AAPL: why stuck at single-digit PE?

Some interesting facts here.

Relatively, AAPL is under-priced as a stock. But opinion and momentum say otherwise. So much for perfect markets.

Does it really have less growth potential than GM or Microsoft? Or Google?

 

Eric Bader

http://seekingalpha.com/author/eric-bader

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I present you with this question: Does Apple (AAPL) deserve to carry a single digit P/E? At its current price, Apple is trading at 10.09x TTM earnings and about 9x forward earnings. At its TTM multiple, Apple is trading at a 79.1% discount to the market … yes, a 79.1% discount. So, I repeat does Apple deserve a single digit P/E? In its current state, it certainly looks like the market thinks so (a 1.0% drop in price will amount to a P/E of 9.99x assuming a share price of $445). Do we truly believe that Apple has no growth prospects (see Apple: Zero Growth … Really!)?

Apple’s share price is beaten, bruised, and hurting. Market sentiment swayed from, “this could be a $1,000 stock (P/E of 22.7x)” and trading at $700 to Apple its current share price of $445. Apple’s P/E is lower than companies such as IBM (14), CSCO (12), GOOG (26), and my favorite, AMZ (N/A). Does Apple deserve this? Some would say yes, others no. In the subsequent paragraphs, I will establish some criteria to help you determine if its current price multiple is justified.

Market Share (Mobile Phones): According to a recent survey by ComScore, “Apple ranked as the top Smartphone manufacturer with 37.8 percent OEM market share [in the U.S.], while Google Android led as the #1 Smartphone platform with 52.3 percent platform market share [in the U.S].”1 These numbers do leave out an important piece of information; if you look at the table presented by SCOR below, one can see that while Apple not only leads the OEM Smartphone subscriber market, it has increased its market share by 3.5 percentage points in January versus 1.9% by Samsung with HTC and Motorola losing market share.

(click to enlarge)(click to enlarge)

However, the worldwide market share numbers tell a different story. Samsung is clearly the worldwide leader in mobile phone cells, taking Nokia’s position as number one and far surpassing that held by Apple. Although once again, Apple is not losing market share, instead it is gaining it. This is apparent in a survey done by Gartner,2 which shows that Apple has increased its market share 2.5 percentage points from year-end 2011.

(click to enlarge)

Market Share Tablets: In addition to Apple’s strength in the mobile phone market, Apple also displays its leadership in the Tablet market. As the chart from ComScore below displays, Apple continues to maintain market leadership in this area. Apple controls 45% of the tablet market followed by Amazon with a little over a quarter of all tablets in use. While Samsung has and is gaining market share, Apple maintains a strong lead with nearly 6.5x the market share of Samsung.

(click to enlarge)

Relative Multiples: As previously established, Apple maintains a low P/E multiple, but how does it stack up against its peers? In looking at two separate groups of companies, as well as its own historical P/E, we will find that Apple is relatively underpriced.

  1. Industry Peers: With Apple’s footprint across so many different industries, it is difficult to establish a clear-cut group to reference, so for ease of comparison, I have chosen the groups that Yahoo! Finance established to quantify my data. The results show that Apple ranks in the 22nd percentile in this peer group. Using the P/E multiple established by the median results in an implied share price of $721 (agreeably high), albeit still at a lower P/E than the overall market. Alternatively, using the 37.5th percentile P/E (14.46x) implies a share price of $638 (this is more like it). Further, simply by taking the P/E represented by the 25th percentile (10.87x) establishes a price of $479, an increase of approximately 7.6% from its current level.
  1. Top 10 S&P 500 Holdings: Apple is one of the top ten holdings in the S&P 500, so why not see how Apple stacks up against the others in the group. Not too surprising, Apple falls to the bottom of the pack-once again in the 22nd percentile-only with ExxonMobil (XOM) and Chevron (CVX) below. In this situation, the results are even more staggering; by using the 25th percentile’s P/E (14.68x), Apple’s share price becomes $647, an increase of approximately 45%.
  1. Apple’s Historical P/E: Since 2004, Apple’s P/E has ranged from 9x – 98x. While there is no reason to suggest that Apple should trade anywhere near 98x, it is trading at the lowest numbers since early 2009 when the entire market was in disarray. In looking at the past 5 years low and high P/E multiples a range of 11.4x – 22.8x is established. This in turn establishes a valuation range of $1005 on the high side (very high side!) and a more realistic number of $503 on the low end. Using the $503 estimate generates a return of about 13%.

(click to enlarge)

(click to enlarge)

Zero Growth: In a previous article, I wrote that Apple is currently priced in the market for zero future growth, which continues to be the case (seekingalpha.com/article/1247181). In addition, the market also prices its Present Value of Growth Opportunities (PVGO) at about $4.00 per share (discount rate of 10%, $445 share price, and earnings of $44.10/Share). Apple’s past ability to innovate and reshape popular culture should garner confidence in a PVGO larger than $9.00 per share.

Conclusion: Apple has helped reshape the landscape in which we live. It has been at the forefront of popular culture and technological innovation for well over a decade. Thanks to Apple, we no longer carry giant boxes clipped to our belts to listen to music, phones that only make calls, and computers the size of suitcases (I am writing this on a tablet smaller than a notebook). Apple is a well-diversified company with an established footprint across the technology sector entering our homes in the form of computers and our pockets with miniature computers that double as phones. Thanks to the iTunes music store, we no longer need to travel to buy music, books, or movies; instead, we can purchase any or all from our mobile device wherever we may be. Yet, we believe right now that Apple can no longer innovate, can no longer add to its stable of products, and will not wow us again.

Perhaps that is just what Apple needs, a new product, an innovation to boost the share price. With the giant momentum over the past seven months, we now believe that Apple no longer has growth prospects and nothing in the pipeline. I find it hard to believe that Apple has nothing to offer us in the near future, whether it is a watch (I think that is just plain weird, but … okay), a T.V., or perhaps something none of us even dreamed of yet. What I can say is this, there is someone sitting in a Cupertino lab throwing spaghetti at a wall, something will stick, and I imagine it will WOW us. Unfortunately, for those of us that are long the stock, I think that is what it is going to take to drive the price back up to an appropriate level. In addition, as a friend of mine said, “Apple will be stuck in limbo until it wows the peanut gallery” and I could not agree more. Alternatively, perhaps Steve Jobs will pull a rabbit out of a hat from his grave.

1.http://www.comscore.com/Insights/Press_Releases/2013/3/comScore_Reports_January_2013_U.S._Smartphone_Subscriber_Market_Share)

2.http://www.gartner.com/newsroom/id/2335616

Avocado–perfect food with lots of calories.

Avocado Health Benefits: The World’s Most Perfect Food?

