Apple 2.0

Covering the business that Steve Jobs built

Apple's gap is closing quickly

October 11, 2009: 8:34 AM ET

The opportunity to cash in on the iPhone's subscription accounting has mostly passed

Source: Deagol's AAPL Model

Source: Deagol's AAPL Model

Apple (AAPL) is scheduled to report its fiscal 2009 earnings next Monday, Oct. 19, and in the days ahead investors can expect to hear a lot about the new accounting rules that will allow Apple for the first time to book iPhone revenue when the sales occur, rather than spreading it out over eight quarters.

The effect of the old rules was to create a gap between Apple's actual revenue and its GAAP revenue (for generally accepted accounting principles) -- the number the company is required by the SEC to report every quarter. This gap grew wider as iPhone sales accelerated, pouring billions into the company's coffers that weren't reflected in its earnings per share.

Many investors and analysts were well aware of this phenomenon. But many weren't, and the company's share price whipsawed dramatically as the stock fell in and out of favor over the past two years. The latest pop came three and half weeks ago when CNBC's Jim Cramer, anticipating that the new rules would boost Apple's EPS, told his Mad Money audience to go "all Jimmy Appleseed."

But Cramer's advice may have come too late, according to the chart posted above (and reproduced full size below the fold).

Source: Deagol's AAPL Model

Source: Deagol's AAPL Model

The graphic is the handiwork of an amateur analyst who calls himself Deagol. Deagol, who prefers to be known by his nom-de-Web, has achieved a large following on the investor boards where he posts detailed estimates of Apple's quarterly earnings that regularly beat those offered by the professionals working for the big banks and brokerage houses. (See, for example, here.)

Deagol's chart compares Apple's forward-looking GAAP and non-GAAP price-to-earnings ratios and then shows the percentage difference over time as a big gray shadow.

The gap, as Deagol draws it, peaks around the mid-2008 forward-looking PE's, which corresponds to a period when Apple was about to begin selling iPhone 3Gs by the millions but would report only a fraction of the revenue. Beginning with next week's report, according to Deagol's current estimates, the money pouring in from subscription accounting will start to catch up to the growth in iPhone sales, and the gray shadow should begin to subside.

A year from now, GAAP earnings and non-GAAP earnings will be moving more or less in lockstep. Forward-looking perception and reality are converging.

Whenever Apple's accountants decide to adopt the new rules -- and the betting is that they will begin this quarter -- the effect is likely to be anticlimactic.

"This opportunity," writes Deagol, "is largely behind us."

To see his full analysis -- and get a preview of his Apple fourth quarter estimates -- visit Deagol's website here and read his postings on The Mac Observer's Apple Finance Board.

See also:

[Follow Philip Elmer-DeWitt on Twitter @philiped]

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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