In business, few things ever happen the way that you expect them to and it is a given that you are going to be surprised, sometimes in good ways and sometimes in bad. In chapter 6 I talked about grounding narratives in the real world, but if the real world changes, your narrative, to stay realistic, has to change as well. In this chapter I start with a look at the causes of narrative changes, which can range from the qualitative to the quantitative and from big macroeconomic/political news stories to earnings reports at companies. I then look at classifying narrative alterations, from shifts, where the story requires tweaking or modifying in specifics but not in structure; to changes, where the story structure is altered; to breaks, where a story comes to an abrupt stop; and I close by examining the value consequences of these alterations to narratives.
Why Narratives Alter
In the last chapter I stressed the importance of using feedback to improve and change your narrative for a business. In this chapter I expand on that notion, but the changes I address occur in response to new information you receive about the company, the sector or businesses it operates in, or the overall economy or the country in which it is incorporated or operates.
If the only constant in business is change, and the pace of change is increasing with technology and globalization, it stands to reason that no narrative can stay unchanged for a long period. It is prudent to respond to new developments and information by revisiting your narrative and evaluating whether any parts of it may need to be changed. The news itself can take different forms and can come from many sources:
1. Qualitative versus quantitative: The news can be quantitative, ranging from the surprises in earnings reports to government reports on inflation and economic growth. It can also be qualitative, some examples being a change in top management, a legal judgment for or against the firm, or the announcement that an activist investor has taken a position in the company.
2. Inside versus outside: The information can sometimes be from the company in the form of either a required financial disclosure or as a corporate announcement (of an acquisition, divestiture, or a buyback) and sometimes from external sources (financial news, equity research analysts following the company, or regulatory authorities). In some cases it may even be from a competitor, with the information that you get changing the way you think about the market and competitive dynamics.
3. Micro versus macro: Much of the information that you get is at the micro level, that is, it is about the company, its competitors, or the sector. Some of the news that you get will be about macroeconomic factors, that is, shifts in interest rates, exchange rates, or inflation can alter your story. To the extent that your company is exposed substantially to these macroeconomic variables, they may cause significant alterations in your narrative.
Suffice it to say that there is no narrative that is impervious to news, and it therefore follows that the intrinsic values of companies (which reflect these narratives) will also change over time, sometimes by large amounts. The view promoted by some old-time value investors that intrinsic valuation is timeless and constant is not only wrong but can be dangerous to portfolio health.
Classifying and Incorporating Narrative Alterations
One obvious way to think of classifying narrative alterations is to think in terms of the bottom line, that is, the value of the business, and break down narrative alterations into good news (increasing value) and bad news (decreasing value). Unless the news that you get is unambiguously better than expected or consistently worse than expected for a company, this classification is not easy to make. With most companies, though, the push and pull of good and bad news will mean that you will not have a measure of the effect on value until you work through the entire narrative and revalue the company. With that in mind, I propose that you think of narrative alterations in terms of how new information changes your overall story, even if some of the changes are very positive and others are clearly negative. Based on this classification, you can classify narrative alterations into narrative breaks, narrative changes, and narrative shifts, with the first representing a complete breakdown of your story and the last requiring a tweaking of your story.
Narrative Breaks
Any number of events can cause a story to come to an abrupt end, and many of them have negative connotations:
1. Natural or man-made disasters: A promising and profitable business story can be brought to an abrupt end by a natural disaster or a terrorist attack. In November 2015, for instance, the Sahafi Hotel, a luxury hotel in Mogadishu, was targeted and bombed by terrorists. It is unlikely that insurance will allow this hotel in an emerging market to be made whole again, and while this may be premature, there is a chance the Sahafi Hotel will not reopen its doors. As an owner or an investor in the company, your value loss may be permanent.
2. Legal or regulatory action: You may be a business awaiting a legal judgment or a regulatory decision that, if it goes against you, can be catastrophic enough to end your narrative. A small pharmaceutical or biotechnology firm with a single (potentially blockbuster) drug wending its way through the approval process can find itself at the end of its story if the FDA rules against it. As an illustration, consider Aveo Pharmaceuticals, a Boston-based biotech company that spent seven years developing a drug to treat kidney cancer and whose market capitalization reached a billion dollars in 2013. After setbacks in clinical trials and questions about the trial design, the FDA rejected the drug, leading to a 70 percent drop in value and the laying off of 62 percent of the company’s employees.
