Apple Computer Inc. (AAPL)                                                           Brian Drumhiller
Date:               ...
Company Summary

Apple designs, manufactures and markets personal computers and related software, services, peripherals an...
Company Strategy

Apple is committed to bringing the best personal computing and music experience to students, teachers,
p...
Historical Revenue and Earnings:

                           Historical Revenue                              Historical Ea...
I. Fundamental Valuation
Apple Company Inc.      PARAMETERS                               FY1       FY2       Ltg
as of 12...
II. Relative Valuation
Comparables
                                                                           Mean FY2
   ...
III. Technical Analysis


Chart 1:       Bollinger Bands
               Fast Stochastics




                             ...
QuickTimeª and a
                            TIFF (Uncompressed) decompressor
                              are needed to ...
QuickTimeª and a
                                TIFF (Uncompressed) decompressor
                                  are ne...
IV. Earnings Analysis
                                            Earnings Surprises
                    Sep. 2004        ...
V. Analysts’ Recommendations
                      Current               1 Month Ago          2 Months Ago           1 Yea...
VI. Institutional Ownership
                                     # Holders        % Beg. Holders     # Shares (000)       ...
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Apple Computer Incorporated 2

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Apple Computer Incorporated 2

  1. 1. Apple Computer Inc. (AAPL) Brian Drumhiller Date: 12/1/2004 Consensus Estimate 12/04 9/05 9/06 Sector: Technology EPS 0.45 1.35 1.68 Industry: Technology Hardware & P/E 91.04 50.06 40.47 Equipment Current Price: $62.68 Long Term Growth Rate: 22.42% 52 Wk Price Range: $69.57-$19.25 Ratio Analysis Co. Indus. Sector SP500 Ave. Daily Vol: 11,620,000 P/E (TTM) 91.04 31.17 30.45 21.93 Beta: 1.78 P/S (TTM) 3.01 1.96 5.25 3.19 Market Cap ($million): $24,246 P/B (MRQ) 4.98 8.90 5.34 4.10 Shares Out (million): 391 ROA (TTM) 3.86 9.02 9.18 7.37 Inst. Hold %: 72.50% EBO Valuation $45.54 Div Yld: N/A Recommendation: Outperform Total Debt/Equity: N/A Stop-loss Price: $50.00 Member S&P 500? Yes Price 6-mo prob 12-mo prob Target Price $75.00 59% 70% Investment Thesis Summary Fundamental Valuation:  Increasing sales in Apple’s iPod and other Bearish: With a discount rate of 13.02%, new products have been the direct factor for Apple’s EBO evaluation is $45.54, showing current earnings growth. Apple to be overvalued by 27%.  With iPod sales reaching three million units Relative Valuation: in the fourth quarter, the iPod currently has Bearish: Most of the ratios are negative. 80% of the market for digital music players Overall, the forward earning values and the with hard drives. historical earnings values show less attractive valuations.  Surveys have shows that 13% of the people that purchased an iPod and were PC users at Technical Analysis: the time have either purchased a Mac or Bullish: A majority of the technical indicators plan to buy one in the next 12 months. suggest a positive outlook.  Apple has recently released iPod Photo, an Earnings Analysis: iPod that can carry up to 25,000 photos and Bullish: Apple has outperformed analysts’ 10,000 songs, which will help Apple recommendations over the last five quarters. differentiate their product from competitors. There have also been 11 upward revisions in the past four weeks for this fiscal year and no  After making a Windows compatible version downward revisions. of their iTunes Music Store, iTunes increased their share of the legal download Analyst Recommendations: music market to 70%. Bullish: Over the past year the number of buy recommendations has increased, along with the  Apple plans to have 100 stores open at the mean rating decreasing. end of the calendar year 2004. They believe that showcasing their products in a user- Institutional Ownership: friendly environment will help increase sales. Bullish: The number of institutional owners has increased as well as the fraction of shares held. 1
