What to expect from Apple’s earnings

Apple reports earnings after the close of markets at 4PM EDT today. This will be a closely watched report. Here are some things to look for.

1. Whisper number: The Business Insider does a good job of capturing the game that analysts play. And Apple is great at dealing with this. Many companies set earnings guidance for the coming quarter which sets the bar for Wall Street analysts. After a while, the analysts usually set a bar for earnings expectations that they believe the company will be able to match or beat based on this guidance, changing it as new information comes to light over the quarter. By that, I mean these numbers are an easy hurdle and most people have a higher stretch hurdle in mind, the whisper number. Business Insider says that Apple’s release guidance is always "comically low". Analysts play along and raise guidance as time goes on. Based on past performance Business Insider says the Whisper number is about EPS of $12.41 and revenue of $38.51 billion while official estimates are only $10 EPS and revenue of $36.63 billion..
2. Margins: Apparently, I am not the only one talking about margins at Apple. BMO Capital Bank Markets released a report yesterday saying that Apple gets a huge margin per phone when selling to wireless carriers. This is a legacy of the iPhone’s brand and the premium that customers assign to the iPhone. BMO thinks the carriers are going to start to cut that margin back. The Financial Post reports BMO saying "“There is a broadening view that over the next year or two iPhone subsidies relative to competitive offerings will come down." We need to watch this.
3. Momentum/Technicals: The momentum has shifted on Apple recently and we have seen a 10% correction going into the earnings. It is chatter like the type that we see from BMO that has pressured shares. Moreover, after a parabolic rise, Apple’s market cap was briefly the largest in the world, putting it under an enormous amount of scrutiny. I think the momentum has shifted on Apple’s stock as a result. And I would like to see the company come close to the Whisper number with an $11.50 EPS and revenue of $38 billion. In my view, both numbers are important because Apple’s share price depends on maintaining strong margins and strong growth.
4. Must own stock: Yesterday, I saw a note from the FT which indicated that "without Apple the earnings of S&P 500 companies would show zero growth as companies have mostly beat low expectations." That’s huge. It tells you that market leadership in the US market is very narrow and that Apple’s continued earnings performance will have a big psychological impact on how the market proceeds going forward. More than that, the momentum in Apple gets back to Jeremy Grantham’s comments in the post I wrote "Grantham: Missing a bull market is a dismissible offense". Apple’s rise in the market is a result of portfolio managers’ being forced to buy Apple in order to beat their index benchmarks. Apple has performed much better than other stocks and this has buoyed shares. But shares have risen a lot more because of Apple’s huge size forcing nearly every closet indexing manager to buy Apple in order to not underperform. The higher Apple went, the more closet indexers had to buy. This is also true in reverse. If Apple’s shares fall, you do not want to own it as indexer. You will have to sell so as to beat your benchmark. This makes Apple more volatile.

I think that last point about Apple becoming more volatile because of portfolio managers managing to a benchmark is important. In the past, I had noted that I would expect Apple, as a market darling, to have to miss a few times before its shares got whacked substantially. I am now of a different opinion. I believe Apple has become of overriding importance in the narrow US market leadership. If it beats its numbers substantially, it will have a lot of momentum to take it to unheard of levels. On the other hand, a miss will cause a massive selloff. This all means a beat in the range between the Whisper number and the official estimates is the one that will produce the least volatile outcome.

Let’s see what we get at 4PM.