3. Failure to make contractual payments: A firm that is required to make contractual payments will find its business model at risk if it fails to meet its obligation. That is obviously the case when you have a bank loan or corporate bonds outstanding, but it can extend to cover lease obligations for retailers and even player contract payments for a sports franchise. In late 2015 and early 2016, as commodity prices plunged and concern about distress climbed, equity values at highly levered commodity companies collapsed.
4. Government expropriation: While expropriation by the government is less common than a few decades ago, there are still parts of the world where a business can be taken over without the owners receiving fair compensation. When the Argentine government nationalized the Argentine oil company YPF in 2011, investors in the company woke up overnight to a diminished value.
5. Capital squeeze: Many ongoing businesses need capital not just for expansion but for day-to-day operations, and a market crisis that shuts down access to capital could cause these businesses to fold. While Greece, Argentina, and the Ukraine may all come to mind when you think of this phenomenon, this problem is not restricted to emerging markets, as we saw in 2008, when developed markets exhibited the same behavior.
6. Acquisition: In perhaps one of the few instances of an unexpected narrative end that is good news, a company can be acquired and become part of a much larger entity. Thus, when Apple acquired Beats, the headphone/music company, the story of Beats ended as it was swallowed up into the much larger narrative of Apple as a company.
As you look at this list, you can see the risk of a narrative break will vary across companies as a function of a number of factors. The first is that exposure to discrete and catastrophic risks is more likely to create a narrative break than exposure to continuous risk. Thus, a large currency devaluation in a fixed-exchange rate currency is more likely to create a game-ending shock than day-to-day movements in floating exchange rates. The second is a related point: companies with risks that can be insured or hedged are more protected than companies with risks that cannot be protected against. The third is that the events listed above will be more likely to tip you into a narrative break if you are a small company with a limited financial buffer than a larger one with more of a cushion. Finally, if you have more access to capital, you are less likely to have shut down your business in the event of a large event. That is perhaps why these narrative breaks are more common in private businesses (with fewer sources of capital) than in their publicly traded counterparts, and emerging market companies more frequently shutter their businesses in the face of unexpected shocks than do developed market companies.
CASE STUDY 11.1: NARRATIVE BREAKS
At the start of 2014, a company called Aereo claimed to have found a legal way to broadcast cable channels on handheld devices, without users having to pay cable fees. While the response from most people was disbelief, that did not stop investors from valuing the company at $800 million in early 2014. In the summer of 2014, the U.S. Supreme Court, which was called to rule on the legality of Aereo’s streaming, ruled against it. Overnight, the value of the business dropped toward zero, and a few months later, the company folded.
A more perverse example is Ashley Madison, an online service that facilitates cheating on spouses via online connections. Without passing judgment on the morality of this business model, the company had no shortage of investors and was looking forward to an imminent initial public offering, where it planned to raise $200 million from the market. Those plans came crashing down to earth when a computer hacker got into Ashley Madison’s website and released a partial list of its customers, not good news in a site dedicated to cheating. While the company was not put out of business, it was mortally wounded, and its valuation crashed in the aftermath of this news story.
Narrative Changes
In a narrative change, a part or many parts of your story are changed significantly by real-world developments. These changes can come from different sources and have positive or negative effects, but one way to organize them is to use the narrative framework that we developed in chapter 8 (see figure 11.1).
Figure 11.1
New stories and narrative changes.
When you make these changes, though, recognize that you will have to explain what parts of the story you have changed and why, and also be ready for criticism from two sources:
• The value scolds: Coming from a belief system that intrinsic value is a stable, perhaps even constant number and that big changes in it are an indication of weakness, value purists will pounce on your changes and argue that this is more a sign that your original valuation was flawed than a sensible adjustment to new information. My response to critics who ask me how my valuations can change so much over short periods is to quote John Maynard Keynes, who is rumored to have said: “When the facts change, I change my mind. What do you do, sir?”
• The hindsight gurus: There will be another group of critics who will take you to task for not having the foresight to see the changes that you have made coming at the time of your original valuation. My defense with this group is to compliment them on their capacity to forecast the future, to accept meekly my inability to match them on this skill, and to invite them to look in their crystal balls and tell me what they see coming in the next few years.
It is true that some companies are more exposed to narrative changes than others. In particular, companies that are early in their life cycle will see bigger changes than mature companies, a point I will return to in chapter 14, when I talk about the life cycle effect on narratives and numbers.
