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Charles Schwab Gives Apple's Stock A Failing Grade

Charles Schwab Gives Apple's Stock A Failing Grade

by , 2:00 PM EDT, October 25th, 2002

BusinessWeek Online has posted an interview with Robert Forsythe, an analyst with Charles Schwab. Schwab has recently introduced a new rating system for stocks to help investors "recognize underperformers." In other words, the rating system is designed to help Schwab customers know when to let go of a stock, and when to hold on to it. Scaled on a school-like A-F rating, D and F rated stocks are considered to be underperforming, and should be sold. This differs from many rating systems in that the terms are easily rankable, easily understandable, and fairly unequivocal.

In the interview with Mr. Forsythe, 5 stocks rated a D or F were specifically discussed, and this includes Apple. AAPL was rated an "F" by Schwab, which means the brokerage thinks that holders should sell. From the interview:

Q: Now, this one is sure to really make some shareholders angry: Apple (AAPL ) is a company that people love, and you dare rate it an F!

A: People certainly are emotionally linked to Apple. However, emotions are the enemy of the objective investor. Per our analysis, Apple is pretty unattractive across the board. It's still selling at an above-average multiple of earnings and cash flow. Management is issuing shares (as opposed to buying them back), which we mentioned before that we don't like to see. And short-sellers are selling more and more of Apple short.

Its fundamentals aren't great either, when you look at free cash flow growth and free cash flow return on investment. Its earnings quality is very poor. We come to this conclusion by looking at the difference between operating cash flow and reported net income. There is some management discretion as to how you report your net income, but in the long run, operating cash flow and net income must converge. If net income is much higher than operating cash flow, the tendency is for net income to fall back in line. Apple looks particularly poor on that measure.

Things that seem to have been left out of Apple's rating by Schwab include cash on hand and assets. Schwab appears to be not so much concerned with what's involved in a stock's value today, but is focused more on long term growth. However, this ignores the fact that most of Apple's price, which is at an "above-average multiple of earnings and cash flow," is actually backed by the company's cash on hand. Remove that cash on hand, and its related stock valuation, and the company is trading at a much lower multiple.

You can read the full story from BusinessWeek Online at Yahoo!'s Web site.

If you are interested in Apple's stock, join our forum members in the Apple Finance Boards, a moderated forum for Apple Investors and people who are interested in Apple's financial dealings. For other stories regarding Apple's stock activity, visit our updated Apple Stock Watch Special Report.

The Mac Observer Spin:

There is certainly merit in approaching stock ratings in this manner, but to every rule there is an exception. Can you ignore all of the other factors that go into Apple's business? Can you ignore the fact that Apple's other assets (patent portfolio, real estate, physical inventory, office furniture, etc.) more than make up the difference between cash-on-hand and the rest of Apple's current stock price? Is Apple's position in the market place relevant? Is the efficacy of Apple's marketing relevant? There are many other factors that play into how well, or how poorly, Apple will perform going forward. Looking at Apple as just another company is what many investors have done throughout the years, each trying to apply the rules for a different market to the company. This may or may not be the proper way to look at Apple, and we leave it to you to look at the merits of this analysis as you see fit.

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