Narrative Resets: Revisiting A Tech Trio (Apple, Facebook And Twitter) by Aswath Damodaran, Musings on Markets

In a post in August 2014, I examined the importance of narratives in valuation and how shifts or changes in those narratives can affect value, using Apple, Twitter and Facebook to illustrate my point. Since all of these companies have reported earnings in the last few weeks, I revisited my valuations of these companies, with the specific intent of seeing whether there is a need to update the narratives (and values) for these companies and whether, as an investor, I need to act.

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Apple

I have been valuing Apple every quarter on my blog for the last four years. While I admitted in my very first posted valuation of the company that I liked the company and its products too much to ever be unbiased in my valuations, I did reluctantly sell my Apple shares when they hit $600 in early April 2012, arguing that the traders were driving the stock in ways that I could not comprehend. That turned out to be a lucky break, because the momentum shifted (as it does in pricing games), causing the stock to go into a tailspin. In January 2013, I reentered the Apple investor sweepstakes, when the stock hit $440, using this post to explain my rationale and in April 2014, I looked at the sometimes divergent paths taken by price and value at the company.

My August 2014 narrative

My last blog post valuation of Apple was in August 2014, after the stock had a 7 for 1 stock split, and the value per share that I obtained was $96. Starting in 2011, my narrative for Apple has been that it is a mature company, with limited growth potential (revenue growth rates< 5%) and sustained profitability, albeit with downward pressure on margins, as its core businesses becomes more competitive, and only a small probability that the company would introduce another disruptive product to follow up its trifecta from the prior decade (the iPod, the iPhone and the iPad). I saw no reason to change this narrative significantly, and as the stock was hovering around $100 at the time of the analysis, I considered it fully priced.

What’s happened since

The biggest news announcements from Apple came in September 2014, where they announced two new products, the Apple iWatch and Apple Pay. While I don’t see much in Apple iWatch to change my narrative in significant ways, Apple Pay offers the potential to provide a breakthrough, because the financial services business is a huge one and ripe for disruption. It is that shift that led me to hold Apple through the rest of 2014 and into 2015. In addition, Apple’s introduction of the iPhone 6 has allowed it to protect its margins much better than I had anticipated that they would. In a valuation that I did as part of my valuation class in March 2015, I revalued Apple at close to $118/share, about 10% below the stock price of $128 at that point in time, leading to a decision to sell the stock and count my blessings.

The August 2015 narrative

The last earnings report from Apple, which came out in late July, contains few surprises or twists, with perhaps the only surprising feature being the unexpectedly large jump in the cash balance to over $200 billion. That fact, while Apple continues to buy back billions in stock and pay large dividends, is a testimonial to the cash machine that Apple has created with its iPhones and iPads. In fact, just incorporating the higher cash balance and the lower share count into the valuation yields a value per share of close to $130. While you can download the valuation by clicking here, I also ran a simulation, where I allowed my assumptions on revenue growth, margins and cost of capital to vary to generate these numbers:

Apple, Facebook, Twitter

At the time of this post, the mood around Apple has darkened and the stock has dropped to less than $110. The purported reason for the stock price drop is the slow down in Apple sales in China, but that sounds to me like an attempt to fit a “good” reason to an old-fashioned sell off. Even allowing for a Chinese economic slowdown, Apple is starting to look like a bargain to me again but given the ebbs and flows in momentum in this stock, I would not be surprised if this round of selling leads the stock even lower, before good sense prevails. I think I will wait a few weeks before putting my buy order in but it looks like I will once more be an Apple stockholder.

Facebook

When Facebook filed for its initial public offering in February 2012, I described it as the most pre-priced IPO in history, as it had been actively traded in private markets before that offering. In my initial narrative for Facebook, I foresaw a company that would tread in Google’s path in terms of generating advertising revenues, while posting substantial profit margins. That “Google wannabe” narrative yielded a value of $71 billion for the company and a value per share of $28. Needless to say, I was not tempted to buy the stock at the offering price of $38 per share, but a few months later, I was extraordinarily lucky to get the stock at $18, as investors dumped the stock after its first earnings report. Since my narrative changed relatively little in the year following, my value changed little, but the stock price recovered to $45, leading to a decision on my part to sell.. The subsequent rise of the stock to $95/share meant that I left significant profits on the table by selling too early, but better than bailing on an investment philosophy that has worked for me.

My August 2014 narrative

In my August 2014 post on Facebook, following another blockbuster earnings report, where they reported more success in their mobile advertising efforts, I admitted that my original narrative was too cramped and that Facebook was perhaps on its way to outstripping Google not only in advertising but also in generating other ways of making money of its monstrously large (and involved) user base. The expanded narrative yielded a value per share of close to $63, still lower than the price at the time ($72) and I concluded that much as I liked the company, it looked over priced to me.

What’s happened since

In its earnings reports in October 2014, January 2015 and April 2015  in Facebook continued to impress markets with its capacity to scale up revenues, while maintaining huge operating margins. In addition, other evidence accumulated that Facebook was moving forward briskly in its business model. In May 2015, Buzzfeed and the New York Times announced that they would be posting articles directly on Facebook, cementing its status as a news source. Facebook has also turned Instagram into a powerful tool for mobile advertising, with revenues of $600 million in 2015 and expected to rise to almost $3 billion in the next few years.

The August 2015 narrative

The last earnings report on