CASE STUDY 11.2: UBER—NEWS AND VALUE, SEPTEMBER 2015
In chapter 9 I valued Uber at $6 billion in June 2014 and found it to be worth significantly less than the investor pricing of $17 billion. In the time period between June 2014 and September 2015, each week brought more stories about Uber, with some containing good news for those who believed that the company was on a glide path to a $100 billion IPO and some containing bad news that evoked predictions of catastrophe from Uber doubters. For me, the test with each news story was to see how that story affected my narrative for Uber and, by extension, my estimate of its value. In keeping with this perspective, I broke down the news stories based upon narrative parts and valuation inputs.
1. The total market: The news on the car service market was mostly positive, indicating that the market was much broader, growing faster, and more global than I had thought a year prior.
a. Not just urban and much bigger: While car service remained most popular in the urban areas, it made inroads into exurbia and suburbia. A presentation to potential investors in the company put Uber’s gross billings for 2015 at $10.84 billion. It is true that this was an unofficial number and may have had some hype built into it, but even if that number overestimated revenues by 20 or 25 percent, it represented a jump of 400 percent from 2014 levels.
b. Drawing in new customers: One reason for the increase in the car service market was that it was drawing in customers who would never have taken a taxicab or a limo service in the first place. In San Francisco, for instance, the city where Uber was born, it was estimated that ride-sharing companies had tripled the size of the taxicab and car service market.
c. With more diverse offerings: The other reason for the jump in the size of the ride-sharing market is that it had morphed to include alternatives that expanded choices, reduced costs (car-pooling services), and increased flexibility.
d. And going global: The biggest stories on ride sharing came out of Asia, as the ride-sharing market expanded rapidly in that part of the world, especially in India and China. That should really have come as no surprise, since these countries offered the trifecta for ride-sharing opportunities: large urban populations with limited car ownership and poorly developed mass transit systems.
The bad news on the car service market front came mostly in the form of taxi driver strikes, regulatory bans, and operating restrictions. Even that bad news, though, contained seeds of good news, since the status quo crowd would not have been trying so hard to stop the upstarts if ride-sharing was not taking business away from taxicabs. The attempts by taxi operators, regulators, and politicians to stop the ride-sharing services reeked of desperation, and the markets seemed to reflect that. Not only did the revenues collected by taxicabs in New York City drop significantly between 2013 and 2015, but so did the price of cab medallions, which lost almost 40 percent of their value (roughly $5 billion in the aggregate) in that two-year period.
In my June 2014 valuation I had noted the possibility that Uber could move into other businesses. The good news between June 2014 and September 2015 was that it delivered on this promise, offering logistics services in Hong Kong and New York and food-delivery service in Los Angeles. The bad news was that it was slow going, partly because these were smaller businesses than ride sharing and partly because the competition was more efficient than the car service business. However, these new businesses moved from just being possible to plausible, thus expanding the total market.
Bottom line: The total market for Uber is bigger than the urban car service market that I visualized in June 2014, and Uber will attract new customers and expand in new markets (with Asia becoming the focus), and perhaps even into new businesses.
2. Networking and competitive advantages: The news on this front was mixed. The good news was that the ride-sharing companies increased the cost of entry into the market with tactics such as paying large amounts to drivers as sweeteners for signing up. In the United States, Uber and Lyft became the biggest players, and some of the competitors from the previous year had either faded away or were unable to keep up with these two. Outside the United States, the good news for Uber was that it was not only in the mix almost everywhere in the world, but that Lyft had, at least for the moment, decided to stay focused on the United States. The bad news for Uber was that the competition was intense, especially in Asia, and it was fighting against domestic ride-sharing companies that dominated these markets: Ola in India, Didi Kuaidi in China, and GrabTaxi in Southeast Asia. Some of the domestic company dominance could be attributed to these companies being first movers with better understanding of local markets, but some of it also reflected the tilt in these markets (created by local investors, regulation, and politics) toward local players. There was even talk that these competitors would band together to create a “not-Uber” network, and that story got backing when Didi Kuaidi and Lyft announced a formal partnership. All of these ride-sharing companies were able to access capital at sky-high valuations, reducing the significant cash advantage that Uber had earlier in the process. As competition picks up, one of the key numbers that will be under pressure is the sharing of the gross billing, set historically at 80 percent for the driver and 20 percent for the ride-sharing business. In many U.S. cities, Lyft was already offering drivers the opportunity to keep all of their earnings if they drove more than 40 hours a week. While the threat of mutually assured destruction had kept both companies from directly challenging the 80/20 sharing rule, it is only a matter of time before that changes.