March 25, 2013 | Filed under: Health,Health Food,News | Posted by: 

Did you know that the avocado has been called the world’s most perfect food and has many health benefits?

avo-super-food

It has achieved this distinction because many nutritionists claim it not only contains everything a person needs to survive — but it has also been found to contribute to the prevention and control of Alzheimer’s, cancer, heart disease, diabetes and other health conditions.

The avocado (Persea gratissima or P. americana) originated in Puebla, Mexico and its earliest use dates back to 10,000 years B.C. Since AD 900, the avocado tree has been cultivated and grown in Central and South America. In the 19th century, the avocado made its entry into California, and has since become a very successful commercial crop. Ninety-five percent (95%) of U.S. avocados are gown in Southern California.

The avocado, also called the alligator pear, is a high-fiber, sodium- and cholesterol-free food that provides nearly 20 essential nutrients, including fiber, is rich in healthy monounsaturated and polyunsaturated fats (such as omega-3 fatty acids), vitamins A, C, D, E, K and the B vitamins (thiamine, riboflavin, niacin, pantothenic acid, biotin, vitamin B-6, vitamin B-12 and folate) — as well as potassium.

Foods naturally rich in omega-3 fatty acids, such as avocados, are widely acknowledged as the secret to a healthy heart, a brilliant brain and eagle eyes.

Dr. Daniel G. Amen, a clinical neuroscientist, psychiatrist, brain-imaging expert and author of the New York Times bestseller Change Your Brain, Change Your Life counts avocados as one of the top brain-healthy foods that can help prevent Alzheimer’s Disease.

That’s not only because of the avocado’s health benefits omega-3 fatty acid content but also its…

Vitamin E content — An international journal called Alzheimer’s Disease and Associated Disorders, reported its findings from years of clinical trials — high doses of Vitamin E can neutralize free radicals and the buildup of proteins to reverse the memory loss in Alzheimer’s patients; reverse symptoms of Alzheimer’s in the early stages and retard the progression of the disease;

Folate content — helps to prevent the formation of tangled nerve fibers associated with Alzheimer’s.

The virtues and benefits of the avocado are too numerous to mention.

But Here Are Just a Few More Avocado Health Benefits That Its Nutritional Profile Provides:

  • Monounsaturated Fats — These types of fats help control triglycerides in the bloodstream, lower blood cholesterol and control diabetes.
  • Folate — This water-soluble B vitamin promotes healthy cell and tissue development. According to the National Institute of Health’s Office of Dietary Supplements, “This is especially important during periods of rapid cell division and growth such as infancy and pregnancy. Folate is also essential for metabolism of homocysteine and helps maintain normal levels of this amino acid.”
  • Lutein — This is a carotenoid (a natural pigment) that protects against cataracts and certain types of cancer, and reduces the risk of macular degeneration, the leading cause of blindness in adults 65 years of age and older. Avocados contain 3 or more times as much lutein as found in other common vegetables and fruits.
  • Oleic acid and Potassium — Both of these nutrients also help in lowering cholesterol and reducing the risk of high blood pressure.

You can add these avocado benefits to your diet in many ways:

1) The easiest way is to cut the avocado in half and sprinkle it with herbal seasoning or maple syrup.
2) Chop the avocado and add it to a salad, or use it as a topping or side garnish for soup.
3) Mash an avocado and spread it on bread or a bagel (in place of butter or cream cheese).
4) Cut an avocado in half and fill the little hollow (left after you remove the pit) with your favorite healthy topping such as herbed rice or couscous.
5) Make an avocado dressing or the crowd-pleasing guacamole dip to add flavor to raw or steamed vegetables. You can easily find many avocado recipes online.

Blended with fruit, avocados make a rich and delicious snack, side dish or dessert — and produces highly-nutritious baby food which delivers “good fat” for baby’s brain and physical development.

Before you indulge in avocados to your heart’s content, however, remember that they have lots of calories because of their fat content. According to WebMD, “A medium-sized avocado contains 30 grams of fat, as much as a quarter-pound burger”.

That’s why diet experts have long urged Americans to go easy on avocados in favor of less fatty fruits and vegetables. But now nutritionists are taking another look.

Racism Meets Journalists

The 20 journalism students listed below are to be commended for composing this letter in response to an unfortunate incident of blatant racism printed this week in the Nanaimo Daily News. And protested today. March 28th, 2013.

nanaimo protest

LETTER TO THE EDITOR OF THE NANAIMO DAILY NEWS

from Jimmy Thomson http://jameswsthomson.com/about/

(photo of protest: Lisa Cordasco/CBC)

This letter was written by students (myself included) at the UBC Graduate School of Journalism in Vancouver, in response to the publication of a racist letter in a Postmedia outlet, the Nanaimo Daily News.

Dear Sir,

As students at the UBC Graduate School of Journalism, we are embarrassed for you at what you consider fit for print.

The letter from Don Olsen entitled “Educate First Nations to be modern citizens,” published March 27, is one of the most racist, ignorant things we have read in any context, much less in a well-read newspaper that is a part of Canada’s largest print media family. And it is only the most recent example of Olsen’s racism in your publication.

Olsen can’t even get his facts straight, suggesting that Aboriginal people contributed nothing to modern society. Among contributions by North American Indians are potatoes, corn, and important elements of the U.S. Constitution, namely the concept of personal freedom. He points out, correctly, that they never developed the wheel, which makes it all the more impressive that their trade networks spanned the entire continent.

As young journalists in Canada’s only Reporting in Indigenous Communities class, some of us have been trying to learn to tell their stories in a way that respects their history and culture. Others among us have been learning about the human rights violations that occurred within our country in living memory. One thing we have learned is that the bigoted misconceptions in Olsen’s letters have real consequences for these people and communities.

We find it incredibly disheartening that any newspaper would consider this to be an acceptable way to draw readers. It is incomprehensible to us that you would provide a venue for material that could just as easily be coming from the headmaster of a 19th century residential school.

There is no excuse for the Nanaimo Daily News to have repeatedly given Olsen a soapbox from which to hurl his racism to a wider audience.

Sincerely,

Jimmy Thomson

Katelyn Verstraten

Rachel Bergen

Stephanie Kelly

Britney Dennison

Zoe Tennant

Hayley Dunning

Julia Kalinina (former student)

Sachi Wickramasinghe

Carlos Tello

Garrett Hinchey

Matthew Parsons

Blake Murphy

Meghan Mast

Sebastian Salamanca

Tiffany Kwong

Matt Meuse

Reyhana Heatherington

Emma Smith

Kirsty Matthews

MONSANTO PROTECTION ACT or “Biotec Rider”

What did Obama sign?