  2. 2. Company Summary Apple designs, manufactures and markets personal computers and related software, services, peripherals and networking solutions. Its products include the Macintosh line of desktop computers, the iMac and the Power Mac. Apple also offers a Macintosh line of notebook computers in the iBook and Powerbook models. Apple also sells the iPod digital music player, which is now offered in four different models, the iPod, iPod mini, iPod photo, and iPod U2. Apple’s products and services also include the Xserve server and Xserve RAID storage products, the Mac OS X operating system, the online iTunes Music Store, a portfolio of peripherals that support and enhance the Macintosh and iPod product lines, as well as a variety of service and support offerings.1 Apple sells its products worldwide through its online stores, its own retail stores, its direct sales force, and through third party wholesalers. Apple also sells a variety of accessory products that are compatible with the Macintosh and iPod product lines. Some of these products include computer printers and printing supplies, storage devices, computer memory, digital video and still cameras, personal digital assistants, iPod accessories, and other computing products and supplies through its online and retail stores. In addition, Apple generates its earnings and revenue from eight sections within the company. Product operating revenue and earnings for Apple in the fourth quarter of the 2004 fiscal year is presented below (dollars in millions).2 Operating % Operating Operating % Net Product Summary Revenue Rev. Earnings Imcome iMac 216 9% N/A N/A iBook 256 11% N/A N/A Power Mac 340 14% N/A N/A Power Book 419 18% N/A N/A Subtotal CPUs $ 1,231 52% N/A N/A iPod 537 23% N/A N/A Other Music Products 98 4% N/A N/A Peripherals & Other HW 271 12% N/A N/A Software & Other 213 9% N/A N/A Total Apple $ 2,350 $ 106 1 Information from www.apple.com 2 Data from Apple’s fourth quarter earning report (www.apple.com) 2
  3. 3. Company Strategy Apple is committed to bringing the best personal computing and music experience to students, teachers, professionals, businesses and consumers all around the world through their innovative hardware, software, peripherals and internet offerings. Apple’s business strategy controls its unique ability, through the design and development of their own operating system, hardware and many software applications and technologies, to bring new products that are easy to use, have seamless integration, and have an innovative industrial design. Apple believes that investing in research and development is critical to facilitate innovation of new and improved products and technologies. Just recently apple released a new version of the iMac that featured in a flat panel display. Apple has also been simplifying its software strategy, changing its Mac OS operating system. Apple’s latest version is the Mac OS X, which the company says has a compelling and easier graphical user interface, and is more robust because it is based on the Unix operating system. Apple’s big competitors in the technology sector are Microsoft, Dell, and Hewlett-Packard. Microsoft is Apple’s direct competitor for operating systems and is known best for their Windows XP operating system. Microsoft currently has operating system running