Thoughts on Google and Apple's Earnings

I sold all of my Google and Apple stock recently and explained that I was selling Apple because I felt that Jobs and Apple's PR were lying to shareholders about Jobs' health (they were). I explained that I was selling Google because I was getting conflicting signals about the health of their core keyword advertising business and wanted to see some actual results. I sold Apple at $91.36 and Google at $330.

This week we got earnings from both Apple and Google. And I thought I'd talk a bit about what we learned.

Apple had a killer quarter. They surpassed $10bn in quarterly revenue for the first time and had net income of $1.6bn. Macbooks did great and so did the iPod and iPhone franchises. This is a company that is firing on all cylinders and beating the competition in every market they are in. And yet the company carries a market value of less than $80bn. When you take out the cash of $25bn, the company has an enteprise value of $55bn. That is something like 7x EBITDA for probably the best franchise in the computer hardware and CE business. So on fundamentals, Apple is a screaming buy and I'd be buying it if it were not for the fact that I am very uncomfortable with Apple's lack of transparency on key issues like options backdating and the CEO's health. So I'll stay on the sidelines on this one.

Google's quarter was not "killer" but they did well enough to calm a lot of fears on the street. Gross revenue, before rev share with partners, rose 18% over the fourth quarter of 2007 to $5.7bn and earnings before one time charges were about $1.5bn, also up about 20% from the fourth quarter of 2007. I've felt that Google's core CPC keyword ad business is fairly recession proof and these results certainly indicate that there is validity to that view. That said, this year will be tough for Google. But they have a lot of excess cost that they have just started to take a look at and I think they'll be able to grow earnings throughout the downturn with a combination of revenue initiatives and continued cost cutting.

I'd like to get back into Google at the right price. If think anytime you can buy Google below $300, you have to do that. I'll put some orders in this morning to do just that. I'd also like to try selling some puts on Google and I'd love some advice in the comments about the best strategy for that.

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Comments (Archived):

  1. fredwilson

    At the current price I think most of the bad news is priced in. If you had 55bn, you could buy the entire company and wait 7 years and be paid back and own it allThink about that

  2. fredwilson

    So the min amount goog I can ‘buy’ using this strategy is 30k?

    1. andyswan

      30k dollars, yes. 100 share blocks.

  3. fredwilson

    New management that tells the truth. But of course we might get that and that is what is weighing the most on the stock

    1. matt

      when you say things like this, you lose credibility.

      1. ace ventura

        why?

      2. fredwilson

        With some and gain with othersI just say what I think and people will act accordingly

  4. rtwomey

    What would make you feel more comfortable with Apple? At what point would such compelling fundamentals make it possible to overlook things like their management transparency track record, or are you out no matter what?

  5. Michael F. Martin

    Buy puts one year out at 330. You make money by not losing money.

  6. andyswan

    Fred…..take the # of shares of GOOG that you DEFINITELY want to buy @300 and divide that by 100. That’s how many option contracts you need to trade.Sell that many FEB 300 puts (currently going for $9.50).On FEB 21, one of two things will happen:1) GOOG will be over $300 and the option will expire worthless, giving you a profit of $9.50/share2) GOOG will be under $300 and you will be forced to buy the stock at $300. You will keep the $9.50/share, essentially giving you an entry price of $290.50If #1 occurs, the next Monday morning you do the exact same thing over again with the March puts.Feel free to email me with any Q’s or whatever….this is what I do 🙂

  7. jquaglia

    With people like you on the Apple sidelines, I am wondering the extent to which the company’s lack of transparency is already priced in or overstated.

  8. jquaglia

    I remember you mentioning that a few weeks ago. That’s a really easy way to explain valuation to the layman (or my mother). If only I had the cash.It seems now that Apple PR (I’m sure it was Jobs’ decision) has botched this entire situation, and wrecked a level of trust with serious investors. It seems likely that the stock will now always be weighted down until Steve is out altogether. But I don’t think anyone really wants that. So at this point, an element of Jobs bolsters the stock while an element weighs it down…the latter is currently on the winning side of this tug-of-war.Hopefully people will get comfortable with Tim Cook and the stock price will not continue to fluctuate so much every time Jobs has so much as a dentist appointment. This would be better for investors and probably for Steve’s level of personal stress.