Definitely there is no Monsanto Protection Act. What there is to benefit Monsanto can be found in Sec 735 of a much larger US federal appropriations bill. Want to see it? Look below for the excerpt or check out the original.

http://www.gpo.gov/fdsys/pkg/BILLS-113hr933enr/pdf/BILLS-113hr933enr.pdf

Ok. Hard to see what Sec 735 means. Essentially, even if the courts decide that a genetically engineered crop is dangerous to the public or the environment, the court can no longer order Monsanto (or any other company) to stop planting the crops

Here’s an interpretation by one of the few small farm legislators in the US Congress.

Sen. Jon Tester (D-Mon.), whose organic family farm makes him the Senate’s only working farmer, delivered a scathing speech against the rider (735) on the Senate floor Wednesday before sponsoring an amendment that would nullify it. “Not only does this ignore the Constitution’s idea of separation of powers, but it also lets genetically-modified crops take hold across the country—even when a judge finds it violates the law,” he declared.

In his remarks, Tester stressed that the source of the rider is murky—there’s no way to find out which senator inserted it. “I don’t know who authored this provision,”  he said. “Maybe someone in Washington knows, but no one is willing to put their name to it. And that’s a shame.” I put calls into the offices of a couple of potential suspects, and got nowhere.

Tester also noted that yet another agribiz-friendly provision made it into the bill, one that would give “enormous market power to America’s three largest meatpacking corporations while stiffing family farmers and ranchers.” The provision, explained in more detail on the National Sustainable Agriculture Coalition blog, would override previous legislation and denies poultry and livestock producers the benefit of the the Packers and Stockyards Act, which seeks to give farmers a fair shake against the might of the few companies that dominate meat processing and can use their market power to shape the price they pay for hogs, steers, etc.. “The additional rider language is disastrous for producers and sets a terrible precedent for future appropriations bills,”  NSAC’s blog states. The Montana senator has introduced a separate amendment that would nullify this provision as well.

SECTION 735

SEC. 735. In the event that a determination of non-
4 regulated status made pursuant to section 411 of the
5 Plant Protection Act is or has been invalidated or vacated,
6 the Secretary of Agriculture shall, notwithstanding any
7 other provision of law, upon request by a farmer, grower,
8 farm operator, or producer, immediately grant temporary
9 permit(s) or temporary deregulation in part, subject to
10 necessary and appropriate conditions consistent with sec-
11 tion 411(a) or 412(c) of the Plant Protection Act, which
12 interim conditions shall authorize the movement, introduc-
13 tion, continued cultivation, commercialization and other
14 specifically enumerated activities and requirements, in-
15 cluding measures designed to mitigate or minimize poten-
16 tial adverse environmental effects, if any, relevant to the
17 Secretary’s evaluation of the petition for non-regulated
18 status, while ensuring that growers or other users are able
19 to move, plant, cultivate, introduce into commerce and
20 carry out other authorized activities in a timely manner:
21 Provided, That all such conditions shall be applicable only
22 for the interim period necessary for the Secretary to com-
23 plete any required analyses or consultations related to the
24 petition for non-regulated status: Provided further, That
25 nothing in this section shall be construed as limiting the 81
U:\2013REPT\CONF\March CR\Bills\DIV A–AG1MAR CR T7.xml [file 8 of
29]
SEN. APPRO.
1 Secretary’s authority under section 411, 412 and 414 of
2 the Plant Protection Act.

This had been turned down earlier. As Mother Jones explains:

In what became known as the biotech rider, the provision would have allowed the planting of genetically modified crop varieties even if a federal judge rules that they have been approved by the USDA improperly—as happened, for example, in 2010, when a federal judge issued an injunction against the planting of Monsanto’s Roundup Ready sugar beets on the grounds that the USDA had approved them without a substantial environmental review.

Reference: http://www.motherjones.com/tom-philpott/2013/03/yet-again-agribiz-sneaks-friendly-riders-unrelated-bill

The best general summary I have found of what and why Monsanto and others are spending so much time and money on lobbying the US Congress is also in Mother Jones.

http://www.motherjones.com/tom-philpott/2012/07/gmo-industry-flexes-its-muscles-capitol-hill

BAM-EH? Brookfield Asset Management

We did very well with this from 20009 but then thought it pricey above $40.

Now it is down to $36? What’s the value? And what is it?

Here’s two articles, both by Anthony Grossi that confirm my suspicion it is trading well below real asset value.

Partly that is because it is so complex.

Spinning out all the parts will let each of them stand on their own and rise or fall accordingly.

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GROSSI ONE

In a recent article here at SeekingAlpha, I laid out an investment thesis for Brookfield Asset Management (BAM) focusing on the qualitative aspects of the business. Now I would like to lay out the investment thesis focusing on the quantitative aspects.

Brookfield is objectively cheap based on a sum of parts valuation. The company is comprised of a sprawling portfolio of investments of which 12 are currently publicly traded entities, one more which will be public shortly, and the actual asset management business.

If you add up BAM’s ownership interests in the publicly traded holdings, the combined market value is around $22 Billion, compared to the holding company’s current market cap of about $22 Billion. Which still leaves the rest of the company. So what else does owning BAM buy you? The two parts will we look into are the soon to be spun-off Brookfield Property Partners (BPY) and the asset management business, also called Brookfield Capital Partners.

On April 15th, Brookfield plans to distribute shares of Brookfield Property Partners to existing shareholders as special dividend units. Under the arrangement, shareholders will receive 7.5% of the company while BAM will retain the other 92.5%. The parent company has already announced that they are targeting an annual dividend policy for the new entity at an 80% pay-out ratio, or $1 per share in the first year. If valued like its peers, the new BPY should trade around $25 per share, or a market cap of $11.4 Billion. This estimated value is derived by assuming a 4% dividend yield, and one times price to book value (based on IFRS accounting reported by BAM in the most recent annual report).

Adding the value of this part of the stub back to the value of the publicly traded holdings gives us an implied value of about $34 Billion, versus the current market cap of $22 Billion, and we still have one more piece of the pie to consider.

BAM’s management assigns a franchise value for the asset management business of about $4.3 billion based on assumptions of AUM growth of about 10% per year, 1.5% gross margins, and a 15% discount rate. That’s very generous of them.

We will attempt to value the asset management business using cash flow yield based off of fee income from management and performance bonuses minus transaction costs. This is an attempt on my part to avoid double counting the many publicly listed assets that are also held by the asset management segment. Applying a 10x multiple to the two-year average fee generation of about $410 million gives a rough value of $4.1 billion for the asset management business. The 10x multiple implies a cash flow yield of 10%, which is in line with the average free cash flow yield on asset managers like Waddell & Reed (WDR), and Legg Mason (LM). While fee income is a far from perfect comp to free cash flow, it may be reasonable to use this measure as a proxy to cash flow as a backup to management’s stated value given the lack of full disclosure on how management arrives at its $4.3 billion asset management franchise valuation. At any rate, we arrived at a number which is fairly close to the supposed intrinsic valuation.

