Chit Chat Stocks - Apple (Ticker: AAPL) with Anirban Mahanti

Episode Date: June 29, 2023

Apple Inc. (AAPL) is a global technology leader renowned for its iconic consumer electronics, software, and digital services, commanding a dominant position in the tech industry. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Use our code "CCM" and get $100 off a subscription at 7investing! Contact us: [e-mail] Timestamps Apple | (3:06) Brand | (16:33) AI | (31:48) Warren Buffett | (51:42) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we interview an analyst on a single stock or industry. And today we're talking with Anirban Mahanty about a little known company called Apple. Anirban is a lead advisor at 7investing. And this show, everyone already knows what Apple does generally. I'm sure they're familiar with the brand, but Anirban has owned the stock for, I believe, a little more than a decade now. And I think going through the company in the eyes of Anirban really illustrates how well the buy right and sit tight approach can perform for investors. And this is a perfect example of it.

He's owned this thing for 10 years. It's been a wonderful investment for him. and a lot of his reasoning and a rationale in the early days was behind those qualitative assumptions, how he assessed the business in the real world. And I think it's just a really fun example. And he goes through the business in great detail, talks about the investment as he sees it today. But before we get to that, we do want to say Seven Investing is a friend of the show. They come on the show all the time. You've probably heard a number of interviews that we've done. Anirban, like I said, is a lead advisor for them. And if you're interested in checking out

any of their write-ups, they have a huge catalog of research now. I really do recommend going and checking it out. We use it all the time for kind of idea generation and exploring new companies to look at. You can get $100 off right now using the code CCM. And I believe we'll have a link in the show notes as well. So if you want to go direct through the link, go ahead, check it out. but that's CCM is the promo code. You get a hundred dollars off the annual pass for 7investing. So like I said, go check it out. But without further ado, here's our interview with Anirban Mahanty. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick

reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. okay welcome in today we are joined by anirban mahanti i think i want to say like third time guest at this point he's been on the show a number of times uh he's a lead advisor at seven investing we will link uh to seven investing's website in the show notes so go ahead check him out he has a lot of recommendations that you can peruse if you enjoy this well if you enjoy this episode

but we're talking about a company, a little known company called Apple. Are they the biggest company in the world right now? They are. Okay. So yeah, I think most people know them, but Anirban, you have been an investor for quite a long time, if I'm not mistaken. So I guess, why don't you take us through that? When did you first start investing in Apple? And do you remember why you what your initial thesis was yeah it's a great question uh you know i've not been an investor for as long as i i would hope i was so my my first i think purchase was late 2012 so it's still a little over a decade um and i was just you know because we're going to talk about this i was just checking that you know cost basis so my cost basis around those you know from

the buys that i made you know 2012 and early 2013 you know that would range between say 15 and 20 dollars right so i mean somewhere between a 10 bagger and an eight bagger or 10 bagger in this time for a company which was pretty large at that time i thought which i think is pretty fabulous just speaks to some of the you know one of the benefits of uh i guess just buy and hold right you just need time to do its thing and good companies given time uh can you know really deliver the goods why did i buy it well um i used to work at a place called nicta as a research scientist at that time. And there was a lot of buzz about Apple products. I had a colleague there who used to buy every new Apple product the moment it came out. And of course, I was an iPhone user,

had an iPhone since 2009. So, you know, the fabulous experience, you know, being a Mac user since 2008, 2009. So, you know, I have experience with their products and I love their products. And there's just enthusiasm of the people lining up to buy the product. The product is coming out. The excitement that comes with the product. The sort of leadership provided by Steve Jobs. Those were all the reasons. I didn't look at financials at that time when I bought the stock.

I didn't think, oh, is the PE reasonable or is the valuation reasonable? I just thought this company makes fabulous products. to the people who buy these products, you know, or use these products, love buying them again and again. You know, they have a fanatical following. The stuff is, like, incredibly well-made. Even the packaging, you know, the joy opening the packaging, all of those, you know, it was all the qualitative aspects

driving it, right? And my wife at that time had a Samsung phone. But we purposefully had one Samsung and one Apple. And last year, she just experienced the two different things And she said, I don't like your stuff more. You know, why do I have this? So, you know, the next cycle of upgrades, you know, she moved on to having an Apple phone.

And then it's always been a question of who has the latest version, because we are like some really fervent fans who upgrade every, you know, every, I would say, yeah, we sort of upgrade every two years. So, you know. That's still pretty regular, Kate. and i think if i'm not mistaken it looks like you've got the apple airpod maxes on the headphones yes i do yeah well we have a lot of apple gear in this house uh you know the airpods and the

max airpods and the home pods and uh yeah this household runs on apple um yeah if some of this stuff doesn't work it'll be a problem i uh i'm quite the apple user myself brett is an android user correct yeah that is correct although i do have an ipad although i did get that one for free but yeah i it doesn't i get complaints all the time people tell me what am i switching which i'm a little bit stubborn about it but that is a fantastic you know positive investment indicator it is funny that or go ahead go ahead please no no i was just going to say that one of the things i used to do in all my previous uh roles i've had is that you know you know when i used to work for the model full at one point you know used to be a very big apple proponent and i i can take credit

for converting a number of people to from windows to macs and you know androids to apple um yeah we have a small business that we run and you know hey are you familiar with apple tools because all our business runs on apple so uh you know recently one of the ladies who worked there she you know moved from an android to the latest apple phone so yeah you know the apple fans do that they you know sort push people to move. That's what Tim Cook calls the switchers. It seems like their customers are sometimes their best salesmen. Let's talk through the business, though. Obviously,

