Comment by j-g-faustus | Hacker News Reader

Comment by j-g-faustus | Hacker News Reader

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Consider a simple model where the "fair value" of a company is the sum of their next 10 years of profit:

If a company made $1m last year and is expected to stay flat for the next decade, it's worth $10 million.

If a company made $1m last year and profits are expected to grow 10% annually, it's worth $16 million.

If a company made $1m last year and profits are expected to grow 100% annually, it's worth $1 billion.

The implicit model for stock pricing is more complicated, but you can see correlations even in a simple model like this.

Nobody knows what will happen several years into the future, so it's mostly bets and speculations. Especially in high-growth companies, where many of the bettors appear to believe that trees grow to heaven, and the company's yearly profits will soon exceed the world GDP.

So the stock of high-growth companies sell at an enormous markup compared to current profits. By the same token, that markup can evaporate very quickly if a formerly-high-growth company shows any sign of slowdown.

In terms of the simple model above: If traders used to think that the $1m-profit company would grow 60% annually for the next decade, and something happens that makes them believe that it won't be more than 40%, the value of the company would immediately drop by more than 60%.

This lesson is well taken, but seems inadequate to explain Apple. Apple has not traded at an enormous markup relative to profits for five years, and is currently priced at a significant discount relative to companies that are not growth stocks, such as Microsoft, IBM, and Cisco.

True enough. IBM and Microsoft currently trades at a P/E (price-to-earnings ratio) around 15, Google at 23, and Apple was at 11 when the market closed.

So at least according to the "a company is worth X years of future earnings" model, Apple is priced as a company that will grow even less than IBM and Microsoft over the next X years. Or perhaps it's priced to grow a bit more in the immediate future, but to start declining after that.

There are certainly other factors at play as well, but I don't know them well enough to enumerate them.

My main point was simply that when you think of "present company value" as the integral (the area under the graph) of the earnings graph far into the future, and add growth rates and fluctuating uncertainty, several non-intuitive aspects of company pricing start to make more sense. Even if it doesn't explain everything.

Actually, it seems quite adequate judging from these graphs on Apple's EPS (earnings per share) growth: http://www.businessinsider.com/chart-of-the-day-apples-days-...

Apple has had a few quarters where year-over-year growth was around 100% (last in Q1 2011), that hasn't been the case in the last few quarters.

The market may be overreacting, but given that investors look at graphs like this and try to project the growth trajectory from the past few quarters several years into the future, pricing Apple a bit below Microsoft in terms of P/E doesn't seem all that unreasonable.

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