So if we take this assumption and add it back to our previous ones, we have an implied value of about $38 Billion for the whole company. At the current market cap of $22 Billion, that’s about 70% upside if the parent company were to trade up to our estimate of net asset value. That strikes me as quite a bargain.

Subsidiary Shares held or

% of ownership stake

Market Cap

(rounded in Billions)

Brookfield Office Property (BPO) 249,362,561 4.2
Brookfield Residential Properties (BRP) 73,555,457 1.8
Brookfield Infrastructure (BIP) 30% 1.5
Brookfield Real Estate Services (BRE.CN) 25% 0.03
Brookfield Renewable Energy (BRPFF) 68% 5.1
Brookfield Incorporacoes (BISA3.BR) 41% 1.2
General Growth Properties (GGP) 357,662,764 7.1
Howard Hughes (HHC) 2,424,618 0.2
Rouse Properties (RSE) 26,580,603 0.4
Acadian Timber (ADN) 75% 0.2
Western Forest Products (WEF.CN) 49% 0.3
Norbord (NBD.CN) 52% 0.7
Brookfield Property Partners (BPY) *pending spin-off* 92.5% 11.4
Brookfield Capital Partners

(the asset management business) *my assumptions*

100% 4.1
Total 38.2
BAM current 22
Implied discount to NAV 42%

Please take into consideration that the numbers in the table above are not exact. The point of this exercise was simply to demonstrate the implied discount. The exact percentage will fluctuate with market prices throughout the day. Regardless, BAM is trading for a demonstrable discount to its parts.

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GROSSI TWO (earlier)

Legendary investor Marty Whitman of Third Avenue Value uses the term “wealth creation companies” to describe companies whose purpose is to create or compound wealth. While this may seem too axiomatic and pertain to all businesses, most companies only provide one specific product or service. For example Coke (KO) sells soft drinks and Nike (NKE) sells shoes. Successful companies do so profitably and the most successful ones grow over time, but their focus is quite specific. The focus of these conventional companies is sales and revenue growth, margins, competitive advantages and so forth.

Wealth creation companies are focused on asset allocation rather than current operations. Warren Buffett’s Berkshire Hathaway (BRK.B) is the most famous example of this concept, and currently sells everything from electric cars to candy bars. The focus for this type of company is on the management team and their capabilities. Analysis of such companies is far more subjective than that of traditional operating companies and this can lead to misunderstanding and mispricing.

Thesis Brookfield Asset Management (BAM) is constructed of two compounding companies whose operations feed each other and thus allow the company to compound at a higher rate of return. First, the company is a large collection of infrastructure and real asset investments that produce free cash flows. Secondly, the company is an asset manager that makes investments in infrastructure and real assets. On the one hand you are earning the rate of return of the investments, and on the other hand you are growing the size of the investment pool, and thus increasing the rate of compound return.

Company Overview Formerly known as Brascan, Brookfield is an immense, sprawling conglomerate with more than $180 Billion in assets under management (AUM) but is essentially comprised of four investment vehicles. The company owns

  • 28% of Brookfield Infrastructure Partners (BIP)
  • 68% of Brookfield Renewable Energy Partners (BRPFF.PK)
  • 92.5% of Brookfield Property Partners (BPY – spinoff pending)
  • 100% of Brookfield Capital Partners, a private equity fund

Funds from operations (FFO) flow from the underlying businesses up to the parent company and are then reinvested to further grow funds from operations. It is important to understand that Brookfield really creates wealth through deals and asset accumulation, not asset appreciation. Their business is generating capital and then redeploying that capital into new investments. The end result of which is a diverse stream of free cash flow. I think the assets that Brookfield owns range from pretty good to truly essential.

Risks Investment Return I think over the really long term Brookfield will only earn a return on investments roughly equal to the overall markets. This is in part because of the law of large numbers, but it is also because infrastructure investments tend to attract the attention of regulators. If Brookfield’s investments were to lag the overall market or lose money, then obviously that would impact investor returns.

Debt Brookfield makes heavy use of capital markets, third party and debt financing, and is constantly buying and selling assets. Infrastructure investments require large up-front capital expenditures and interest rates have to go up some time. A rise in the cost of debt used to fund investments will diminish long term returns.

Macro Economics Heavy infrastructure investments make more sense in an expanding global economy. A slowdown in the global economy will diminish the number of investment opportunities for the company.

Politics It is at least possible that the governments of the countries where Brookfield owns assets could decide to nationalize those assets or drastically change the terms of the original investment agreement.

Opportunity Asset Appreciation The opportunity for growth comes in three categories for Brookfield, the first of which is asset appreciation. The company should be able to roll-over existing leases and contracts at higher market rates. In other words, Brookfield’s assets should be worth more over time.

Asset Accumulation Brookfield will continue to make investments in additional assets. This is the company’s bread and butter.

Assets Under Management Brookfield’s past success should allow them to attract new capital from an expanding base of clients. This will result in an expanding base of management, incentive and performance fees.

The cash flows from these three growth categories will primarily be reinvested in further asset accumulation.

Financial Strength Brookfield is a complicated conglomerate, but they have proven the financial strength of the business model during the 2008-2009 debt crisis. After buying an asset the company will “lock in” revenues with a 10 to 20 year contract. For example, an office tower will be leased on a 10 to 20 year contract to the corporate tenant, or a hydroelectric plant will pre-sell its energy production on a similar long term contract. Once an investment has been “locked in”, it will safely and quietly generate free cash flow for the duration of the contract. These investments are staggered in such a way that no one year’s contracts will sink the ship, so to speak. So during the 2008-09 crash they retained their cash flows and thus their liquidity. While competitors were selling, they were in a position to buy.

Management Brookfield is run by a man named Bruce Flatt. While the company has many moving parts, it is run with the single-minded purpose of generating sustainable low-risk cash flows and increasing shareholder value. As a matter of fact, Brookfield has a share ownership program that requires management to own stock valued at 5 times their annual salary. By definition, if you choose to invest in Brookfield you are taking a leap of faith in the management team’s ability to continue generating results similar to those of their past. Brookfield is a “tailcoats” investment, in that shareholder success depends on management’s investment skills.

Valuation Management at Brookfield provides their own lofty evaluation model for the company, but I wouldn’t want to take them at their word for it. Once the spin-off of Brookfield Property is completed it will be easier to assess the parent company’s value by simply adding up the value of its publicly listed parts. The company can effectively be broken into two parts; the value of the investment portfolio and the value of the asset management firm. As of December 31, 2012 the company estimates the value of its net invested capital at $37.71 per share and the value of the investment firm at $7.22.

