Apple Computer Valuation Challenge

Here is a challenge to all finance students in my U of U classes.
The first one to provide the correct solution will get to write the next blog post :-)


Assume ΔCAPEX=0, ΔNWC=0, Depr=0, no debt.


Before the dividend announcement, we can use the FCFE1=E1 valuation method. Estimated E1=45 and r=18%. So a stock price of P0=600 implies the growth of free cash flow at 10.5%.


After the dividend announcement of D1=11 = 4x2.65+e, still the same r=18%, still the same E1=45, compute what Apple's rate of return on (plowed back) retained earnings has to be to justify the $600 stock price. Do you think Apple can earn it?


Bragging rights and extra credit possible. Don't ask any questions. The race is on.

March 20 Update - Apple, Treasuries, Banks, India

The $2.65 quarterly dividend plus $10 billion in share repurchases means about $25 bn in cash outlays. A drop in the bucket if you are generating more than that per year in free cash flows. The main signal from Apple is: we will not waste money on side bets/new technologies that will destroy shareholder value. We will keep the cash pile constant and have plenty of high-ROI plowback opportunities.

The 10-year Treasury yield rose 0.36% to 2.38% last week. Watch the long rates for signals about the economic recovery. For the yield to rise, investors must think that the economy is stronger than the offsetting purchases of long-term bond by the Fed, and, more importantly, that they can earn more elsewhere - in stocks and real estate

Most banks passed the stress tests last week, except Citibank. Vikram Pandit can't run a bank and doesn't even know how to cook the books. Of course, the dumbest thing is the Fed stopping the stress test-failing banks from paying dividends. So they keep losing money and investors can't take the money out. Only the government can come up with that.

And lastly, if you felt depressed about the U.S., here is something that will cheer you up. Of the 1.2 billion people in India, 670 million have cell phones, but only 500 million have access to toilets. Come on Apple, get working on the toilet app!

Pandora: A Case Study in Valuation

Pandora Media boasts over 1.5 bn listening hours in Q1 2012, predicted to grow to 3 bn in Q1 2013. Business model: Revenues - ads only since most users opt out of the ad-free service and pay nothing; 70% of the content streamed to mobile devices where ads cost 1/3 of what they cost online. Costs - for every song streamed Pandora pays royalties. The result: a net loss and the stock down 24% on Wednesday. Unless advertisers pay up, more subscribers will simply mean more losses.

Greek Bond Deadline

The deadline for the holders of the Greek bonds to submit to the "voluntary" restructuring is the end of the day today. The choices are: accept the swap deal and take a 70% haircut (=accept a reduced principal and super low interest payments through 2020 dropping the PV of the bonds by 70%) or sue the Greek government in a Greek court. If enough creditors accept the deal then it will not be deemed a default and credit default swaps will not be triggered (insurance will not be paid). The analogy would be to an insurer saying that your house burned down but so did your neighbor's so they don't owe you an insurance payout. An interesting interpretation of an insurance contract.

Oh no! China Diversifies Out of Dollars. Oh yes, They Are Smart

WSJ reported that the share of the $3.2 trillion of China's official reserves allocated to the U.S. dollar dropped from 75% in 2002, to 65% in 2010 and to 54% in 2011. Are they going to stop financing us? Is the world going to end?
No. Point No. 1: They have been cleverly diversifying, buying low-selling high for years. When the dollar was weak at $1.60 per euro, they bought dollars. Now that the dollar is stronger at $1.30 per euro, they try to allocate a larger share of each year's increase in reserves to other currencies. Point No. 2: The yield on the 10-year Treasury went from close to 4% at the beginning of 2010 to around 2% in 2012. I also bought more bonds in 2009-10 than in 2012 to lock in higher rates. This is just common sense, not a devious plot to take over the world or reflection on the dollar losing its reserve status.
The bigger story about this that people miss is: Why do we have no foreign currency reserves while they have huge ones? Who is scared here?
The mercantilist closed capital account policy has worked for China redirecting investment inward. Now the signs of wasteful investment into real estate and infrastructure are growing. The only solution to that will not be a "smarter" government interference in the economy (the U.S. is currently proving the case), but the opening of the capital account.

Term vs Whole Life Insurance - Basics

Term: You pay a fixed schedule of premiums for a one-time death benefit. The future value, with interest compounded at the insurance company's rate of return, is equal to the death benefit (at your actuarial life expectancy). Minus profit to the insurance company and commissions to the selling broker. Whole Life: You pay much larger premiums which go into an account earning the insurance company's rate of return, profit and commissions being subtracted from that. Out of the account, premiums are paid for a term life policy to provide the actuarial death benefit; the rest accumulates for a cash value. So theoretically, whole = term + investment account. Universal is a variation on the whole life theme where the rate of return in the account is up to you and not the insurance company. Considerations: 1. Can you earn an after-tax rate of return on investment that is higher than of the insurance company? Most people think yes, but the trick is to compare apples to apples risk-wise. The insurance company's return is likely to be a stable bond-like return since that is what they do with your money. 2. Do you like the credit rating of the insurance company, because that is the risk of your investment fund? If the company is AA-rated and pays 4% interest, that is pretty good. 3. The whole / universal life policies are more complicated allowing the insurer to hide mulitple layers of fees (admin, investment management, insurance, etc.), and the borker commissions come out in the first few years. If you understand compounding, having money come out at the beginning reduces fures values a lot. 4. The good side of whole life is the forced savings mechanism. If you buy term, are going to commit to save extra and to invest it? 5. If you plan to die tomorrow, buy term, pay little and have your loving wife cash out early. If you plan to die much later, the whole policy may give you the option of cashing out vs your estranged ex-wife cash out on your policy..
Did I miss anything? Comments please.