    1. tim

      ‘Serious’ investors don’t base stock buying decisions on what the children at Gizmodo prints on their website or what they hear in some coffee shop. Which is why I completely ignore Fred’s stock opinions. Hopefully he puts more effort into his portfolio companies then he does his own personal portfolio.

      1. jquaglia

        Most people don’t have time to do much quantitative analysis on individual stocks day in and day out. If you’re not going to do so, mutual funds probably make the most sense for individual investors. But that’s no fun and I appreciate the back of the envelope valuation to justify the position I have taken in both companies even if Fred’s understandably sketched out about Apple management.

  9. Daniel Shi

    Love the blog Fred. I generally read your posts thru Google Reader and don’t always jump over to read the comments. However, whenever you solicit any type of response, I am there man. I really appreciate it because 1) it frames the discussion and 2) I know that I am in for a treat when I click over to read it on the avc.com page.

    1. fredwilson

      That¹s great to hear daniel

  10. Doug Kersten

    Liked the statement by Warren Buffet yesterday. It applies here but I was really thinking of it in terms of the VC business: ‘I look at how much I am getting for my money, how good the management is, how the competitive position of that business compares to others, how durable it is and just fundamental questions. The stock market is… you can forget about that. Any stock I buy I will be happy owning it if they close the stock market for five years tomorrow. In other words I am buying a business. I’m not buying a stock. I’m buying a little piece of a business, just like I buy a farm. And that doesn’t change. And all the newspapers headlines of the world don’t change that. It doesn’t mean you can’t buy it cheaper tomorrow. It may turn out that way. But the real question is did I get my money’s worth when I bought it?’ -WB

    1. fredwilson

      That¹s fundamental investing which I subscribe to as well

  11. CoryS

    Imagine how different the perspective would be if Apple had announced a significant product at MacWorld. Let’s be honest, what people want from Apple is a continuing product road, Steve or no Steve. Since the 3G iPhone, the company has done little to show that it is responding to the economy or provide derivatives to its new cash cow and likely LT profit driver. If Apple does with iPhone what it did to iPod in creating a line of products at a range of price points, then they should garner an commanding market position in the US and a respectable global position v. Nokia. If Jobs is the only one at the company that can get a new product vision accomplished, then clearly the stock is not worth much if he isn’t there to push buttons.My current bet is that Apple is savvy enough to roll with a broader line of iPhones later in 2009 and run the same play it did late in 2008 – leveraging lots of ad dollars and winning the battle for discretionary consumer spending.(disclosure: I’m long in AAPL)

  12. awatterson

    SAI made these observations already, but are you concerned that Google has yet to really make money of anything other than Search? A market in which they are getting darn close to owning? Google is in great health now, for all the financial factors that you listed, but are they in strategic danger without having a 2nd money-making product?

    1. fredwilson

      I think apps (mail, calendar, docs) and local (maps, local search) are bigtime oppty¹s for them that are also near term oppty¹s if they get focused onthem

  13. fredwilson

    Its all the same effort tim. I just call it as I see it. I wouldn’t invest in a mgmt team that lies no matter how good they are

    1. kidmercury

      lol, gotta love the youngsters boss. always roll up to the crib to drop hate. never have a covestor badge to back it up.