Over the course of a long-term investment, I think it is reasonable for Brookfield to earn market like returns on their investments. So that’s about 6%-7% historically. In addition to this, I think the company can grow its asset management franchise by an additional 4%-6%. Thus, my expectation is that the company will grow its net invested capital at about 10%-13% a year. If you can buy shares at a reasonable margin of safety it’s within reason to expect an annualized return of 15% or better.

While the number for net invested capital includes some fair value estimates made by the company, it is a reasonable guide of fair value. With this, investors can gauge the value of the asset portfolio and basically get the asset management franchise for free. If you can buy the company at a reasonable margin of safety to the value of net invested capital, I think Brookfield Asset Management is a high quality company that would make for a dependable core holding.

Bulls Say

  • Broad exposure to high quality “real assets”
  • Outstanding long-term management
  • Growing investment portfolio
  • Growing asset management franchise

Bears Say

  • Fear of future investment mistakes
  • Exposed to interest rate risks
  • Exposed to currency risk
  • Exposed to emerging markets risk
  • Complicated conglomerate structure

 

Smaller REITs

THIS IS A DRAFT

WE WILL LOOK AT MY TOP 20 SMALLER REITS

On the TSX, the Capped Reit index (XRE) has risen 34% in the past 5 years. Individual TSE REIT stocks have done better. One of my favourites, AP.UN, is up 82% in the same period.

But what about smaller Canadian REITS.

A LIST from 2011 that I found very useful at the time.

Dividend Guy

http://www.thedividendguyblog.com/2011/01/12/2011-top-10-canadian-reits-list/

HE SAYS:

After discussing Canadian REITs this Monday, I thought of building the 2011 Top 10 Canadian REITs List for your viewing pleasure (and trading ideas ;-) ). As I have mentioned before I think this is the right time to buy Canadian REITs. While restructuring my portfolio, I am considering adding one or 2 Canadian REITs.

2011 Top 10 Canadian REITs List

Ticker Name Market Cap Price 1Y Return Dividend Yield
REI-U RioCan Real Estate Investment Trust $5,718,694,000.00 $22.13 22.78765 6.23
HR-U H&R Real Estate Investment Trust $2,864,070,000.00 $19.64 28.14426 4.01
CWT-U Calloway Real Estate Investment Trust $2,702,908,000.00 $23.65 30.57648 6.5
BEI-U Boardwalk Real Estate Investment Trust $2,205,670,000.00 $42.00 21.72624 5.45
BOX-U Brookfield Office Properties Canada $2,152,773,000.00 $21.75 N/A 2.92
REF-U Canadian Real Estate Investment Trust $2,092,598,000.00 $31.38 20.80782 4.46
D-U Dundee Real Estate Investment Trust $1,485,945,000.00 $30.23 60.89588 7.24
PMZ-U Primaris Retail Real Estate Investment Trust $1,360,410,000.00 $19.79 32.25037 6.23
CAR-U Canadian Apartment Properties REIT $1,319,796,000.00 $17.24 25.22318 6.26
CUF-U Cominar Real Estate Investment Trust $1,304,211,000.00 $20.84 14.52305 6.88
CSH-U Chartwell Seniors Housing Real Estate Investment Trust $1,199,403,000.00 $8.40 23.04563 6.41

Updated to March 22, 2013, that’s an average increase in price of 31.8% over a little more than two years. Plus the yield. Not a bad list he prepared.

Ticker Name Price: 2011 Price: 2013 % Increase
REI-U RioCan Real Estate Investment Trust $22.13 27.25 23.1%
HR-U H&R Real Estate Investment Trust $19.64 23.24 18.3%
CWT-U Calloway Real Estate Investment Trust $23.65 29.29 23.8%
BEI-U Boardwalk Real Estate Investment Trust $42.00 62.07 47.8%
BOX-U Brookfield Office Properties Canada $21.75 28.16 29.5%
REF-U Canadian Real Estate Investment Trust $31.38 44.67 42.4%
D-U Dundee Real Estate Investment Trust $30.23 36.46 20.6%
PMZ-U Primaris Retail Real Estate Investment Trust $19.79 27.15 37.2%
CAR-U Canadian Apartment Properties REIT $17.24 25.13 45.8%
CUF-U Cominar Real Estate Investment Trust $20.84 22.68 8.8%
CSH-U Chartwell Seniors Housing Real Estate Investment Trust $8.40 10.99 30.8%
AVG 32.8%

What To Consider When Buying A Canadian REIT

While there are many reasons why the whole sector will go well, it doesn’t meant that you can close your eyes and any stock pick will do. I would say that there are a few points to consider before buying any REIT. Along with regular stock analysis factors to consider, there are a few other things to look at before trading REITs. Here’s my Top Check List on Canadian REITs:

– Types of property held (apartment buildings, golf courses, shopping malls, mortgages, etc)

– Concentration of location (big cities, small cities, overheated market?)

– Stability of distribution (this is what we are looking for, right?)

– Level of depreciation of assets (in Canada, we call it amortization. It is important to understand the accounting distortion when looking at financial statements)

GLOBE AND MAIL

March 23rd-2013

Investors who bet on the big boys of Canadian real estate investment trusts have made good money in recent years, but it might be time to look further down the REIT food chain for tomorrow’s best deals.

The iShares S&P/TSX Capped REIT index, XRE, which is dominated by the country’s biggest REITs, has gained about 83 per cent, including reinvested distributions, over five years as it recovered from the 2008 financial crisis, but this year the benchmark has been flat, suggesting that many investors regard it as fully valued.

By looking beyond the index, investors can find opportunities that are below the radar among smaller players that may “give a nice yield advantage and provide some good returns,” says Derek Warren, a portfolio manager with Morguard Financial Corp. “You can benefit from capital appreciation if the business grows over time.”

Smaller REITs are still able to make acquisitions that can substantially increase their earnings per share, while larger players are having a tough time finding takeover opportunities big enough to have a significant effect on their results, he said.

In addition, smaller REITs offer a degree of protection if market winds begin to shift and money managers decide to dump their real estate holdings to invest in another hot sector. In that scenario, most of the selling pressure would be directed at the biggest, most easily traded names, rather than smaller firms.

Some smaller REITs and real estate operating companies are also well positioned to be swallowed up by larger players, which could produce big takeover premiums.

Cominar REIT acquired Canmarc REIT last year at a 24-per-cent premium to the price that Canmarc was trading at before the takeover bid was launched. On Tuesday, shares of C2C Industrial Properties Inc. surged 26 per cent after Dundee Industrial REIT announced a takeover bid for the company.

Still, smaller REITs can come with higher risks because they may not always be able to get financing for acquisitions that will add value and sustain their yield, Mr. Warren warned.