on about 90% of PC in use today.3 Dell and Hewlett- Packard are Apple’s main competitors in producing desktop and notebook computers. Today Apple has around 3% of the market share and looks to gain back some of the market share from consumers who purchase iPods. In 2003, Apple released iTunes to offer digital music downloads from the Internet. As of January 2004, Apple estimated that iTunes had a 70% share of the legal download music market beating out competitors such as Napster and SonyMusic. In January 2004, Apple also announced that HP planned to bundle software in its PC’s that directed used to Apple’s iTunes site for downloading music. Apple’s recent growth can be directly attributed to sales in the iPod. Apple hopes that the iPod would impress people with its technology enough to make people switch from Windows to Apple computers. iPod sales are expected to reach three million units in the fourth quarter after selling two million in the second quarter. Currently the iPod has 80 percent of the market share for digital music players with hard drives.4 Apple continues to open retail stores in an effort to introduce user to its platform. Apple plans to have 100 retail stores open at the end of calendar year 2004. By showcasing their products in a user-friendly environment they think they will be able expand their customer base.5 3 Information from www.harrisdirect.com 4 Information from moneycentral.msn.com 5 Information from www.harrisdirect.com 3
  4. 4. Historical Revenue and Earnings: Historical Revenue Historical Earnings FY (09/04) FY (09/03) FY (09/02) FY (09/04) FY (09/03) FY (09/02) 1st Quarter 2,006.0 1,472.0 1,375.0 0.17 -0.02 0.11 2nd Quarter 1,909.0 1,475.0 1,495.0 0.12 0.04 0.11 3rd Quarter 2014.0 1,545.0 1,429.0 0.16 0.05 0.09 4th Quarter 2,350.0 1,715.0 1,443.0 0.26 0.12 -0.12 Total 8,279.0 6,207.0 5,472.0 0.71 0.19 0.19 Apple’s revenue has increased in each of the last two years. Apple’s earnings for 2003 stayed constant with earnings for 2002 and increased from $0.19 to $0.71 per share in 2004. Revenue has increased in every quarter, except for the second quarter in 2003, in the past two years. 4
  5. 5. I. Fundamental Valuation Apple Company Inc. PARAMETERS FY1 FY2 Ltg as of 12/01/04 EPS Forecasts 1.35 1.68 22.42% Model 1: 12-year forecasting horizon (T=12). Book value/share (last fye) 12.97 and a 7-year growth period. Discount Rate 13.02% Dividend Payout Ratio 0.00% Next Fsc Year end 2005 Current Fsc Mth (1 to 12) 3 Target ROE (industry avg.) 29.80% Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Long-term EPS Growth Rate (Ltg) 0.2242 0.2242 0.2242 0.2242 0.2242 Forecasted EPS 1.35 1.68 2.06 2.52 3.08 3.77 4.62 Beg. of year BV/Shr 12.968 14.318 15.998 18.054 20.572 23.654 27.427 Implied ROE 0.117 0.129 0.139 0.150 0.160 0.168 ROE (Beg. ROE, from EPS forecasts) 0.104 0.117 0.129 0.139 0.150 0.160 0.168 0.194 0.220 0.246 0.272 0.298 Abnormal ROE (ROE-r) -0.026 -0.013 -0.002 0.009 0.020 0.029 0.038 0.064 0.090 0.116 0.142 0.168 growth rate for B (1-k)*(ROEt-1) 0.000 0.104 0.117 0.129 0.139 0.150 0.160 0.168 0.194 0.220 0.246 0.272 Compounded growth 1.000 1.104 1.234 1.392 1.586 1.824 2.115 2.471 2.952 3.602 4.488 5.709 growth*AROE -0.026 -0.014 -0.002 0.013 0.031 0.054 0.081 0.159 0.266 0.418 0.637 0.958 required rate (r) 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 0.130 discount rate 1.130 1.277 1.444 1.632 1.844 2.084 2.355 2.662 3.008 3.400 3.843 4.343 div. payout rate (k) 0.000 Add to P/B PV(growth*AROE) -0.02 -0.01 0.00 0.01 0.02 0.03 0.03 0.06 0.09 0.12 0.17 0.22 Cum P/B 0.98 0.97 0.96 0.97 0.99 1.01 1.05 1.11 1.20 1.32 1.49 1.71 Add: Perpetuity beyond current yr (Assume this yr's AROE forever) -0.18 -0.09 -0.01 0.06 0.13 0.20 0.26 0.46 0.68 0.94 1.27 1.69 Total P/B (P/B if we stop est. this period) 0.80 0.88 0.95 1.03 1.12 1.21 1.31 1.57 1.88 2.26 2.76 3.40 Implied price 10.71 11.79 12.77 13.83 14.98 16.23 17.58 20.97 25.12 30.31 36.94 45.54 Check: Beg. BV/Shr 12.97 14.32 16.00 18.05 20.57 23.65 27.43 32.05 38.27 46.70 58.20 74.04 Implied EPS 1.35 1.68 2.06 2.52 3.08 3.77 4.62 6.23 8.43 11.50 15.84 22.06 Implied EPS growth 0.244 0.224 0.224 0.224 0.224 0.224 0.348 0.354 0.364 0.377 0.393 Inputs: 1. EPS Forecasts and long-term growth rate (LTG) are from Reuters (12/01/04). 