a lot of movement parts here. You just mentioned all the different product lines they have. What drives the business today? What do you see as the important revenue generators? Yeah. So, at a high level, you see, Apple is a hardware and a software business, right? I should say hardware and a services business. The best way to think about Apple is to go to Apple's webpage and you can see what stuff they have lined up there, and that's basically the main revenue generators for them. It's pretty transparent. So, iPhone happens to be their biggest revenue generator that they have of course the ipad they've got the mac line and then they've

got what they they bundle a bunch of things which they call the um the home and wearables and accessories business now over time i guess one of the main things that that has happened is um previously apple was mostly in hardware business um and majority revenues and some at one point maybe 60 65 revenues were coming from the iphone right and that was back in say 20 say 2016 2017 one of the big issues with people was or investors who happened to be well if the iphone iphone upgrade cycle slows down this company is going to be really hurt because that's it's been butter and you know people where their their upgrade cycles elongating and things like that but at the same time apple was working on what i'd call the services business which is

things like you know icloud subscriptions apple tv plus you know apple music apple fitness um you know all the you know the various services that can apple care uh which is basically providing extended warranties and things like that and it's built that over time and today the business sort So it looks like roughly, I'd say 55% of the revenues come from, 50, 55% come from iPhone, right? About close to 20% of revenue today is coming from services, right? Which is very interesting because this business did not really exist. Let's say if we go back five, six years, it was a really small component. And the rest of the stuff is, you know, between the Mac and the wearables and so on.

What I think, though, is interesting is if you look at, you know, the product revenue distribution, I think this is what is interesting is that, you know, if I ask people, what do you think is the second biggest line after the iPhone, right? And that happens to be actually services, right? So services is almost getting close to an $80 billion run rate today. And it probably would hit $100 billion maybe in a couple of years, right? Think of this from the point of view of a company which has a trailing revenue of about, say, $380, $390 billion. That's a lot coming from services. Services has already moved to number two position. What I think is it'll be hard for people to think of is what's number three, right?

And number three is, it's a far number three in the sense that, you know, the gap between the two, you know, the gap, as much as there's a gap between one and two, there's a gap between two and three. And the third position today is held by the wearables and home and accessories, you know, that speaks volumes to Apple's success in, say, for example, the Apple Watch and the AirPods, the smaller ones, not the big ones, right? So, those have been really popular. And the accessories business and the wearables business has really done really well. Again, this business has grown from pretty much nothing, right? It used to be a really small business. There were no AirPods at Steve Jobs' time. There was no Apple Watch at Steve Jobs' time.

Beats was a relatively, you know, was a Tim Cook acquisition, right? So I think that's how the business is. It's basically selling hardware to people and then getting people into the ecosystem, getting them to then sort of subscribe to different services, right? And you have different tiers of services that you can buy today. but i'm a you know whatever is the highest apple one plus plus tier you know because we have the terabytes of storage and we have pretty much every apple service so we just have the apple one this you know thing and i didn't even talk about anything like the other ancillary things that

they're doing in services which is like you know apple pay apple you know buy now pay later apple savings account and all the financial fintech stuff that they've been doing now you talked about how investors were worried about the let's all call it the cyclicality risk of iphone or the iphone segment has that do you think that's totally gone now and if so why like how did they solve that potential issue that you know plagues a lot of hardware makers yeah so i think okay so there's a the answer is yes and no which is just like you know it's a funny way to answer things right because i think the cyclicality is there it was always there but i think that at the same time i don't think the cyclicality is that big a deal right i'll explain it so let's go back

to 2016 2017 around that time when apple's p was like you know price to earnings was really low because they were thinking of this like as a hardware maker you know um how many iphones were out there at that time probably half a billion iphones were out there today probably There are a billion iPhones, billion-plus iPhones that are out there, right? Now, the way I think about this is I just think, you know, you can think of it as a cyclicality, or I think of it just as a recurring revenue model, right? Because Apple as a company is actually making sure that its products run

as long as they can potentially run. So they're, you know, giving you up, you know, they provide you software updates for as long as they potentially can for a hardware device, right? Make them better, make them more useful. They would provide warranty coverage for it. So they want you to use it for a long time. But if you've got, let's say, a billion iPhones out there,

and even if you assume that four years is sort of the lifespan of these devices, then you're still looking at 250 million-odd replacement phones each year on average. And some years it's going to be more because there's been maybe an exciting feature that has come out that people want. Some years less because maybe the economic climate is not that good. But that recurring revenue business from, and that's the thing with these type of hardwares is that they don't have infinite lifespan, right?

How good it gets, maybe five years, people are going to push it to. But there is a recurring model for these phones, right? And then the mix will change a little bit. And then when you factor in things like Apple's push into countries, emerging economies, that's been a huge push lately. And they've been trying this for a long time.

but it's only starting i think to take effect now whereas that's pushing to say india or vietnam those countries are growing at a really fast pace and i can tell you honestly like you know android has a huge uh vast uh user base but if you talk to a you know upper middle class indian person for example they would love to have an apple iphone the brand is still strong right The brand is strong. Exactly. They want it. The only reason they don't have it probably is the cost or whatever. If they can convince people that you can get this phone and you can stick to it for five years, there will be a lot of switchers coming. I think the story about the switchers is not done. I think Apple's share is likely to increase over time than decrease

because the brand is that powerful. This is one of the things that they've done. is that they have very cleverly cultivated the brand, whether it's about privacy, whether it's about security, whether it's about ensuring that everything stays on your device, whether making the device better and intuitive to use. It's all about Apple cares about you. We charge you and we care about you. You are our customers. Your data, what you're doing, is not what we're interested in. We are interested in helping you. That's the messaging that they have used and that's actually i think it's working right if you look at the year-over-year growth rates in in those countries then it makes sense yeah i mean i think uh like you know apple a lot

