold (perhaps $1 million) as a compromise level if they gain a second term.

The Joint Committee On Taxation (a non-partisan, professional staff of economists attached to Congress) recently issued a report in response to a question about the ability of reducing various tax deductions and exemptions as a means of funding a reduction in the nominal tax rates and balancing the budget. Their conclusion was that there is not enough tax capture to solve the problem. In their study they assumed:

(1) all tax deductions would be eliminated [including mortgage interest deduction, charitable contributions, medical expenses, and state and local taxes],
(2) taxing both capital gains and dividends at ordinary rates,
(3) eliminating tax exemption of municipal bonds issued after 2012,
(4) repeal of the Alternative Minimum Tax.

They did not assume taxing retirement plan contributions or employer paid health care premiums.

While the changes for 2013 are unlikely to go full bore as in the Committee study, it does point to the direction of change.

You may find this table of the total value of various tax exemptions (“tax expenditures” in government speak) interesting. It shows how much more revenue is believed to be available to the government by eliminating the separate deductions. It does not take into consideration possible macro-economic impacts of eliminating deductions (such as less money given to non-profits, or fewer home purchases or negative impact on home prices if the cost of ownership rises).

click to enlarge

Both Obama and Romney have proposed some level of reduction of the tax exempt income benefit of municipal bonds issued in the future — that would inevitably result in higher local taxes as the cost of local finance would increase — thus hitting upper income investors twice — lower net income on the muni bonds and higher local income or property taxes. The confusion and disruption in municipal bond pricing would probably be major for a while.

Banks and insurance companies (mostly property & casualty companies) currently own 22% of the $3.7 Trillion of municipal bonds outstanding. How their taxes would be treated is not clear.

There is also talk of reducing or eliminating the tax free buildup of cash values in whole life insurance (which includes deferred annuities). That would change the relative value of life insurance companies that are term insurance heavy versus those that are whole life heavy, and would change the relative appeal of variable and fixed deferred annuities as retirement asset accumulation vehicles.

Under current tax policy, one might think that tilting toward tax sheltered investments such as municipal bonds, equity REITS or direct rental property holdings, oil & gas and other mineral extraction partnerships, and pipeline partnerships would be a good choice. However, according to the political dialogue, there is no certainty that the rules that provide that shelter will be preserved, or that the shelter benefit might not be phased out for upper income investors.

As a result of high certainty of some form of increased investment taxes in 2013, some investors are selling their positions to capture profits in 2012 at lower tax rates, in some cases with the expectation of repurchasing the same or similar securities to maintain market exposure. The result may be an added level of year-end selling.

Even with increased taxes expected for dividends, the need for yield within pension plans and among retiring boomers is likely to maintain the general tilt toward yield being a larger share of total return targeting than it was in years gone by. Bonds can’t do it for now, but high quality dividend stocks can, and also provide income growth.

In the aggregate, state and local pensions, union pensions and many corporate pensions are underfunded ($2.8 Trillion for state and local pensions, $0.369 Trillion for union pensions, and $0.355 Trillion for S&P 500 corporate pensions). Because bonds yield so little now, those funds may be forced to allocate more to dividend stocks, if they wish to have an income stream more like the days when bonds paid more — the conundrum being the higher volatility that is associated with stocks than bonds. Those entities, however, are tax exempt. Therefore dividend stocks would be relatively more attractive to them than to those for whom the tax rate on dividends will increase.

The current recessionary pressures and concerns are weighing heavily on natural resource equities, but the long-term inflationary probabilities as a result of all the quantitative easing would tend to favor real assets, including stuff in the ground, and to the extent available tax sheltered investments and accounts.

We are where we are in our portfolios, and need to wait to see what the election tomorrow brings. Today will be a day of mostly market watchers, not market actors. Volume will probably be light. The direction of taxes will become somewhat more clear, but far from totally clear, once we know which party will control the executive office.

The history of tax rates on capital gains and on dividends since 1913, shown in the charts below, seem to indicate the S&P 500 price level not to be highly correlated with the tax rate, but the dividends tax rate seems to have impacted corporate behavior on dividend payout.

When the dividend tax rate rose to over 90% on taxable income over $400,000 the yield on the S&P 500 declined, not surprisingly. The reduction to the 70% range is associated with a rise in the yield on the S&P 500. However, subsequent dividend tax rate decreases did not lift the yield on the S&P 500. Our speculation is that by that time, management were used to keeping the money in hand, and had the cover of the evolution of academic theories that companies are the best stewards of profits on behalf of their owners, as opposed to distributing profits. We think that is bunk, but that’s what happened.

Judge for your self about the correlations with these charts. Unfortunately there are gaps in our information about capital gains tax rates in some years, but the dividends rate data is complete.

For some years, we listed the dividends tax rate as zero, because of either very high thresholds before taxes were imposed ($5 million 1936 – 1939). We also listed dividend tax rates as fully taxable due to small exempt dividend amounts ($50 to $400 in years from 1954 – 1982). In each year, we used the highest ordinary tax rate as the dividend tax rate when they were fully taxable, or fully taxable subject to an exempt amount.

You can see the history of these tax rates, along with ordinary tax rates and corporate tax rates year-by-year in a 2010 article we wrote about that at this URL.

The next few months should be very interesting to watch as tax policy negotiations proceed.