      1. fredwilson

        Every time I say something negative about Jobs or Apple, I get flamedI think I need to do it at least daily

  14. hypermark

    I have this thesis that part of Apple’s low pricing relative to its peers and relative to Microsoft-like execution (not now, of course; in MS’s heyday) is that all of the company’s technical, marketing and financial wizardry has taught the market to expect supreme magic from Apple, and, thus, when they merely deliver that feels like failure.In other words, they’ve lost their wizardry premium.After all, who looks better than Apple on a long-term basis in terms of differentiated products, diversified revenue sources, depth of product pipeline, quality/depth of management team, operating margins, profits, cashflow, cash reserves and absence of debt?I blogged on this point, if interested:Punishing the Wizard: On Apple and Steve Jobshttp://thenetworkgarden.com…That said, your reasoning, “If I can’t trust you to tell the truth, that’s binary for me” is hard to argue against, although I remain LONG and heavy on the stock.Cheers,Mark

  15. davidst

    I’ll second andyswan’s advice but put it a slightly different way: Always view put selling as a way to get into a stock at, on average, a below-market price. Never sell a put that you wouldn’t be happy to have exercised. Keep this in mind and you’ll stay out of trouble with options.

    1. Druce

      I’ll third but you have to be happy either way, if you get exercised and if you don’t.If the stock goes to 280 between now and the exercise, but is 350 on the exercise date, you get your $10, but you missed your $50 profit vs. just buying at 300.And in the unlikely event some crazy news comes out when it’s 310 and it goes down to 250, you missed the chance to cancel your order on the news, or to buy it at 250 instead of around 300.You could put on half the position at your initial target and then sell puts below that to get to your full position. It sort of uses the options as a sort of damper or speed limiter, so you get automatic price improvement on the entry, and fire full blast only when you see the ‘whites of their eyes.'(Of course the contrary wisdom would say you should always put your full position on at your price…otherwise you’ll only be fully invested on the positions that are moving against you, which stand a good chance of being your worst ones)

      1. davidst

        > I’ll third but you have to be happy either way, if you get exercised and if you don’t.That’s exactly it. The ideal position is neutral on the outcome. The discipline to stick with this is hard to come by and is why the majority of investors shouldn’t trade options.> If the stock goes to 280 between now and the exercise, but is 350 on the exercise> date, you get your $10, but you missed your $50 profit vs. just buying at 300.This is the reason why you (the put seller) were paid the option premium for accepting the risk of this outcome (both on the upside and downside.) It’s a reminder to never trade options without being willing and able to have them exercised.I have come to believe all options traders have to pay some tuition (in the form of avoidable losses) before the fundamentals really sink in– myself included. I’ve funded more than a few ivy-league educations for the children of the counter-parties of my positions. I’d like to believe I’ve learned something from their educations.

        1. RoryBellows

          As a former professional options slinger, I agree with the comments above. Selling puts, especially the near term Feb’s mentioned above for 9.50 is a terrible way to build a long position. Fred’s mildly bullish sentiment would be much better served by accumulating the stock as he mentioned he’s doing, while selling farther out month upside calls. With that position he has the possibility of having two wins. For instance, buying stock at 300, and selling the 400’s next January, if the stock was at 400 next January, he’d make his 100 bux int he stock, and collect all the premium of the 400 calls finishing worthless.

          1. RoryBellows

            Of course selling any option is better at higher volatility levels… which would be lower today after earnings than yesterday before earnings. But the volatility in GOOG options will remain high for the near term anyway, as long as the global economy continues to collapse 🙁 But anyhoo, as I tell anyone who asks, the only option position anyone who is not a professional should do, is selling upside calls against their long stock positions. Everything else is DANGER for the non professional.