of the times they have the best product in their category right but sometimes you know sometimes there might be a better one technologically that goes out there whenever i say have a conversation with someone about say a new tablet or a new watch or whatever they always immediately think that the apple product is the best even though you know most of the time it is even if it's not that point they still have that brand perception that it is the best yes yeah absolutely yeah so the brand is a huge deal and the brand means something opening for example those retail stores and tim cook was there in india the reason to do that was and you could see the lines that we have seen here in sydney people you know in the past used to see these lines because now everybody

buys stuff online um those lines are incredible that just shows how much people care about this brand how much people want this brand so i think they've got an incredible um brand a brand they cultivate it very nicely they care for their customers customer service has always been a rated like you know if you go to their store for a service you are going to get this service they never try to sell you something you see that you know microsoft had stores nobody was there apple had stores just next door everybody was there it's just i think when it comes to consumers and understanding consumers, they do a great job. So that's their superpower in many ways.

Yeah, 100%. I think there's like a million rabbit holes we could go down here with Apple because there's so many different segments to their business. But I wanted to touch on the services side of things. For anyone that doesn't follow Apple closely, and I know they aren't entirely open about it, if I remember correctly, but what makes up the majority of that service's revenue? Yeah, so that's an interesting question, and it's hard to know

because they don't really give us the breakdown, right? But I would assume that – and the only way, I guess, I try to read into this is if you read a 10-K, which is the annual report, and if the ordering of certain things are provided in a certain order they're not alphabetic that's probably indicative of something um right and so i think app store revenue is up there um you know uh tac so which is uh you know for for traffic acquisition costs that other companies pay to apple so this would be like you know people like google for example um they would be up there i would think icloud would be up there sort of you know then apple

music um and then you know maybe apple fitness and um and then probably some of the other things right um i think financial services like apple's fintech services have been actually they grew they're growing really quickly but i think they're from a revenue generation point of view they're relatively small well what's small for apple is really big for other people but it's small for apple right um so i would think that apple's uh you know apple pay and and all the other related services, actually they're small contributors to the total revenue. You know, my guess would be it's the App Store,

App Store probably and iCloud, those are the biggest contributors and maybe potentially followed by, you know, Apple Care and then, you know, Apple Music and things like that. But I think the other thing to think about though is that some of those businesses have higher margin relative to others, right? So if the fintech services probably are very high margin,

iCloud probably is high margin, but things like Apple Music, for example, may not be high margin because there's a lot of revenue that there are a lot of cost of goods that they have to pay back to the record labels and the artists and things like that. So there's that aspect to consider. But yeah, I would say those are,

I think the way I think about this though is, you know, and we can come to this later, we can ask the question, and I've been thinking about this a little bit, why did Apple do provide services, right? And, you know, one of them is, yes, they can provide a better alternative or an alternative that suits their customers, right? But I think the other reason could be that Apple wanted a platform of services, owned services that would help it that would help the company actually build or innovate the next computing platform right and if you talk about you know vision pro later on then i think there

is a link here um that you know this is a company that is an incredibly long-term thinker so if you think about you know you want to change experiences then the best way to you know you can't always depend on developers and other people coming online because they've seen this doesn't really work very well right you know um so netflix for example does not allow a lot of integration with apple tv it has reduced his integration it has made um things like payment via you know the apple pay apple store order um or you know if you've been paying for it in the past then it's okay but you can't no longer do that right so the experience the frictions so one way if you want to completely innovate in computing experience then you actually need to own services because

then you can show people this is how things should be and then other people should follow so i think that's what you know i think there's a story behind services and that's largely around you know these two sort of new areas one is wearables oh it's mostly around wearables if you think about it but it's really wearables around you know glasses and wearables around the wrist so it's really health and entertainment and other experiences in computing that can change so i the services are really a driver for that okay i have i guess kind of a two-part question here so first of all i think maybe one misconception especially in the us is that apple is the dominant mobile operating system globally because it is here in the us but if i'm not mistaken i think

android has around 70 percent of the global smartphone operating system market so i guess how far do you think uh apple can kind of carve into that um you know are they having success abroad in in different places i know you mentioned you called out a couple of of other geographies but maybe how much uh headroom do you think they can make there and then the other question is what segment of apple specifically do you think will be growing the fastest over the next kind five to 10 years? Yeah, great question. I don't have the exact numbers, but I think it's probably something like 70-30, Android 70, or maybe even 80-20 could be Android has 80%. Because in countries like, for example, India and Vietnam, the number of Android users is eight and just

share volume is high. And then the percentage is like 95%. Everybody has an Android or a feature phone basically that runs on android um so i think there's an opportunity for you know apple to creep that number up over time now i think it would never get close to what it is in the u.s in u.s i think it's like you know apple is like 40 or something like that or 45 i don't think it'll get there but potentially could get to as high as 20 in many of those emerging markets right which would then tip the balance over uh to some extent so i mean you know and every you know if you get if it goes from 80 20 to 70 30 that's actually a big deal it'll happen over time but i think yeah i think that there's a good potential for that happening like places like india for example

could have 20 25 iphone penetration you know or ios penetration um given how the ecosystem really works you know many other countries like vietnam and so on could be the case so i think that's definitely the in terms of like revenue growth i i sort of look at it's really hard because again apple is secretive doesn't really tell us what's in the pipeline but i i really feel like services have a lot of legs um and they haven't really pulled all the levers you know and then many ways to look at services but you know if you have good services people want because the services are linked to devices people want to buy your devices if people buy your devices and you have good services then they you know they want to subscribe to those things it's a little bit of

this loop that they've got they've got going but you know for example they could do an ad like i personally feel like apple tv plus has some of the best programs available really nicely curated but they're expensive for people for the small catalog but they could for example run an ad tier right if netflix can run an ad tier why not run an ad tier or maybe they can add care available for example in india for a very low subscription cost right and and that that could work so i think services is are likely to grow have the fastest growth rate for the business because especially as as sort of their hardware array expands services should expand whether it is in entertainment whether it's in in finance what's in health like health is another like

tim cook was on record saying that health is going to be the biggest impact that apple is going to have right and we haven't really seen anything substantive in terms of health services out there from apple we have seen a lot of health devices you know so you know if they bend to you know know, the heart rate stuff and all of that stuff, the ECG that they're doing, or VO2 max, there's all health related things that they're doing, but they haven't really leveraged that opportunity yet. So I think, so I really think services is going to be the growth engine. Yeah.