“Be very cautious when it comes just buying small companies with high yield. It is much better to invest in a company that has a slightly lower yield, but with good growth prospects … somewhere in the 7-per-cent range, but not 8, 9 or 10 per cent.”

Here are three top picks among smaller-cap REITs from real estate equity fund managers.

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Derek Warren, portfolio manager, Morguard Financial Corp., CIBC Canadian Real Estate Fund

Pure Industrial REIT

Annual distribution: 0.312 cents a unit for yield of 6 per cent

Last close: $5.20

The REIT, which owns industrial properties across Canada, has an average lease of about nine years on its properties, which means its cash flow and yield over that period are highly predictable. “This is a very safe dividend payout,” Mr. Warren said. Unlike many large-cap peers that have payout ratios exceeding 90 per cent, the comparable figure for Pure Industrial is only 82 per cent. Pure Industrial REIT trades at roughly 13.5 times its estimated adjusted funds from operations (AFFO) for 2014 – a reasonable valuation, he said. He has a one-year target of $5.75 a unit.

————-

Jeffrey Olin, manager, Vision Capital Corp., Vision Opportunity funds

InterRent REIT

Annual distribution: 16 cents a unit for a yield of 2.5 per cent

Last close: $6.39

Mr. Olin says that InterRent, which operates apartments mainly in Southern Ontario, has an experienced management team that typically looks to acquire properties where the REIT can add value. “They don’t buy coupon-clipping assets.” Besides raising rents, it will increase revenue by adding new suites in existing buildings or reduce costs by installing submeters for hydro consumption that will be paid by tenants, he said. The REIT, which could climb to the $7.50-to-$8 range in one to two years, is expected to raise its payout this year, he added.

———–

Lee Goldman, co-manager, First Asset Investment Management Inc.,First Asset REIT Income Fund

Morguard North American Residential REIT

Annual distribution: 60 cents a unit for a yield of 5.4 per cent;

Last close: $11.22

The apartment operator has 55 per cent of its properties in the United States and the rest in Canada. “We expect most of the growth to come from the U.S.,” partly owing to an improving real estate market and higher-quality properties, Mr. Goldman said. The REIT, which could raise its payout next year, trades at a discount to peers, and to an estimated net asset value (NAV) of $12.75 a unit, he added. Morguard Corp., a long-term shareholder, owns 49 per cent of the REIT so there won’t be takeover premium priced into it, but “the discount is pretty extreme right now,” he said.

  • AAR.UN-T
  • IIP.UN-T
  • MRG.UN-T

Monarchs: time to expand our milkweed patch!!

1008_butterfly121-300x200

One of the key indicators of health for North America are the Monarch butterflies that come back each spring.

2012 was a lousy year for them.Herbicides are probably a major problem, but they face lots of challenges besides Roundup. The Monarch  has large orange and black wings. The Monarch prefers Milkweed as a host plant. For nectar, it feeds on such plants as Milkweed, Aster, Cosmos, Daisy, Red Clover, and Zinnia.

For us in the vineyard, the quantity of Monarchs is an indicator of the quality of the vintage.

Western monarchs reach British Columbia only in summers with extended periods of warm, sunny weather in the Pacific northwest.

The CBC Says:

http://www.cbc.ca/news/technology/story/2013/03/20/f-monarch-butterfly.html

Soulsby Farm shows what they are doing:

http://soulsbyfarm.org/2013/03/24/build-a-monarch-rest-stop-waystation-butterfly-garden/

PATTERNS:

In a monarch butterfly’s life cycle, it goes through a complete metamorphosis involving four stages: egg, larva (or caterpillar), pupa, and adult. In addition, each individual monarch contributes to a larger population life cycle, involving many generations. The fall migrants are usually 3 or more generations removed from the monarchs that overwintered in Mexico during the previous winter. In other words, each fall the last generation of monarchs must navigate to a location, perhaps 2000 miles away, which they’ve never visited.

The majority of monarchs who make the fall journey are in reproductive dormancy. The goal of this initial population is to survive the trip to the overwintering sites in Mexico. After their season in the migratory site, the female monarch reproductive organs become fully developed and mating takes place.

As they migrate north in the spring, they lay eggs on milkweed along the way. These larvae appear in the southern return path in March and early April. This generation will also migrate North following their parents. The reproductive cycle continues and by August to early September, three to four generations will have evolved. So losses which have occured througout themigration cycle will be replenished by this population buildup.

It would be nearly impossible for an individual monarch butterfly to complete this entire migratory cycle. Because of this, their rapid system of reproduction is of great importance to the survival of the species and the completion of the migratory cycle from year to year.

III. Migrational Pattern/ Behavior:

The migration of the monarch butterfly begins in Canada and the northernmost parts of the United States. The fall migration begins in late August ending in the months of November and December. The destination of the butterflies lies in Central Mexico, in the Oyamel forests. Traveling in a southwesterly direction, the monarchs fly east of the Great Lakes and south-southwest in areas west of the Great Lakes. Those that reach the gulf of Mexico follow the coastline in a continuous stream. They continue in a southwest direction eventually reaching the overwintering site in the Transvolcanic Plateau of Mexico. As many as 300 million spend the winter there.

During the migration, monarchs encounter many dangers. These dangers include such things as storms, predators, humans (more accurately, their cars), and simple fatigue. Many butterflies are the casualties of storms and are eaten by birds. Hundreds are crushed by cars crossing the highways, and still many more can be seen limply trying to keep aflight, ready to collapse at any moment. Even after the monarchs arrive at their winter retreats, the danger of storms is still a major factor on the survival. The danger is greater, particularly in Mexico, where temperatures, strong winds, and snow kill thousands.

As mentioned before, this migration takes up to three generations to complete! The exact migratory path is still being plotted today. Scientists are tagging the butterflies, and recording their locations during the months of the fall migration.

During the migration, the monarchs feed extensively on flowers to gain carbohydrates from nectars which fuel daily activities and contribute to the build up of the fat body in the abdomen. This fat supply gives energy to the monarchs on their long journey. Monarchs travel distances as great as 3,100 miles during their migration, traveling roughly 50 miles per day. Monarch flight speeds have been measured at 12 miles per hour. Once they have reached their roosting site, they cluster in large numbers in the branches and trunks of the oyamel trees. While clustering they remain quiescent (they stay relatively sill and maintain low metabolic rates). In mid-February, the monarchs at the roost sites become more active and mating behavior begins. By the end of February, some of the monarchs begin moving northward, by mid-March the roost is usually depleted (Urquhart1987).