          2. fredwilson

            HmmI am slowly realizing that options is a whole new world out there

          3. OPC

            I guess the main thing I would add is that on average, options are a very efficiently priced instrument. That is, you will most likely over time break even at best when implementing any combination of strategies (there is no obvious way to make good, risk adjusted profits).For example, as mentioned in previous posts, a lot of wealth managers advise their clients who own a stock, say google, to sell out of the money calls as a way to earn extra income. But most investors never really understand that this is essentially equivalent to selling a put. If you asked that same person if they wanted the payoff of selling a put, a lot of them would say no even after saying yes to the first suggestion.Professional options traders do not trade GOOG options for the “delta” aspect of it (how the options move when the stock itself moves). They trade it because it has convexity, and therefore exposure to how volatile GOOG is in the future. They care not which direction it moves, but the magnitude of the move. This is hugely important in its pricing, and therefore anytime you decide to either sell a call or buy a put, you are essentially hoping that the implicit volatility is priced fairly or favorably.There are good reasons to trade in options. If you have a very strong view of either the volatility of Google or some view on the potential path of the stock (options are hugely path dependent), then this is something you cannot express by buying or selling the stock. In addition, if for some reason you estimate that your opportunity cost of capital is high, then you can acquire something called a synthetic option position where you pay the market maker’s price of funding the position, which you might estimate to be lower than yours.Absent these conditions, most likely a general bullish view of Google is most cheaply expressed by simply buying the stock. The transaction costs of buying Google stock are lower than in options (option liquidity providers make quite a bit buying or selling options with retail investors).

    2. fredwilson

      Thanks DavidI really want to try this but you have to be investing real money to do this

      1. AC

        Fred, You could also buy Jan2010 Leaps on GOOG (say at strike price of 300) and sell the front month calls (say at 340) to reduce your net money exposure. For even longer term, you could even buy Jan 2011 calls. At today’s prices, Jan2010 300 / Feb 350 would be a net investment of 7000 per contract; Jan 2011 300 / Feb 350 would be about 9200 per contract.

  16. Parkite

    GOOG has poor corporate governance. The “do no evil” slogan is nothing but garbage. Did you notice in yesterday’s release that they will be repricing employee stock options on a 1-for-1 basis? Nice. Glad I am not an outside shareholder that bought at $700. Many other companies will now follow GOOG’s lead on repricing options.

  17. elementaryfinance

    Good work! I also wrote an article about Google and Microsoft’s earnings. Check it out

  18. andrewparker

    My take on the GOOG Q4 report.Long form: http://thegongshow.tumblr.c…Short form: I’m concerned about paid clicks growth 10% q/q doesn’t add up when you run the numbers. I think their click through rate on ads is dropping, and that doesn’t sound good to me.

  19. fredwilson

    I agree that aapl is an amazing buy on fundamentals. If you are comfortable investing in a mgmt team that doesn’t mind lying to shareholders, this is a great stock

  20. Ferruccio

    One accounting wheeze that’s often overlooked when discussing AAPL is how they chose to recognize the majority of their iPhone revenues — those that come from payments to them from AT&T (and their other telecom partners in other countries). Apple recognizes those revenues (hundreds of $ per iPhone — and over 10 millions iPhones were sold in the last 6 months) on a cash flow accrual basis — i.e., spread over 24 months from the time of sale, even though they’re contractually assured (unless AT&T goes bankrupt;-). So the yearly net income of 4.8 B$ is in fact substantially understated (not for an accountant, but for an investor) — there’s an extra billion or so of certain but as-yet unbooked cash coming in 2009. This tilts the ratios further in favor of investing in Apple, if you’re in it for the mid-long term, past gyrations due to mass hysteria about Jobs’ health. (Disclaimer: I’m long AAPL and plan to stay so going forward).

  21. lrd

    Hey Fred, buy some Microsoft stock. Heard they’re doing just fine. Zune sells are -50 up; Windows Vista is all the rage; the XBOXs will soon sell for $99 and the new Word & Excel will have 50 more features that nobody will ever use. Sounds like compelling fundamentals to me. Don’t miss the boat.PS: Do be on the outlook for icebergs!

  22. lrd

    Ok Fred, how about this radical idea:Now that Circuit City is history and with Best Buy following in their footsteps. What if Apple, with its $28B cash horde, can out last Best Buy and become the only nation wide brick & mortar computer distributor? I know Walmart sells computers; but who the hell would by a computer from people who could barley use one?????Think about that!