And with that health stuff, it seems like there's a lot of runway to reinvest into new products. I want to talk about something that also may have a long runway for reinvestment and is something I think a lot of listeners are either excited about or is on the top of their mind. And it's the Vision Pro. It is the new mixed reality device, just for any context for the listeners. It's the one they're releasing in early 2024. It's going to cost $3,500 and seems to have some big time technological breakthroughs. So I want to just keep this as an open-ended question. Anirban, as someone who's followed this company for a long time, what are your thoughts

as an investor on the vision pro you know my number one thought you know that's not even as an investor is that how soon can i get my hands on this device so i'm going to be up there clicking to get the device as soon as made available in australia which unfortunately is not among the launch countries right so usually australia is among the launch countries but this time but it's not um i i'm actually very excited about this i'm very excited because this detect as you just mentioned the tech breakthroughs that they have introduced here is just mind-boggling so for example the new input model where you know you have these very fine gestures that you're making with your you know fingertips and and they're not like you know placed here they're placed like you

know on your lap and it's able to detect that with no delays and work like in a buttery smooth way that is just phenomenal like there's nothing like that with no controllers right with no controllers exactly with no controls you're using your eye and your hand now i'm sure other people are going to copy it but i don't think something like this exists in even the top research labs today so this is a phenomenal like i think just this shows the depth of like you know the vision work the artificial intelligence work and the you know the semiconductor work the the depth of that knowledge is in full display here like this is the other thing i guess i forgot to mention is that apple as a company we think of apple as a hardware device company but you know if i you know if you

have to ask which is the largest chip maker in the world the answer would be apple right because you know they design their chips they're you know potential the best chip designers right and i like to say you know people think about nvidia so if apple wanted to kill nvidia's business they just needed to decide that they want to and they could because they have the skill set in in the house Now, they might, you know, like every business decides, okay, I'm going to only do this because this works for me. So, they're probably not going to get into, you know, selling GPUs, but they, you know, they probably have the best GPUs if they wanted to. So, I think the full display of Apple's capabilities across the tech stack, whether it is hardware, software, you know, assembly language, you know, machine learning, you know, semiconductors and display with Vision Pro, which I think was really, really astounding

in terms of the amount of work that they've put into it. So in my mind, the Vision Pro came across as a device that is being positioned as, I think, as a replacement or at least as a very nice companion to your Mac. So because you could actually do work on it, and it's a standalone computer, right? you think about it as a standalone computer with a screen that is like two 4k tvs uh sitting near your eyes that gives you all this perception of you know depth and width and things like that

uh you know an immersive experience then the 3500 price point doesn't look like you know it has the the top end processor that a mac would have right and then two or whatever it has m12 i'll try it i'm not sure exactly but so i think it looks like it's a work companion device along with an entertainment device along with um in a potentially gaming device right so that's how it has been positioned um yes i think the technology there is in terms of the input new input model is very exciting the experience of augmented reality you know the immersion experience i think is is again i think one of the biggest disadvantages this product has is is that you can't really demo it

the way you can demo other things because you have to experience to actually, I think that's the biggest drawback you've got in terms of getting sales is you can't get the 3D effects and the immersion effects unless you're actually a user, right? But anyone who has actually tried it on

is just going, okay, this is like, it was an aha moment for them, right? And there's an array of reviewers who have tried it and they're just saying, okay, this was this is something that you have to use to experience you know to experience to understand uh this step change but but i think yet so they're basically reinventing computing in a way here with spatial computing and uh yeah it's gonna be really exciting but i think it's more of a mac and a apple tv sort of thing replacement or or adjacent to that sort of device that this is being

positioned positioned in wouldn't surprise me if you know in 10 years a lot of people have these things and they'll become much sleeker over time uh wearing them and moving around right now it seems like a far-fetched that you know people are going to do that but when i go to do my school pickup for my daughter and i see all these children coming out from school you know they do have an iphone they have an airport and they're just walking like this and the teachers are telling them oh what's the traffic right so they say in a way people are already wearing something the stuff that they're wearing is the iphone why not just put the iphone on your you know it's actually safer that way because you actually have um the uh the environment in front of you

because the environment doesn't vanish right that's the key thing here and you you can see the environment how much of the environment you want to see is decided by you and also by the environment i guess if people come close to you then you can see them for sure we were talking before the show uh before we hit record that a lot of people doubt apple's ai and machine learning capabilities do you think it i guess why do you think that's uh why do you think they're wrong to doubt it and do you think the vision pro is maybe one of the biggest examples to demonstrate that they have that power yeah so i think part of it is just like so right now every tech company is an ai company right so we we can go and read conference transcript transcripts and basically