2. Book value per share derived from 9/25/04 balance sheet. Total equity = 5,076M, common stock outstanding = 391.44M implying BVPS = 5,076/391.44 = $12.97 3. Discount rate: Used 20 year t-bond rate of 4.99% for risk-free rate, and expected return on the market of 9.5%, and Apple’s beta estimated as 1.78 (from Reuters) yielding a CAPM discount rate of 13.02% (=0.0499+1.78(.095-0.0499) 4. Dividend payout ratio is the trailing 12 months as reported by Reuters 5. Next fiscal year-end is 2005 6. Current fiscal month is 3 (December) 7. Target ROE= 29.80%, is the lagging 5 year Computer Hardware industry ROE reported by Reuters. Output and Sensitivity Analysis: 1. Based on these parameters, a 12 year forecasting horizon and a 7 year growth period, the EBO valuation is $45.54 2. Changing the discount rate to 11.25% (-1.77%), the EBO valuation is $62.41. Thus, if the expectations in the model are realized, we should earn a return of approximately 11.25%/ year. 3. Changing the growth rate to 11.17% (-11.25%), the EBO valuation is $35.98. 4. Changing the industry ROE to $26.80 (-3%), the EBO valuation is $39.02. 5
  6. 6. II. Relative Valuation Comparables Mean FY2 Earnings Estimate Forward Mean LT PEG P/B ROE Value Ticker Name Mkt Cap Current Price (next fiscal year) P/E Growth Rate (MRQ) 5 yr ave Ratio P/S 1 SUNW Sunwest Microsystems Inc. 18,127 5.21 0.10 52.10 12.86% 4.05 2.79 -2.49% -1.12 1.53 2 MSFT Microsoft Corp. 294,511 27.23 1.39 19.59 11.61% 1.69 3.90 16.02% 0.24 7.84 3 DELL Dell Inc. 102,974 41.65 1.56 26.70 18.21% 1.47 17.58 40.11% 0.44 2.28 4 HPQ Hewlett-Packard Co. 62,119 20.99 1.66 12.64 10.77% 1.17 1.66 7.86% 0.21 0.80 AAPL Apple Computer Inc. 25,526 62.68 1.68 37.31 22.92% 1.63 4.83 6.15% 0.79 2.93 Implied Price based on: P/E PEG P/B Value P/S 1 SUNW Sunwest Microsystems Inc. $87.53 $156.00 $36.21 -$89.43 $32.73 2 MSFT Microsoft Corp. $32.91 $64.97 $50.61 $19.43 $167.72 3 DELL Dell Inc. $44.85 $56.46 $228.14 $34.98 $48.77 4 HPQ Hewlett-Packard Co. $21.24 $45.21 $21.54 $16.86 $17.11 High $87.53 $156.00 $228.14 $34.98 $167.72 Low $21.24 $45.21 $21.54 -$89.43 $17.11 Median $38.88 $60.71 $43.41 $18.14 $40.75 Indicator Interpretation P/E Bearish: Apple’s P/E ratio is higher than most of it’s competitors. This implies that you are paying a higher price for a higher growth rate. PEG (P/E/G) Neutral: Apple’s PEG ratio is in the middle of its competitors. P/B Bearish: Apple’s P/B ratio is higher than most of it’s competitors. This could mean that Apple is overvalued due to Apple’s low ROE. Value (P/B/ROE) Bearish: Apple has the highest value ratio of its competitors after adjusting the P/B ratio for historical ROE differences. P/S Neutral: Apple’s P/S ratio is higher than most of its competitors but it also have a higher growth rate than all of its competitors. Summary Most of the ratios for Apple are bearish. The historical indicators are relatively higher than their competitors suggesting that the market expects Apple not to maintain its high forecasted growth. 6
  7. 7. III. Technical Analysis Chart 1: Bollinger Bands Fast Stochastics QuickTimeª and a TIFF (Uncompressed) decompressor are needed to see this picture. Chart 2: Exponential Moving Average MACD 7
  8. 8. QuickTimeª and a TIFF (Uncompressed) decompressor are needed to see this picture. Chart 3: Linear Regression Channel Price Rate of Change 8