  23. Guest

    For a longer term investor that is willing to average down into a market that could easily fall another 50% but likely to knock around in a trading range for a while, selling naked puts makes some sense.You can collect premium for as long as the market knocks around in this trading range, roll if the position from month to month, and start selling covered calls if you get put.You’re not going to get much upside if there is a phenomenal recovery, but you’ll do fine in a flat market, and better than simply averaging down.And keep in mind that any rally at the moment is almost certainly going to fail over the next 6-9 months, so worrying about lost upside is a bit misguided unless you have a clear plan to lock in short term gains.

  24. Dave B.

    I think you are letting your emotions effect your decision on Apple. You lay out the stellar fundamentals but sideline yourself out of some kind of protest.

    1. fredwilson

      It¹s not a protest. It¹s my money. If I am uncomfortable with themanagement, I don¹t feel having my money invested with them.

  25. PlanMaestro

    Fred, can you in a later post defend your optimism regarding Amazon? I find it VERY overpriced at 34 P/E and it is mainly a retailer.Regarding Apple, remember than overreaction to bad news is the best time to buy. Job’s health importance is overblown given the current product line-up. If it does not disminish my trust in their accounting and law abbiding I don’t care. Some examples:- Coke during the New Coke mess: Buffett’s greatest investment, P/E of 10 how do you like them AAPLs?- HealthCare during Clinton: One of Buffett’s greatest errors of omission and it’s deja vu again (UNH, WLP, WCG)

    1. PlanMaestro

      And regarding AAPLs accounting remember they are accruing the iPhone revenues in a VERY conservative 2 year period.

      1. Incrediblesoftwaresolutions

        @andrew parkerAFAIK Google knows about this and has been buying up small tech firms, some relative unkowns however my research tells me that the next possible purchase could well be twitter. I also heard through the grapevine that they are thinking about doing a major shift in their business model in line with what they have experimented before, charging for the free services. We have seen that before in the search or custom search for$100 per year. With twitter they could monetorise this perfectly in much the same way they did with youtube., twitter japan makes money in this way already. I heard through a software engineer that they might be working on a facebook equivalent but I could not get confirmation of this.One of the reasons their ppc/cpc model is suffering is partly because of Facebooks successes.I also understand they are going to be laying off some 3500 people through various means such as attrition and relocating some of their smaller units to Africa where labour is cheaper. Of course you know that Microsoft is to lay off nearly 7000 people over the next two years?If you want to look at a good company that is very good at doing this recession thing have a look at DiData

    2. fredwilson

      I agree that amazon is expensiveMy most recent purchases were at $35 and $40, where the PE was a lot lowerBut you also get the entire web services franchise which is in its earlydays of scaling into a huge business when you buy amazonI also think more retail will move online in the downturn as high costretail goes bustSo that¹s why I am still holding the stockI agree that apple is a great stock at a great price right nowI just don¹t like the way they treat shareholders and at times customersSo I am staying awayfred

      1. Donald Johnson

        I sold AAPL after it announced Jobs wouldn’t make MacWorld. I was worried about his health and unhappy with the secrecy. And I had a profit on my hedged covered call trade.10.17.08. Bot AAPL @ $97.73. Sold Jan 09 90 strike calls at $19.90 for a 20% hedge, or cushion. 12.17.08. Bot APPL Jan 09 90 calls for $7.50. Sold stock for $90.17.Profit = $5.09 after commissions. Annualized return in 62 days = 30.63%.This worked on 4 of 5 trades. On one, a 15% cushion didn’t protect me enough and a sharp drop in the stock the first day after expiration killed me. Now working out of it by selling covered calls. You have to be a trader to succeed with options.As for the outlook for AAPL and GOOG, I’m very bearish because I’m bearish on the economy and the markets.See Abelson in this week’s Barron’s, for starters. Premium priced gadgets won’t sell with 8% to 9% unemployment. And businesses cut advertising when nothing sells.

  26. Ed

    How do you know Jobs & board were lying?

    1. fredwilson

      I didn’t know until the news came out and it was clear they’d been hiding and saying misleading things about the facts about his health

  27. Steve

    Big mistake on Apple, eh? It is $100.00 higher per share than when you sold it. Ouch.

    1. fredwilson

      Yup