you'll see how many times the word ai has been uttered and you know all executives are being pushed to utter the word AI. So it was like 70 times that, you know, Sundar Pichai said it, because Microsoft, you know, Satyendela said it, maybe more, so he's now forced to say it. So there's a subtle rub that Tim Cook applies in all of this, is that the entire WWDC, and they probably didn't utter the word AI even once, right? And I think part of this is, is a way of telling the community that look telling it's very nice and fascinating for analysts and other people who are analyzing companies you know you're doing this ai stuff and it's going to be all mind-boggling right consumer actually doesn't care right because

the consumer really cares about i have certain things that i want to do can you make that happen for me or can you give me an experience that i didn't have that i really want to have they didn't they don't need to know whether it's ai or some voodoo or some magic right they just need that experience and i think what that what apple is basically has always focused on is that you have to deliver the experience and you have to deliver the product that people want not a buzzword um so i think that's one thing that the and and and the other thing that happens with apple which is different from other companies is i remember a few years back there was a alphabet demo uh that was done which was very interesting which was like you

know you could call you made a call and the call went to like a you know an ai and then it you know it spoke with you and it made for example a reservation at a restaurant for you right there was a very cool demo but where's the product there's been a couple of years there has been no product right so a lot of companies have these demos that they do because the wind is blowing in a certain way apple never does that because you know they just keep those things hidden um but as we as we just saw with vision pro well all these products that exist you know they're significantly inferior to to apple today and the tech that they've got there is mind-boggling whether it is you know the the immersion immersive experience that you've got whether it is the

eyesight that they've developed where you know the fact that you need to be able to see the human computer interaction components that they've thought about the controllers that they've thought about which is you know the new input model using just your fingers um and your eyes all of that stuff a lot of these things require uh as i said you know work across the stack but a significant amount of ai is built into these things so apple is constantly building ai into its tools it just doesn't talk about it and i think you know sometimes analysts think that you know they're falling behind but i really you know for a company that has basically displaced intel completely from the chart of being the leading semiconductor company um i think you

know saying that they don't know what they're doing is i think a little bit far-fetched right but they have they have a more of a consumer product oriented service oriented focus so they want that to speak and not the technology technology is a means to an end and they're They're focused on the end. And I think a lot of other companies get caught up in the means because it seems to help with the stock price in the interim. It kind of reminds me of when there was that interview with Bezos way back when, when the interviewer was like, are you guys a tech company or a retail company? Like, it doesn't matter. We're a customer-focused company.

It feels like analysts are like, are you an AI company? No. I know this will be kind of a tough question to answer because there's a lot, but what do you think are Apple's biggest competitive advantages? And then who do they actually compete with? It's a competitive advantage. I think we can say, like, you know, if you think of it more, you can think of it as a whiteboard company like, say, an Alphabet or Microsoft, right? But in terms of competitive advantages, you know, say number one is brand, right? The brand and the brand affinity is like the brand power is significant.

That's one. They've got scale advantages, right? Because, like, think about it this way. For another company to design something like Vision Pro, it's going to be very difficult because, you know, the number of components Vision Pro could share with other lines of Apple devices, right? same thing with the the processor for example right that allows you to amortize costs it allows you to also use the best things that you have in other parts and not have to buy that or source

that or invent that right so i think the scale um is is another immense thing that they've got and the scale is not just in terms of product scale but it's in customer scale in terms of the retail footprint scale those are like you know this is just built over time um Then, I think the other key thing for them is they are a company that controls, and very few companies are very good at this, they control sort of the entire experience and the protocol, or let's call it the technology stack, right? So, whether it is the hardware, the software, and, you know, whether it's the chip, the GPU, the CPU, the, you know, the memory processing, the AI neural engine that's all inbuilt in-house,

right? Significant control on roadmap. So, they know what the roadmap is. they decide and you know they're in control of their destiny to a large extent so that actually really helps them um they've got a bit of pricing power i would say as well well because uh you know of their reach with their customers and yeah you know and again i think this this integration they've got a lock-in effect as well right i mean you know if i've got an ipad and iphone and this and that you know i'm more likely to get a vision pro than ever think of getting an oculus right

because you know that lock-in effect really you know if you've got one device you can probably buy the other devices i think those sort of things really work in their favor so those are really their big strengths i think as a company and i think at a higher level they are very long-term focused and if you look at other comparable companies at scale they are very good in terms of managing their r d spend so a great example would be apple could produce vision pro how much money did they really spend on vision core? And just compare how much money Meta has burnt trying to get Oculus and its Metaverse going, right? So it's just, sometimes it's not just about how much money you throw, it's about how you manage it. So they are a very good,

a very capital conscious as a business, right? And this I think is an important thing that often is not thought about. Yeah. And yeah, I totally agree with that. I think we don't have to talk about the metaverse stuff with meta but uh because that would be a whole another 30 minute conversation of and there's a lot of uncertainty there but i do want to maybe talk about who their competitors are because it seems like android versus apple it's very separate you know it's almost like it's a it's very symbiotic i mean google and apple have a very strong relationship are there really competitors out there because i mean some could argue maybe even like whatsapp is kind of a competitor to imessage and stuff like that i mean what do you

see as maybe the competitive threats to apple today that's like i think they compete so i think they compete with different players in different areas right and there's a lot of competition it's like so if you think about for example if you take the mac line that competes with a whole bunch of windows and other you know these chrome os based stuff right so there's strong competition there if you think about uh where was they mostly won that battle but there is still you know the various android where and stuff you know samsung where and google is doing something there's this competition there um there's competition in these these sort of things right trillions of companies make these uh these these things uh there's of course android versus uh you know iphone

competition so there's samsung there's htc um in terms of devices so there's tons of competition then in terms of services there's a lot of competition right so there's you know if you think about buy now pay later for example they've launched this they're late to launch there's so much competition almost all services have significant competitors uh in them so there's a lot of competition and but i think apple's upside really is that for apple's customers providing um instead of services and devices that they would like to use is their upside really right you know within their own ecosystem and slowly growing their ecosystem is what they're really trying to do um but there's a lot of competition and you know in consumer electronics

there's a lot of competition always so i think there's a lot of competition but there's not you know what i think what you're referring to there's no direct like competition but it's not a monopoly like search right it's it's not a monopoly like search and the search is really a monopoly there's Like, you know, if you think about it, there's just a monopoly. But there isn't a monopoly here in that sense. They have a strong hold on customers. Right, yeah. And we'll get to any, I have to do, I have a follow-up in the risk section about any potential antitrust legislation.