  9. 9. QuickTimeª and a TIFF (Uncompressed) decompressor are needed to see this picture. Indicator Interpretation Bollinger Bands Poised for a move: At the top band, Apple is likely to move soon with either a breakout (bullish) or a reversal (bearish). Because other indicators are primarily bullish, the move should be bullish. Stochastics Bearish: The %K has recently fallen below the %D and the gap is increasing. Moving Averages Bullish: Price is above both the long-run and short-run moving averages and the gap has been increasing over the past two months MACD Bullish: MACD is greater than zero and increasing. The MACD is also above the signal line. Regression Bullish: Price is on an upward trend. The price has also just gone below the trend line and should move back up in the future. PriceROC Bullish: Price is higher than it was 100 days ago, which signals positive momentum. There is also an upward slope signaling increasing momentum. 9
  10. 10. IV. Earnings Analysis Earnings Surprises Sep. 2004 Jun. 2004 Mar. 2004 Dec. 2003 Sep. 2003 (Last qtr) (2 qtrs prior) (3 qtrs prior) (4 qtrs prior) (5 qtrs prior) Estimate 0.18 0.15 0.10 0.14 0.07 Actual 0.27 0.17 0.14 0.16 0.08 Difference 0.09 0.02 0.04 0.02 0.01 Mean Earnings Estimates Dec. 2004 This Mar. 2005 Next Sep. 2005 This Sep. 2005 Next LT Growth Quarter Quarter Fiscal Year Fiscal Year Rate Earnings 0.45 0.28 1.35 1.68 22.42 # Estimates 23 21 23 21 10 Earnings Per Share Estimates Revisions Summary Last Week Last 4 Weeks Revised Up Revised Down Revised Up Revised Down Quarter ending 12/04 5 0 10 0 Quarter ending 03/05 3 0 8 0 Year ending 09/05 5 0 11 0 Year ending 09/06 3 0 7 0 Apple has experienced positive earnings surprises in each of the last five quarters, which should have a positive effect on their future stock price. If Apple meets analyst expectations for the rest of the year they will have annual earnings of $1.35 / share. If Apple meets expectations for 2006 they will have annual earnings of $4.71 / share. Over the past four weeks there have been 10 upward revisions on earnings per share for the current quarter and 11 for the year. There have also been seven upward revisions for 2006 earnings per share. Over the past four weeks there have been no downward revisions. The drive in upward revisions is mainly due to increased sales in Apple’s iPod products. 10
  11. 11. V. Analysts’ Recommendations Current 1 Month Ago 2 Months Ago 1 Year Ago Buy 5 5 4 0 Outperform 7 7 7 3 Hold 11 11 13 11 Underperform 0 0 0 0 Sell 0 0 0 0 No Opinion 1 1 1 0 Mean Rating 2.26 2.26 2.38 2.93 Analyst recommendations over the past two months have stayed very consistent. The recommendations also look positive for the year with five new buy recommendations. Overall, Apple’s recommendations are positive. There are currently no underperform or sell recommendations, the number of buy recommendations has increased, and the mean rating has been improving from last year. 11
  12. 12. VI. Institutional Ownership # Holders % Beg. Holders # Shares (000) % Shares Shares Outstanding 388,122 100.00% # Institutions/Total Shares 418 129.01% 281,388 72.50% # New Buyers 68 20.99% # Closed Positions 35 10.80% # Buyers/3 Mo. Shares Purch. 248 76.54% 62,970 16.22% # Sellers/3 Mo. Shares Sold 154 47.53% 39,710 10.23% Beg. Total Inst. Positions 324 100.00% 258,128 66.51% # Net Buyers/3 Mo. Net Chg. 94 29.01% 23,260 5.99% The net change of 94 new institutional owners is a bullish indicator. The net change in percent of shares held by institutional investors was positive with an increase of about six percent. This indicates that there is more institutional interest in investing in this stock than before. 12

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