Neil Costa

The sorry state of Apple analysis

March 28, 2013: 11:47 AM ET

Are all Apple analysts really "nothing more than glorified financial reporters"?

Screen Shot 2013-03-28 at 10.24.41 AM

From Apple 2.0: The best and worst Apple analysts: Nine-quarter edition

FORTUNE --Because he uses my data to make his point, I feel obliged to respond to AppleInvestor's Ernie Varitimos, who begins a piece posted Thursday with the observation that "there are few people on the planet that can destroy wealth faster than an Apple analyst."

While it's true, as he suggests, that a single ill-timed note by an analyst can wipe out billions of investor value, I'm not sure that justifies the broad brush with which Varitimos tars the whole class of sell-side Apple (AAPL) analysts -- good and bad.

"If they had real talent," he writes, "they'd be clawing for a spot on the brokerage sales desk, because that's where the real money is."

That joke, it turns out, like many of the points Varitimos makes, comes from Neil Costa's "The problems with fundamental analysis" -- which is also where Veritimos seems to get the idea that the kind of work Apple analysts do has no value whatsoever.

But Costa's point is a little more subtle. He's saying that fundamental analysis -- i.e. identifying an undervalued stock by calculating a company's intrinsic value -- is of limited utility when used in isolation to predict the behavior of a stock. He ticks off a variety of problems with relying on such factors as liquidity patterns, capital management, return on assets, dividend yield, earnings per share, etc.

According to Costa:

  • Reported earnings can be dubious due to creative accounting. For example, property valuations; value of mastheads; deferring the reporting of product development costs.
  • The data used can be at least six months out of date.
  • It is difficult to give appropriate weightings to the factors.
  • The results obtained from this analysis are only valid for a limited period of time.
  • The rules change to suit the game.
    • In the early 1970s and 1980s price/earnings multiples of 80 or 90 were considered acceptable by some for 'blue chip' stocks in the United States.
    • In the 1980s in the United States some biotechnology stocks sold at '50 times sales'. The companies had no earnings and paid no dividend. The new yardstick to value these became 'products in the pipeline'. By the late 1980s most had lost three-quarters of their stock price!
  • Even when fundamental analysis reveals an undervalued company, or a stock with high growth prospects, it does not tell us anything about the timing of the purchase of the stock.

In the context of that last point about timing Costa goes on to discuss the pros and cons of technical analysis, which he seems to favor. And he ends his critique of fundamental analysis with an analogy that may strike a chord with investors who have stuck with Apple for its long ride down:

"Buying a stock based on the fact that a stock is fundamentally undervalued, alone, is the trading and investment equivalent of driving at high speed on the wrong side of a major highway, heading into the oncoming traffic and screaming 'I'll be fine, I'll be fine - I am driving a safe car'!"

Varitimos' piece is called How To Rate Apple Analysts, but be warned that it doesn't deliver on the title. "The answer is, don't even try," he writes in the last paragraph. "They're likely to be wrong."

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