So we will hit that, any listeners who are interested about that. But first, I want to talk about valuation, just general thoughts on that. I know it's trading at, you know, the trailing multiples at a premium level. So I guess, what are your thoughts on what sort of returns, you know, forward returns Apple investors should expect, especially at a market cap of, are we at $3 trillion again? I know the buyback made it, so it's not, it's a little bit low. No, we're not, I think we're at about $2.8 trillion. So the question is, do you, are you cool for me to share a sheet and we can talk through a sheet? Oh yeah, let me, I'll do, I'll let you, okay, you should be able to share.

Go ahead. Okay, so let me see, let me see, this might be a different way of sharing a screen. Okay. All right. Can you see my screen now? Perfect. Yes. Okay. So, this is a rough model. And this is actually, maybe this is a way to think about valuation. This is what I call a reverse DCF. So, I'm not trying to build a discounted cash flow model. What I'm doing is I'm using a simple discounted cash flow model to understand what is baked into the share price today, right which will answer sort of your questions towards the upside and it's all qualitative stuff i'm not making a quantitative trying to make a quantitative judgment the inputs are really

uh what what's apple's free cash flow trailing last 12 months you know close to 100 billion dollars uh you know what's this net cash position you can do it based on total cash and total debt but it's really what matters is what's the net cash position because you're going to use that to calculate the enterprise value uh total shares out uh and it's just a simple model where you just are trying to predict what is the in what is the free cash flow growth rate baked in for the first decade assuming a certain terminal rate and a certain discount rate okay so i've always fixed for these sort of models the discount rate between nine and eleven percent and the reason the logic behind that is so between nine and ten percent is what the s p 500 returns on over the long term so

i just use that as the as the discount rate now there's not got you know people would use the whack and things like that i just try to simplify things because my my theory with all of these things is all models are wrong because they're my definition they're models and they have lots of assumptions but what i'm trying to do is some models are useful i'm just trying to get some useful insight here all right so i fixed my discount rate at ten percent um i generally fix my terminal rate at three or four percent so i've given apple a four percent uh terminal rate and then based on today's share price i'm just reverse solving for the growth rate of free cash flow, which would allow the current share price to be a fair value today, intrinsic value today.

That works out to be actually 11%, which is not nothing. You'd expect the free cash flow to grow. One way to think is the market is saying that free cash flow should at least grow at 11% over the next decade, which means in 10 years from now, roughly $280 billion of free cash flow, just you know two and a half times 2.7 times of where it is today all right possibly doable uh so that's one way of you know um to cross-check that you know if apple can grow its services business at a decent clip um you know it should be able to do another way to think about this is to get free cash flow to grow at say 10 11 you probably need your revenue to grow between at a high single digits you know mid to high single digit revenue growth should be enough

right but that's basically saying that apple is basically fairly valued right it's not so it's not market beating in that sense right but i think the one thing that is not considered in this in this uh you know reverse dcf is the total number of shares out which is up here right because i did not change it um i'm not changing and i'm keeping it fixed but we know that what is Apple doing? It's free cash flow. When it generates $100 billion of free cash flow, it basically is just buying back its shares, which means we can almost be certain that if Apple is on the trajectory to generate these billions of dollars of free cash flow that we have got here on the spreadsheet, it's going to be used to reduce the number of shares that it owns

that are outstanding, which means if you think about it from that point of view and you think was capital allocation strategy, then I think you get to a point where it's potentially quite market-beating from here on, as long as they can keep generating the free cash flow because the share count is just going to decrease. Apple's share count is down by 40% over the last decade or so. It won't be down that much in the next decade, but even if it's down, let's say, 20%, that's going to be enough to deliver market-beating returns. Then there's the upside in of if the revenue grows faster or things change then you know you can get right so yeah it's in other words the price is not um i wouldn't say the price today is something that you know like

it's like you know an obvious buy it you know i think the only time that i felt it was an obvious buy was in like 2016 2017 2018 when people were like you know pricing it for like debt and it And it was trading at like a 10% free cash flow yield. Today, it's trading at roughly a 3.5% or 3% free cash flow yield. Still, significantly better than many of the other companies which trail at 1% free cash flow yield or other companies that do not generate any free cash flow and have no plans or looks like have no plans of generating free cash flow. So, you know, I think it's a fair deal. And I think there's a good chance of market beating returns from here. But it's, you know, it's not the same thing as buying, you know, at $150 or $120, $130, it's like, okay, it makes sense to you.

So when the panic button hits, and you always get this, when the panic button hits, you know, companies like Apple are good ones to buy because, you know, chances are that nothing has significantly changed for these businesses. And so just to kind of rehash what you just said there, because it might be sometimes hard. We go through this all the time where we talk a bunch of numbers and then listeners might be like, all right, I'm lost. So you're saying that the market is basically forecasting or expecting 11% free cash flow growth. However, with Apple plowing so much of that into buybacks, you could potentially get – they're not factoring that in, so you could potentially get higher returns at 11% growth. Like you said, that isn't nothing. I mean, 11% growth, that's a good amount, especially for a business that's generating, what is it, $400 billion in sales every year or somewhere around that. I guess my question to you is, if you weren't a shareholder for the last 10 years, would you be buying today?