This initiates the start of the spring migration. The spring migration starts out with only about half of the original roosting population. Forty to sixty percent of the monarchs die during their stay in Mexico. During the spring migration, the monarch butterflies return to their homes in Canada and the northern most parts of the United States. Along the way, they roost and reproduce, giving rise to new butterflies that will continue the spring flight back.

IV. Migration Mysteries:

Now that the details about the actual migration process of the monarch butterfly has been covered, a common question that most people wonder about is why the monarch butterflies migrate in the first place? Unfortunately, there is no one simple answer to this question. Researchers in this field are collecting field data related to the monarch’s biological migratory behavior to try to uncover this mystery. Although there are no definite answers to the question of why monarchs migrate, several hypotheses have been formulated.

The first and most simple explanation is that like migratory birds, monarch butterflies migrate to warmer climates to escape from the upcoming cold weather and the food shortage that will result from the temperature fall. But how do the butterflies “know ” that the winters are cold? They don’t. What the monarch butterflies sense is the changing amount of light present and the variability of day and nighttime temperatures. With the change of seasons from fall to winter comes the inevitable shortening of the days, longer nights, and also colder nighttime temperatures. Once these characteristics show up, the monarchs leave for their overwintering sites.

The question now is: Why do the monarchs follow such a particular flight pattern and destination? In his book the Monarch Butterfly: International Traveler, entomologist Fred A. Urquhart addresses this issue, and developed a hypothesis based on his studies of monarch butterflies. Mr. Urquhart states that migration is related to three principle factors: (1) monarch larvae feed exclusively on species of milkweed; (2) the migratory pattern is from northeast to southwest; and (3) there is a long history, extending over eons of time, of the distribution of the milkweed species of the genus Asclepias (p.119).

The conclusion is that, ” the northwesterly-southwesterly migrations are correlated with the changing distribution of the species Asclepias resulting from changes in the North American land mass over millions of years.” (Urquhart 1987) In plain terms, the migrational pattern presently observed originated in the distant past when the monarchs were following the milkweed species which were spreading westward. This east-west movement was eventually incorporated into the monarch’s genetic code to produce a cyclical migration related to some as yet unknown response to seasonal changes on the planet.

PACIFIC COAST

There is a distinct population for the pacific coast, west of the Rockies.

The western population includes all monarchs found west of the Rocky Mountains in the United States and Canada. The current annual breeding range of western monarchs extends from Arizona and New Mexico to southern British Columbia and from the Rocky Mountains westward to the Pacific coast. Western monarchs reach British Columbia only in summers with extended periods of warm, sunny weather in the Pacific northwest. During such favourable years, breeding occurs in scattered locations across the province, particularly in the Okanagan Valley and along the Fraser River.

Monarchs of the western population undertake an annual migration much like that of the eastern population. They overwinter at numerous sites along the nearly 1 000 kilometres of the California coast to the Mexican border. More than 200 overwintering sites have been recorded in California, and individual colonies may support dozens to tens of thousands of individuals. The vast majority of these overwintering sites are associated with stands of non-native Australian eucalyptus trees.

The annual southward migration of the eastern and western monarch populations begins in Canada in early August and continues through to mid-October. When monarchs are migrating, they do not reproduce. They avidly seek nectar from flowers to fuel their migration and to build up a critical fat reserve to sustain them through the winter. This stored fat is also essential for their northward migration in the spring, when nectar sources are not available.

The Central American monarch population occurs in Guatemala, El Salvador, Honduras, Belize, Nicaragua, Costa Rica, Panama, and southern Mexico. Unlike the eastern and western populations, the Central American population migrates only 10 to 100 km between highland and lowland areas, according to dry and wet seasonal conditions. This monarch population reproduces throughout the year.

 

FOODS

Butterfly season generally starts in April and goes through October. When planning your butterfly garden, choose a variety of plants that will bloom at different times throughout these months. If everything blooms in the spring, your butterflies will pack up and move on by summer.

A standard butterfly garden includes a mix of annuals, perennials, herbs and shrubs. Plants that are considered butterfly friendly include: Alyssum, Anise, Aster, Bee Balm, Butterfly Bush, Butterfly Weed, Catnip, Chives, Clover, Columbine, Coreopsis, Cornflower, Cosmos, Day Lily, Delphinium, Dianthus, Digitalis (Foxglove), Dill, Echinacea (Purple Coneflower), Fennel, Honeysuckle, Hollyhock, Impatiens, Lavender, Lilac, Lobelia, Lupine, Marigold, Milkweed, Mint, Nasturtium, Parsley, Petunia, Phlox, Queen Anne’s Lace, Salvia, Sage, Shasta Daisy, Snapdragon, Sunflower, Sweet Peas, Sweet William, Thistle, Trumpet Vine, Verbena, Veronica, Yarrow, Zinnia.

AAPL: Jensen Two

Here is Jensen’s follow-up from the March 17th article.

Looking pretty prescient from a week ago but we will see how April goes.

********

BRET JENSEN

There are four basic types of investors; Growth, Value, Income and Momentum. For many years, Apple (AAPL) was a stock that appealed to all these investors with the exception of Income investors. Although its growth was phenomenal for years, its earnings multiple rarely got above the overall market especially if one considers its giant cash hoard. From the stock market bottom in March 2009 to its all-time in Mid-September, Apple was a stock that made all of its investors (growth, value, momentum) consistently happy. However, starting with its descent from over $700 a share in September all the way down to its recent low of $420 a share; Apple gradually lost its investor base. First, momentum investors started to bail when the stock moved under its 200 day moving average in early November. Then growth investors started to abandon the stock soon thereafter as concerns about declining gross margins and increasing competition from Samsung (SSNLF.PK) weighed on growth investors worried about falling earnings estimates. This left only the value investors to support Apple’s stock price.

It was a long, ugly ride from $705 a share down to $420 a share earlier this month. I recently penned an article on why I believe that $420 level was likely to be the bottom for Apple. Since then the stock has gained some 10% and is on its way to recapture more of the investors that recently abandon the shares. After underperforming for months, Apple beat the S&P substantially last week (see chart 1).

(click to enlarge)

More importantly, AAPL crossed its 50 day moving average for the first time since October (see chart 2) Friday. This should start to recapture the momentum investors that dumped the shares late last year. The next momentum milestone will be around the $500 a share level where the current 100 day moving average currently hovers.

(click to enlarge)

I think the stock could soon hit that important level as it is about to start to appeal to income investors. The company paid its first dividend in August of last year and the stock now yields 2.3%. A nice yield, but not the 3% dividend level that normally is necessary to attract income investors. However, that is about to change as a dividend hike is widely expected to be announced in the near future. Projections are all over the map including the possibility of a special dividend. Most expectations seem to be for a 50% to 100% increase with a recent poll of analysts by Bloomberg showing an average prediction calling for a 56% hike. This would put Apple’s dividend yield to over 3.5%. This is more than traditional dividend stocks like Procter & Gamble (PG) which yields 2.9% and sells at more than 17x forward earnings (Apple sells at just over 9x forward earnings in contrast, under 7x forward earnings subtracting cash).