3. Cost structure: This is the area where mostly bad news was delivered. Some of the pain came from within the ride-sharing business, as companies offered larger and larger upfront payments to drivers to get them to switch from competitors, pushing up this component of costs. Much of the cost pressure, though, came from outside:
a. Drivers as partial employees: Early in the summer of 2015, the California Labor Commission decided that Uber drivers were employees of the company, not independent contractors. That ruling was further affirmed by a court decision that Uber drivers could sue the company in a class action suit, and it looked likely that there would be other jurisdictions where this fight would continue. It appeared almost inevitable that at the end of the process, drivers for ride-sharing companies would be treated perhaps not as employees but at least as semiemployees, entitled to some (if not all) of the benefits of employees (leading to higher costs for ride-sharing companies).
b. The insurance blind spot: Ride-sharing companies in their nascent years have been able to exploit the holes in auto insurance contracting, often just having to add supplemental insurance to the insurance their drivers already have. As both regulators/legislators and insurance companies tried to fix this gap, it looked likely that drivers for ride-sharing companies would soon have to buy more expensive insurance and that ride-sharing companies would have to bear a portion of that cost.
c. Fighting the empire is not cheap: Groups vested in the status quo (the taxi business and its regulators) were fighting back in many cities around the world. That fight was expensive as the amount of money spent on lobbying and legal fees increased and new fronts opened up.
The evidence that costs were running far ahead of revenues again came from leaked documents from the ride-sharing companies. One showed that Uber was a money loser in the previous two years and that the contribution margins (the profits after covering just variable costs) by city not only revealed big differences across cities but were uniformly low (ranging from a high of 11.1 percent in Stockholm and Johannesburg to 3.5 percent in Seattle).
Bottom line: The costs of running a ride-sharing business are high, and while some of these costs will drop as business scales up, the operating margins are likely to be smaller than I anticipated just over a year ago.
4. Capital intensity and risk: The business model that I assumed for my initial Uber valuation was minimalist in its capital requirements, since Uber not only did not own the cars in their car service but invested little in corporate offices or infrastructure. That translated into a high sales-to-capital ratio, with $1 in capital generating $5 in additional revenues. While that basic business model had not changed by September 2015, ride-sharing companies were recognizing that one of the downsides of this low–capital intensity model was that it increased competition on other fronts. Thus, the high costs that Uber and Lyft were paying to sign up drivers could be viewed as a consequence of the business models they had adopted, in which drivers were free agents without contracts. In September 2015 there was no sign that any of the ride-sharing companies were interested in altering the dynamics of this model by either upping their investment in infrastructure or in the cars themselves, but there was a news story about Uber hiring away the robotics faculty at Carnegie Mellon, suggestive of change to come.
Bottom line: Ride-sharing companies will continue with the low–capital intensity model for the moment, but the search for a competitive edge may result in a more capital-intensive model, requiring more investment to deliver sustainable growth.
5. Management culture: Though not a direct input into valuation, it is unquestionable that when investing in a young business, you should be aware of the management culture in that business. With Uber, the news stories about its management team and the responses to these stories would have reflected your priors on the company. If you were predisposed to like the company, you would have viewed Uber’s management team as confident in its attacks on new markets, aggressive in defending its turf, and creative in its counterattacks. If you did not like the company, the very same actions would be viewed as indicative of the arrogance of the company, its challenging a status quo would signal its unwillingness to play by the rules, and its counterattacks would be viewed as overkill.
Bottom line: There seems no reason to believe that Uber will become less aggressive in the future. The question of whether this will hurt them as they scale up remains unresolved.
In summary, a great deal had changed between June 2014 and September 2015, partly because of real changes in the ride-sharing market during the period and partly because I had to fill in gaps in my knowledge about the market. In table 11.1 I compare the inputs that I used to value Uber in June 2014 with my estimates in September 2015.