Or would you just – I know it's a little more difficult when you have kind of the – maybe not the emotional connection, but you've been with them for so long. yeah so like i that's i think that's the ownership bias coming into play so here's the as i said so um i think that something like you know 10 11 percent of free cash flow growth is baked into the share price assuming no buybacks um that i think and then and i think it's free cash flows the key thing is that the free cash flow can grow at a faster rate than the revenue so every actual growth doesn't have to be very high is so i think the amount of revenue growth that's baked in is actually not that high. I think a high single digit is probably somewhere between 7-8% is what's baked in. If they can surprise

on the upside, then there's a lot of surprise potential there. You'll remember it this way. I think the portfolio construction is such a personal thing. I almost hold Apple as an anchor core position. If I didn't have it, I would still have it because it's a nice... To have a company that generates so much free cash flow, those companies tend to get a higher multiple just because they generate so much money. I would own it.

I would not personally be looking to have a substantial increase in position. That's it. The contradictory thing here is, and this is where psychology comes into play, but my Apple position is pretty large already. It's probably around 8%, 9%. Maybe I should be looking actually to downsize it a bit or maybe run covered calls on it, but I'm not doing anything on it.

Largely because the other thing I've found over time is it's just so difficult to precisely value things, right? We just know that, you know, it's roughly around, by this measure, I think there's a decent chance of big market beating and we just leave it to the company to execute. And, you know, I guess the thresholds are not that high and I just leave it at that

and then they see what happens, right? And it has consistently overperformed its peer group. But yeah, there has been a lot of PE expansion and so on. So yeah, I would not be rushing into buy at this, but I would, as a core, I love having it as a core. It just gives me comfort. You know, it doesn't move that much relative to some of the other stuff that I own

that can drop by like 60%. So it is just a core position in my holding. But yeah, this is a hard one. And I think it depends really on individuals. and and what they are trying to do with their portfolios yeah and you know and it's funny because brett and i spend a lot of time doing valuation work on a lot of the companies we own but that first qualitative assessment you had in 2012 where you're like okay the customers are avid for any product that comes out and the business is just executing and has a history

of executing incredibly well seem to be really the two most important things for that investment. So, I mean, I think sometimes it just, like you said, the buy and hold approach, a lot of it, I would say probably 90% of it comes down to the qualitative assessments. I guess one more question for me, and then Brett has a few. Warren Buffett is the largest outside shareholder, I believe, other than Vanguard and BlackRock. So Berkshire is the largest individual, I guess, shareholder. They, I think, bought in around kind of that 2016, 2017 timeframe. Do you think he's had any impact on Apple's capital allocation strategy?

I don't think so because, I mean, the buybacks started in Tim Cook's era. So buybacks were already happening. Well, they were well and truly on its way. Um, and so I don't think so. I don't think, you know, it's nice to have a cornerstone holder in Buffett, uh, Berkshire, but at the same time, Berkshire actually, in my opinion would be like, you know, there's a lot of variability and unknown unknowns with that company right now. Right.

I mean, um, both Charlie Munger and Buffett are, you know, uh, are very old, right. And we don't know what happens in a succession. We don't know what the success is going to do with the portfolios. Don't know how much more active trading they're going to bring and things like that. There's definitely a lot of stuff. We can say that it's going to be more of the same, but we just don't know. But I don't think it has – there have been temporary bumps in the PE and things like, oh, Buffett bought, so it must be good, must be value.

But I don't think there's been any big changes in their allocation, like capital allocation strategy. And when I say capital allocation, I mean it broadly in terms of the share buybacks, putting the money for investing in different projects. They're very, very measured. in you know the r d is very measured relative to other companies um here's a fun fact that people don't know where almost all the big tech report non-gap numbers apple always reports gap numbers as has reported all those gap numbers so you need to kind of adjust the apple's p of whatever is

actually the gap p whereas the other people's the p's that we see is all you know the diluted normalized blah blah they share their sbc is also very modest so a lot of these things uh for apple are um are quite uh quite unique to apple there are actually very few companies that are like this in terms of um yeah and i think going back to 2012-2013 i think the biggest thing that at that point was that post steve jobs we did not know what was you know there was a lot of uncertainty as to you know did we lost an innovator what's going to happen uh but as i like to tell people is Tim Cook is the swan song of Steve Jobs. Steve Jobs did two things before dying.

One was put Tim Cook in charge and the other was to tell people do not think like Steve Jobs. And I guess the third thing was he built the Apple campus. But those were the things that he did for the longevity of the company, right? And I think Tim Cook is a very underrated leader.

So I guess if a longer term risk is who is the next leader for Apple, that's very unclear, right? And that I think is a risk because you want a leader like Tim Cook who can navigate politics and the relationship with customers and so on really nicely. Yeah. And speaking of risk, I want to hit that before we close out. No company is riskless.

There's one that's big, at least in my mind, and then maybe you disagree, and there's one that's smaller that could have a potential impact, but I still think wouldn't be detrimental. The first one is just any exposure to China, both from a consumer standpoint and a supply chain standpoint, specifically with Taiwan Semiconductor. And then second, could antitrust legislation or any sort of that type of thing really have a big financial impact? So curious your thoughts on either of those situations.

