Apple found itself with the back against the wall when it reported the slowest profit growth since 2003. Unless it does something to get back on the horse right away, things are going to get very ugly. Already, Apple bears are rubbing their hands with glee, thinking that it might be the end of an era for this stock. But, is it really the beginning of the end for Apple?
Pay attention to ROIC
When investors study a company’s fundamental and technical state seeking a compelling investment opportunity, they ask themselves a bunch of questions: Has this company enough cash piled up in its coffers? Does it pay juicy dividends? Is it cheap?
What I care about most when examining a company’s overall financial and competitive performance is profit. By profit, I do not mean what the company reports in its income statement as accounting profit. I mean economic profits or rents: how much the company earns in excess of the opportunity cost of capital, which includes the cost of equity and the cost of debt.
In other words, economic profit is based upon the notion that true profit should account for the hidden cost for trying up investors’ money to support operations. A company may be profitable based on the bottom figure in its income statement. But, in terms of economic profit, it might not be able to generate wealth, simply because an alternative investment of similar risk would have been more lucrative. At the end of the day, what really makes a company worth investors’ money is the value it creates for its shareholders. True value can only be generated when the return on invested capital is larger than the cost of capital.
For the period 2009-2012, Apple Inc. (NASDAQ:AAPL) had an average return on invested capital greater than 42%. Google Inc (NASDAQ:GOOG)’s, on the other hand, stood at slightly over 20%. If we take a look at trailing-twelve-month data, Apple scores a return of more than 38% and has a weighted average cost of capital of roughly 10%. Google’s cost of capital is slightly lower to somewhat above 9%, but the return on invested capital is barely above 15%.
Apple knows how to get the job done. It is as simple as that.
Getting back on the horse
It was Joseph Schumpeter, an Austrian-American economist and political scientist, who first supported the idea that innovations can create wealth. Schumpeterian rents imply that a company can enjoy profits for as long as its breakthrough products dominate the market. A new and unique product can be a real money-spinner until someone else does something similar. After all, it doesn’t matter how well you do something if there are others who can do the same thing.
This is, more or less, the story of Apple Inc. (NASDAQ:AAPL)’s success. Back in 2000, Apple was a nobody. After releasing the iPod and changing the way we listen to music, it went from zero to hero. The iPod was just the first in a string of innovations that enabled Apple to become the most valuable company worldwide.
So, why this recent slump in the stock price? At the moment, Apple is taking a — what I’d like to think — short break between past and future eureka moments. The market is reacting over abnormally dull product launches that caused a certain degree of uncertainty, even fear, among investors. There was a reason behind Apple’s decision to reduce the production of its newly released iPhone 5. Sales were not as strong as anticipated. But, it won’t take long before Apple experiences another eureka moment. All Apple needs is another “cool” idea.
What if….
What if Apple has lost its charm? Back in the early 2000s, Research In Motion Ltd (NASDAQ:BBRY) revolutionized the mobile industry when it created a power e-mailer. But since then, a series of misfortunes and management mistakes painted a rather gloomy picture. BlackBerry has been struggling for a turnaround for quite some time now. It wasn’t until the introduction of its new and improved BB10 that it managed to escape from a long-term steep downtrend. Nevertheless, although Research In Motion Ltd (NASDAQ:BBRY) is heading to the right direction, it has a long way to go before it can regain its past glory.
What if this were to happen to Apple Inc. (NASDAQ:AAPL), too? Certainly, intense competition from Google Inc (NASDAQ:GOOG) isn’t helping at all. Google has been working overtime trying to step its game up and crush every single player in an overcrowded tech-market. From Sci-Fi glasses to talking shoes for athletes, there isn’t much that this company can’t do.
What differentiates Apple from its peers, though, is the ability to capture people’s needs and translate them into simple and stylish solutions. For Apple, the eureka moment might have already occurred with the concept of the iWatch, a wristwatch-style device that, according to analysts, could prove to be extremely profitable.
Who knows? All I know, is that the company is famous for bringing to the table ideas that, in a way, change our lifestyle. Apple knows how to create fashion and attract customers as nobody else does. The iPhone might be one of the most expensive smartphones on the market, but still, everyone has to have one. Never ignore what a company has achieved in the past. It can give you a glimpse of what it is capable of doing in the future.
The takeaway
Apple might be experiencing a temporary slump. This most definitely does not mean that it is the end of an era for this stock. Apple will be able to get back on the horse in no time, and then, its faithful shareholders will be sufficiently rewarded.
The article Waiting for Apple’s Next Eureka Moment originally appeared on Fool.com.
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