Questions on Apple

A few years ago, I read a thought-provoking essay. The author argued that the financial services industry was vastly overrated, and overvalued from the capital markets point of view. I was reading the article with only a mild interest until he presented the clincher argument. He estimated the salaries we pay to financial services professionals and the profits generated by the industry were excessive relative to the value they provide to mankind. His rationale was that they don’t really produce anything physical. He presented some crude estimates of the salaries of the financiers relative to, say, teachers, soldiers and engineers.  I believe the writer was Eric Sprott, but don’t quote me.

Several years later, while financial services is still a large industry, it is considerably less than what it was years ago. Several big players (AIG, Bear Stearns and Lehman) have disappeared altogether. Citi is a shadow of what it used to be. College kids don't plan on taking a 6 months course on securities and becoming a financial advisor. The anomaly that the article spotted has been dealt with by the market forces. Some say the financial services bubble is still bursting.

What does all this have to do with Apple? Think about this – a company that produces neat devices, largely for entertainment (well-designed, clever, creative, I grant you all that) is now the most valuable company on the planet. Some of its output is used for producing value and wealth, but a large part of what it makes has no more than recreation and entertainment value. You may argue that Apple’s products get used for communication and business as well, but that’s a stretch. Apple’s products have very close substitutes in those areas. It’s the design novelty and cultish following that encourage people to pay a premium for Apple’s products.

What does this tell us? Does it mean profitability or expected profitability of business has nothing to do with the value a business holds for our living? Have we just temporarily lost sight of what’s important for the world economic activity, lifestyle and the like? Or are we awarding Apple this kind of importance because it provides us the escapism we need from the stressful economic realities of these days?

Is the importance we assign to entertainment and communication device maker, and the market cap that we’ve awarded to company as a result rational? Or is this just a mistake, a fleeting aberration? Are we going to see the light in a year or two? Are we going to be asking “what the hell where we thinking?” 5 years from now? You know, like we did after the dot-com days?

To put some real numbers behind this argument, I’ve drawn a chart based on the market capitalization of market leaders in various industries – Apple, Microsoft, Walmart, Shell, Johnson and Johnson, Pfizer, Coke, HSBC, Toyota and Disney.  

Companies and Market cap - as of 14th September, 2012

I know financial markets work on profits and expected returns, so the difference in market cap can be simply explained away with growth rate and profit margins. Apple is certainly doing well in those respects, perhaps substantially better than the other leaders in the list. However given the importance of its products in the scheme of things, are the profits high simply because of a fleeting delusional behavior on our part? Do we really expect the profitability and growth rates to be sustainable?

Radical innovation is easier when you are defining a market, as opposed to defending one. All companies get to a stage where they get too big to be innovative. Given that it’s already the biggest company on the planet, is Apple already there?