|
Published: December 22, 2009
One of America's premier technology
companies has a problem: Too much cash.
You see, because of
GAAP rules, it has to conservatively account for sales by
spreading it over two years. But it gets the cash upfront. So
its reported earnings are tiny compared to its actual cash flow.
The official GAAP earnings investors see don't reflect this
company's impressive profits. But that may soon change. A new
accounting rule will change that would let the firm book most of
its revenue upfront.
This past quarter, its earnings per share would have been +58%
higher under this new rule.
Once the new rule takes effect, Wall Street analysts will jack
up their earnings estimates, the company's reported earnings
will surge... and the stock could attract a slew of new
investors.
You know this company. You probably use its products. And it's a
great stock to own regardless of its accounting policies.
The Details
Steve Jobs and the folks over at Apple (Nasdaq: AAPL) are
lobbying the Financial Accounting Standards Board, the group
which lays down the nation's accounting laws, to correct a rule
that has unfairly punished the firm for years.
Apple decided long ago to extend free software updates to
iPhone owners. Unfortunately, that generosity forced the firm's
bean counters to spread iPhone sales over the two year life of
the phone contract. But here's the problem: Apple takes in that
revenue on day one.
When you're selling more than two million smartphones every 30
days, subscription-based accounting methodology leads to
severely understated sales and earnings. Last quarter, the firm
reported earnings of $1.35 per share, when it really booked a
profit of $2.14 -- about +58% higher.
This type of gimmickry is exactly why I favor cold-hard cash
flow analysis over manipulated GAAP figures.
Apple, along with Oracle (Nasdaq: ORCL), Hewlett Packard (NYSE:
HPQ) and others, have long been pressing for a change. They have
a solid case. The rule was part of the
Sarbanes Oxley Act -- a response to Enron artificially
inflating earnings by reporting income for future events before
they occurred.
Apple is essentially doing the exact opposite and deliberately
under-reporting. If sales remain level, the problem could
correct itself over time. But demand has exploded, and by the
fourth quarter of last year the company had to "hide" $3.8
billion of its $4.6 billion in iPhone sales.
Fortunately, the FASB recently voted unanimously to correct the
problem. In the near future the company will be able to
recognize iPhone sales and costs upfront as they occur. Much of
the value in Apple's lucrative smartphone business that had been
reflected on the balance sheet will now be transferred over to
the income statement.
To be clear, this won't have an impact on cash flow or the
company's intrinsic value. But it will lead to truer earnings --
and a much lower
price-to-earnings ratio. Under the new accounting rules, the
shares would trade at just 19 times forward earnings, compared
with the current multiple of about 30.
Without a doubt, that valuation will look much more attractive
to retail investors, not to mention many quantitative-driven
funds in search of growth at a reasonable price.
There are plenty of other reasons to like Apple. After all, the
company sold three million Macs, seven million iPhones and 10
million iPods last quarter -- with most of the world still in
recession.
But with this tiny quirk ironing itself out, we could see Apple
breaking new ground next year.
Good Investing!
-- Nathan Slaughter
Chief Investment Strategist
StreetAuthority Market Advisor
P.S. -- This prediction about Apple is just one of 11
investment predictions for 2010 I recently shared with readers
of
Market Advisor. For the full details on all of the
predictions,
click here and I'll send you a free copy of my special
report "Hottest Investment Opportunities for 2010" just for
joining me. |