Table 11.1
Input Changes from News Stories—Uber
| Input |
June 2014 |
September 2015 |
Rationale |
| Total market |
$100 billion; Urban car service |
$230 billion; Logistics |
Market is broader, bigger, and more global than I thought it would be. Uber’s entry into delivery and moving businesses is now plausible, perhaps even probable. |
| Growth in market |
Increase market size by 34.00%; CAGR* of 6.00%. |
Double market size; CAGR of 10.39%. |
New customers being drawn to car sharing, with more diverse offerings. |
| Market share |
10.00% (local networking) |
25.00% (weak global networking) |
Higher cost of entry will reduce competitors, but remaining competitors have access to capital and, in Asia, the hometown advantage. |
| Slice of gross receipts |
20.00% (left at status quo) |
15.00% |
Increased competition will reduce car service company slice. |
| Operating margin |
40.00% (low-cost model) |
25.00% (partial employee model) |
Drivers will become partial employees, with higher insurance and regulatory costs. |
| Cost of capital |
12.00% (ninth decile of U.S. companies) |
10.00% (75th percentile of U.S. companies) |
Business model in place and substantial revenues. |
| Probability of failure |
10.00% |
0.00% |
Enough cash on hand to fend off threats to survival. |
* CAGR = Compound annual growth rate
In table 11.2 I summarize Uber’s valuation in September 2015 and estimate a value of $23.4 billion. Note that this value is weighed down by the negative cash flows in the first 5 years (the “cash burn”) but the cash flows turn around in the later years to deliver a terminal value high enough to more than compensate.
Table 11.2
Uber, The Global Logistics Company
| The story |
| Uber is a logistics company, doubling the market size by drawing in new users. It will enjoy weak global networking benefits while seeing its slice of revenues slip (85/15), higher costs (with drivers as partial employees), and low capital intensity. |
| The assumptions |
| |
Base year |
Years 1–5 |
Years 6–10 |
After year 10 |
Story link |
| Total market |
$230 billion |
Grow 10.39% a year |
Grow 2.25% |
Logistics + new users |
| Gross market share |
4.71% |
4.71% → 25.00% |
25.00% |
weak global networking |
| Revenue share |
20.00% |
20.00% →15.00% |
15.00% |
Lower revenue share |
| Pretax operating margin |
−23.06% |
−23.06% → 25.00% |
25.00% |
Semi-strong competitive position |
| Reinvestment |
NA |
Sales to capital ratio of 5.00 |
Reinvestment rate = 9.00% |
Low capital intensity model |
| Cost of capital |
NA |
10.00% |
10.00% →8.00% |
8.00% |
At 75th percentile of U.S. firms |
| Risk of failure |
No chance of failure (with equity worth zero) |
Cash on hand + capital access |
| The cash flows ($ millions) |
| |
Total market |
Market share |
Revenues |
EBIT (1−t)* |
Reinvestment |
FCFF† |
| 1 |
$253,897 |
6.74% |
$3,338 |
$(420) |
$234 |
$(654) |
| 2 |
$280,277 |
8.77% |
$4,670 |
$(427) |
$267 |
$(694) |
| 3 |
$309,398 |
10.80% |
$6,181 |
$(358) |
$302 |
$(660) |
| 4 |
$341,544 |
12.83% |
$7,886 |
$(200) |
$341 |
$(541) |
| 5 |
$377,031 |
14.86% |
$9,802 |
$62 |
$383 |
$(322) |
| 6 |
$416,204 |
16.89% |
$11,947 |
$442 |
$429 |
$13 |
| 7 |
$459,448 |
18.91% |
$14,338 |
$956 |
$478 |
$478 |
| 8 |
$507,184 |
20.94% |
$16,995 |
$1,621 |
$531 |
$1,090 |
| 9 |
$559,881 |
22.97% |
$19,935 |
$2,455 |
$588 |
$1,868 |
| 10 |
$618,052 |
25.00% |
$23,177 |
$3,477 |
$648 |
$2,828 |
| Terminal year |
$631,959 |
25.00% |
$23,698 |
$3,555 |
$320 |
$3,234 |
| The value |
| Terminal value |
$56,258 |
|
| PV (terminal value) |
$22,914 |
|
| PV (CF over next 10 years) |
$515 |
|
| Value of operating assets = |
$23,429 |
|
| Probability of failure |
0% |
|
| Value in case of failure |
$- |
|
| Adjusted value for operating assets |
$23,429 |
Venture capitalists priced Uber at about $51 billion at the time of the valuation. |
* EBIT (1 − t) = (Revenues* Operating Margin) (1 minus tax rate)
† FCFF = Free cash flow to firm
I was wrong about Uber’s value in June 2014, when my estimate of $6 billion was below the $17 billion assessment by venture capitalists. Correcting for both my cramped vision and the changes that had occurred since June 2014, produced my new estimated value of $23.4 billion in September 2015 (as shown in Table 11.2). Even though my estimated value for Uber increased from June 2014 to September 2015, the investor pricing took the company from $17 billion in June 2014 to $51 billion in September 2015. Talk about a moving target!