By the time earnings come around again on April 23rd, Apple should be a core holding for value, income and momentum investors, which should bode well for continued upside on the beaten down shares. Getting the growth investors back on board might take an earnings report that does not show eroding gross margins. A bigger or cheaper iPhone, an iWatchor iTV announcement could also appeal to growth investors. I think having the momentum and income investors behind the stock could get the stock back to $560 a share (recovering roughly have the decline from $700 to $420 a share) but getting the stock back to its previous highs might require a successful launch of the new version of the iPhone 5 rumored for late summer. Still, a $100 a share increase in the shares until that happens should be enough to satisfy current shareholders in the meantime.

Monie Carr

A good, thoughful article.

Taking a long range view of things.

Cmmments on Jobs grooming Cook are useful

 

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Apple (AAPL) has been a fantastic company to follow since it was created in 1976 by Mr. Jobs and Mr. Wozniak, providing students with multiple case studies and career motivation. Apple is the perfect example of what the American Enterprise System can create. Apple’s product successes drove the stock from the 2009 bottom of around $90 to a high of $705 in 2012.

Pessimism around the stock and the company has risen dramatically with the fall of the stock price. At this point, it doesn’t seem as though Apple can do anything to please any of their analysts. I read as many of the analysts’ reports as possible and find the analysts to be financially brilliant. Their knowledge however, of product development, product marketing or manufacturing in the consumer electronics space, I find is quite deficient. Therefore, many of the conclusions they reach in regard to what products should be created, what their competitive deficiencies or advantages might be or what a future build plan portends to be naively inaccurate.

Estimating Apple earnings has also been problematic, and Apple has missed analyst estimates the last three quarters, resulting in a decline in price of some 35%.

So how can we be absolutely sure that Apple is still performing at world-class standards and not careening into oblivion as many analysts and writers would lead us to believe?

I decided to turn to the acknowledged expert on what makes a great company, Jim Collins. Mr. Collins has a research lab and consulting practice based in Boulder, Colorado. Four of his six books cover this subject: Good to Great; Built to Last; Great by Choice; and How the Mighty Fall.

One of the persistent criticisms of Apple is that it is no longer an innovator, its last product innovation being the iPad. Mr. Collin’s research does not support the premise that 10X companies, as he refers to them, are any more innovative than their less successful comparison companies. The 10X companies, in some cases, were clearly less innovative than their comparisons. Other researchers support this same conclusion as well. This doesn’t mean that innovation is unimportant but that the combination of creativity/innovation and discipline are important. Apple’s creativity is clearly evident in their product design and their prolific patents. Their discipline to do things the Apple way often drives their critics to distraction.

Another concept that Mr. Collins introduces in Great by Choice is that world class companies fire bullets before cannon balls. The object is to turn small successes into larger successes. The definition of a bullet is: an empirical test aimed at learning what works. One that costs little or that is low in risk and a test that imposes little distraction for the company. What the market seems to want from Apple is the next big thing, an iTV or a huge acquisition like Netflix or a large cash payout. Bold moves like this (cannonballs) fired indiscriminately, is what dooms good companies to failure. We have seen Apple make multiple acquisitions of small companies (bullets). We have recently seen Apple fire a bullet in the form of Apple TV. I suspect the next bullet they may fire might be an SDK for Apple TV. I would suggest that when Apple has the empirical validation they need, they would then fire the cannonball the market is expecting.

Another symptom of decline can be the failure of a leader to develop a strong successor. Tim Cook has received his share of criticism from outsiders. Like other CEO’s, Mr. Cook must prove himself to employees, board members and stockholders daily. We cannot, however, accuse Mr. Jobs of not carefully grooming and choosing his successor. In fact, if we refer back to Mr. Collins’ book Good to Great, he has carefully researched the leaders of great companies and Mr. Cook nearly perfectly fits the personal and professional profile Mr. Collins has developed for great corporate leaders. Mr. Cook has great promise. Only time will tell if he develops into a great leader.

In an earlier book How the Mighty Fall, Mr. Collins researches formerly great but failed companies, why they failed and how some companies recovered and returned to greatness. Apple, like IBM has already recovered from past near failures. Mr. Collins’ research identifies five stages of decline that are present in failing or failed companies.

The first crack in a company’s armor is overconfidence created from past success. Demonstrable hubris manifests itself in different forms. It might be demonstrated by getting into a business that they know very little about. It might be rushing a product to market, pursuing growth that they cannot support, risky decisions that appear to have conflicting evidence or just plain neglect born of arrogance. Apple has clearly been successful since Mr. Jobs started his second tour of duty. Mr. Cook has said, “The most important thing to Apple is to make the best products in the world that enrich customers’ lives.” Outsiders are frustrated by the limited flow of information from Apple but at this point the term hubris (excessive pride) does not seem to apply to Apple.

The second stage of decline is the undisciplined pursuit of more. It is commonly understood that most companies fail or falter because they become complacent and failing to innovate, an allegation we often see in the media regarding Apple. Mr. Collins’ work demonstrates that complacency is seldom the cause for decline but over reaching is more often the problem. Growing the company too fast, not being able to hire enough highly qualified people or acquiring companies that they are unable to absorb efficiently or in a timely manner are indications of over reaching. This is the area that probably least applies to Apple, demonstrated by their conservative use of a very large cash position and the constant calls in the media to spend that money in some spectacular way.

The third stage of decline is the denial of risk. Companies can characterize this state when they make big bets concurrent with mounting evidence that appears to be contradictory to their success. Mr. Collins identifies a common corporate behavior in this stage when leaders begin to blame others or external factors as they decline. Another manifestation of this problem is obsessive reorganization. So far, we haven’t seen this type of behavior from Mr. Cook or his lieutenants.

We do have some warning flags that deserve careful scrutiny. Financially, the deterioration in gross margins is the most disconcerting. Their debt is not an issue but there might be signs of mediocrity. Declining customer engagement, inventory issues (most of these have been related to the inability to meet demand) and any potential pricing power issues.

The final two stages of decline identified by Mr. Collins are management grasping for salvation and finally capitulation, which results in a sale or cessation of business. These two final stages are clearly not in play.

We can conclude that by studying Mr. Collins’ work we see little evidence that Apple has symptoms contained in stage one or stage two of corporate decline. The description provided of stage three provides us with areas to watch that might determine Apple’s future direction. The bottom line, as is often the case, will Mr. Cook and his management team lead Apple to even greater success? They certainly have that opportunity!