Yeah, so I have broad thoughts on the China thing. So I think here's the thing, the way I look at China. So, yes, there are some tech companies that don't have exposure to China, but I can't imagine a scenario in the world where there is a huge conflict between, say, you know, let's say the West and China, because that impacts every consumer company, that impacts every consumer, that impacts all of us in so many different ways, right? So it's, it's, and I don't, I don't think there's a good, you know, knowing, you know, there's, there's no way to position yourself in this, you know, I want to be China safe, so-called, right? And the reason for that is, well, you know, but you won't be wearing shoes, shirts, you won't get maybe some of your cereals and food items, you won't get your cars. And, and all of those, all of those things, cost of living is going to go up. There could be nuclear war, all of those things, right? So I think there's no – so as an optimist, I believe that things will work out and things should work out because there's just too much for everyone to lose in this situation where things get ugly with China, right? That doesn't mean that they wouldn't compete and they would be using, you know, like things like, you know, your legislative policies and investment decisions to, you know, tackle and block each other. That's only to be expected. And I think that's going to continue to happen.

environment so that that's one so i actually de-weight china because on the uh the risk largely because you want to be playing and you want to be engaging with everyone to have an impact so non-engagement is actually not useful so i would i would expect that a company should try to actually be in china and that's the second largest you know market to be in in many ways right so if you just give up on that market then you've given up on opportunity for revenue growth an opportunity for influencing customers so that's one um antitrust because i look at antitrust as the antitrust issues i think there's a lot of nuance there the problem i see with antitrust regulation is not revenue that's not the problem that you know they mandate because apple could

take a smaller cut of its digital goods or apple could take a smaller cut of payments none of those things are actually that material to apple i think what is really material is if like you know and if regulators basically require things like side loading it's just gonna it's gonna make the i think regulators have a way and regulators are really poor decision makers because you know i think we should just make let the capital markets make the decision because i'm just you know i i just don't like the red heavy-handed regulators deciding what cables are going to be put into my computer um you know what app you know how should an app market run there's competition there's app market opportunities and people can decide uh whether they want you know if they don't like

apple's ecosystem they can go to android right it's not like this you know it's it's insurmountable difficulty each company makes it easy to switch from each other but i think that the problem is that if if regulators regulate such that the integrity of the app store is destroyed that has an impact on experience now i think companies in general tech companies are able to uh think three steps ahead whereas regulators today are thinking about stuff today and they probably get replaced bureaucrats get replaced by other people um so it could be that apple itself disrupts the app store business model enough that you know so there's the point case in point would be that the app store is not that relevant for things like wearables right maybe the app store

is not going to be that relevant for things like a vision pro and you know app store is not that relevant even for things like mac right so the the you know maybe it doesn't matter for iphone maybe it matters i don't know but i think there is such risk that it can make the experience bad or worse all right let's wrap things up uh you already mentioned you know some of the risks kind of play into this as well but just as we close things out anything else that you're looking at as sort of a pre-mortem as sort of okay what would happen 10 years from now from an investment in apple to go poorly yeah so i think the biggest thing in my mind the biggest risk that people don't talk about is who's tim cook's replacement who is the next person in in line it's clearly

and i think that's important because it's not it potentially isn't jeff williams who is the ceo today who's an operations guy uh he does actually manage the the hci design team uh but you know that's after johnny i've left he's sort of been managing the design team um but but he's almost the same age as cook right so it's really not clear to me who is sort of the next and the only person i can think who is young enough uh but has a deep apple strength bench strength and experience is Craig, I can't pronounce that name, but he's probably the youngest of the lot who has worked with Steve Jobs, has worked with Tim Cook, is deeply embedded into Apple. So he seems like a guy who could take over. But that's, I think, the big question is, is the next leader

of Apple going to be able to navigate Apple? Because Apple is going to be a much bigger company. It's a much bigger company today than, say, 10 years ago, potentially, and they would like to make it even bigger in another decade. So you'd have to navigate navigate a lot. I think it's really leadership would matter. And those are certainly again, unknown unknowns, you know, you can pick someone, they might be like, well, but they might make a lot of bad decisions. But at the same time, the way I look at this is hopefully, the DNA of the

company is so solid, that you know, this company operates in a different way has, you know, very flat hierarchies doesn't It's not a very hierarchical company. It works across design systems and across teams very nicely. So hopefully the genes of the company are strong enough that the new leader is able to work in and bring their own mark to the company like Tim Cook has over time. So I'm cautiously always optimistic. I try to be optimistic about any company I hold because otherwise it's very difficult to hold through difficult times. yeah i think it's probably fair to say this is one of the best businesses in the world um i think

that's probably reflected with the reflected in the market cap um but i think you're right there's definitely got to be a lot of talent uh deep bench a deep bench uh across the executive suite there that is all the questions we have though unless brett has any more he's he's giving me the thumbs up so that is going to do it um i guess for listeners that haven't heard of you before or want to follow more of your work what's the best place to find you oh look i i'm a lead advisor at seven investing so you know you can find uh stuff that i write about on seven investing.com um yeah um you know if you're into reading research papers and i've written a lot of technical research papers you can go to google scholar and find my work uh from my

past life but i'm assuming a lot of your readers are not going to do that uh but yes i dabble a bit in research still do that um and uh but i like write actively about companies that are like mostly in this sort of the enterprise software you know consumer electronics um electric vehicle space sort of thing you know there's a small set of companies that i follow i follow them closely but i cover them most of them i talk about on seven investing so and on twitter uh you know i always have something to say about it might not be always the best thing to say but uh there's something to say on twitter and it's a nice way to connect with people and chat about things and just exchange ideas all right well that is going to do it we want to remind our listeners that

brett and i are not financial advisors anything we say or discuss here on chit chat money is not formal advice or recommendation we are however general partners at arch capital so clients may have positions in the securities discussed in this podcast thank you all for listening thank Thank you, Indira Vaughan, for coming on the show again, and we'll see you all next time.