Narrative Shifts (Tweaks)
If all or most news stories caused narrative breaks or changes, our valuations would be in a constant state of motion and investing would become a chaotic and risky endeavor. That is what happens during a market crisis, and it is one reason why periods like the last quarter of 2008 are so harrowing for investors. Luckily, this is the exception rather than the rule, and information has only a marginal impact on narratives and on value for more mature companies in more settled markets. Again, you can use the narrative framework to illustrate these small shifts in stories from period to period. Specifically, you can trace how a news story changes the total market for a company, even if all the company does is stay in its existing business model. Alternatively, you may be called upon to tweak the market share, profit margins, or risk characteristics of a company as news stories about the company emerge.
If you invest primarily in mature companies, with established business models, this is perhaps the state of play for you, and your intrinsic value will follow the smooth path that value scolds assume is a universal one. Is this stability good or bad for investors? While at first sight it seems like a blessing to have stable stories and values, there is a downside, at least from an investing standpoint. The market prices for these stocks will also reflect this stability in story line and will be less likely to wander away from values. In the language of value and price, the gap between price and value will be smaller at these companies. Since investors make money from exploiting the gap, it stands to reason that you will find fewer and smaller market mistakes with stable companies than with the younger and more unstable companies that are exposed to narrative breaks and changes. That is the reason why I prefer to spend my time and resources valuing companies on what I term the “dark side,” where there is significant uncertainty about how narratives will evolve in the future. I know that this contradicts traditional value investing advice, which is to stay with the familiar and the comfortable, but that approach also offers far less upside to investors.
CASE STUDY 11.3: APPLE—THE MEH CHRONICLES, FEBRUARY 2015
I have valued Apple multiple times over the last four decades, but my current sequence of valuations had its start in 2011, when I valued Apple after it became the largest market-capitalization company in the world. Every three months after that valuation, I revalued Apple to reflect what I had learned about the company and in comparison to the stock price. Figure 11.2 chronicles my estimates of value for Apple and stock price movements starting in 2011 and going through February 2015.
Figure 11.2
Apple price and value, 2011–2015.
Note that while stock prices ranged from $45 to more than $120 over this period, my value estimates had a much tighter range, reflecting my largely unchanged story line for the company over the period. Starting in 2011, my narrative for Apple had been that it was a mature company, with limited growth potential (revenue growth rate of less than 5 percent) and sustained profitability, albeit with downward pressure on margins as its core businesses (especially smartphones) become more competitive. I allowed for only a small probability that the company would introduce another disruptive product to follow up its trifecta from the prior decade (the iPod, the iPhone, and the iPad), partly because of its large market cap and partly because I thought it had used up its disruption magic over recent years.
Looking at the earnings reports and news stories from the company between 2011 and 2015 in table 11.3, you can perhaps see why my basic story did not change much over the period. For much of the time period, Apple matched or beat revenue and earnings estimates, albeit by small amounts, but the market was unimpressed, with stock prices down on six of the nine postreport days and seven of the nine postreport weeks.
Table 11.3
Revenues, Operating Income and Price Reaction
| Report date |
Revenues (in millions) |
Operating income/margin |
Price reaction |
| Actual |
Estimate |
Percent surprise |
Income |
Margin |
1 day after |
1 week after |
| 7/24/12 |
$35,020 |
$37,250 |
−5.99% |
$11,573 |
33.05% |
−4.32% |
−11.12% |
| 10/23/12 |
$35,966 |
$35,816 |
0.42% |
$10,944 |
30.43% |
−0.91% |
−3.10% |
| 1/30/13 |
$54,512 |
$54,868 |
−0.65% |
$17,210 |
31.57% |
−12.35% |
−3.89% |
| 5/1/13 |
$43,603 |
$42,298 |
3.09% |
$12,558 |
28.80% |
−0.16% |
0.50% |
| 7/24/13 |
$35,323 |
$35,093 |
0.66% |
$9,201 |
26.05% |
5.14% |
−2.65% |
| 10/30/13 |
$37,472 |
$36,839 |
1.72% |
$10,030 |
26.77% |
−2.49% |
−1.85% |
| 1/29/14 |
$57,594 |
$57,476 |
0.21% |
$17,463 |
30.32% |
−7.99% |
−0.83% |
| 4/23/14 |
$45,646 |
$43,531 |
4.86% |
$13,593 |
29.78% |
8.20% |
4.17% |
| 7/23/14 |
$37,432 |
$37,929 |
−1.31% |
$10,282 |
27.47% |
2.61% |
−1.41% |
Note that after controlling for the quarterly variations, revenues were flat or only had mild growth, and operating margins were on a mild downward trend. With Apple, the other focus in the earnings reports was on iPhone and iPad sales, and table 11.4 reports on the unit sales that Apple reported each quarter, with the growth rates over the same quarter’s sales in the prior year. In the last two columns, I report Apple’s global market share in the smartphone and tablet markets, by quarter.
Table 11.4
Apple’s Smartphone and Device Sales
| Report date |
iPhone (in millions) |
iPad (in millions) |
Global market share |
| Units sold |
Year-over-year growth rate |
Units sold |
Year-over-year growth rate |
Smartphone |
Tablet |
| 7/24/12 |
26.00 |
28.1% |
17.00 |
83.8% |
16.6% |
60.3% |
| 10/23/12 |
26.90 |
57.3% |
14.00 |
26.1% |
14.4% |
40.2% |
| 1/30/13 |
47.80 |
29.2% |
22.90 |
48.7% |
20.9% |
38.2% |
| 5/1/13 |
37.40 |
6.6% |
19.50 |
65.3% |
17.1% |
40.2% |
| 7/24/13 |
31.20 |
20.0% |
14.60 |
−14.1% |
13.2% |
33.1% |
| 10/30/13 |
33.80 |
25.7% |
14.10 |
0.7% |
12.9% |
29.8% |
| 1/29/14 |
51.00 |
6.7% |
26.00 |
13.5% |
17.6% |
33.2% |
| 4/23/14 |
43.70 |
16.8% |
16.40 |
−15.9% |
15.2% |
32.5% |
| 7/23/14 |
35.20 |
12.8% |
13.30 |
−8.9% |
NA |
NA |
While the market fixation with Apple’s iPhone and iPad sales may be disconcerting to some, it made sense for two reasons. First, it reflected the fact that Apple derived most of its revenues from smartphones/tablets and that the growth in unit sales and change in market share became a proxy for future revenue growth. Second, Apple’s earnings were being sustained by its impressive profit margins in the smartphone and tablet businesses, and looking at how well Apple was doing in these markets became a stand-in for how sustainable the company’s margins (and earnings) would be in the future. Each quarter, there were rumors of another Apple disruption in the works, but each time the promises of an iCar or an iTV did not pan out, and investor expectations that Apple would pull another rabbit out of its hat eased.
The price behavior of Apple in the quarters starting in the middle of 2014 going through February 2015 reflected this period of stability, temporary though it may be for Apple, when investor expectations had moderated and the company was being measured for what it really was: an extraordinarily profitable company with the most valuable franchise in the world: the iPhone. It seemed to have stabilized its position in the smartphone world and was seeing its tablet market shrink, while its personal computer business was being treated as a ancillary business. Investors and analysts were treating it as a mature company that was being powered by the iPhone money machine, for which margins were declining only gradually. Since that is the narrative that I had been using all along in my valuations, I saw little change in my assessment of intrinsic value for Apple. Allowing for the stock split, the value per share that I assessed in February 2015 with the information in the new earnings report incorporated into my estimates was $96.55, almost unchanged from my estimate of $96.43 in April 2014.
It is natural to want to hold onto your narrative and to keep it unchanged, even in the face of contradictions. Rather than let hubris keep you wedded to your old story, you should think about how your narrative is altered by events, small and large. In this chapter I started by looking at classifying narrative alterations into breaks, changes, and shifts and the resulting effects on value. In particular, narrative breaks represent an end to a story that might have had promise at some stage, but no more. Narrative changes make significant modifications to the story that you have for a company, and with those changes can come large changes in value. Narrative shifts are much smaller alterations that nevertheless will show up as increases or decreases in value. Admitting you were wrong on a narrative (and the resulting value) is never easy, but it gets easier each time you do it. Who knows? One day, you may actually enjoy admitting your mistakes! I have not reached that level of serenity yet, but I keep trying.
