Alphabet, Apple and Tesla: Recreating Chapter 18 of The Intelligent Investor in 2020

Introduction:

This is a modest attempt at recreating a section of Chapter 18 from Benjamin Graham’s The Intelligent Investor.

In Chapter 18, Ben Graham writes,

“In this chapter we shall attempt a novel form of exposition. By selecting eight pairs of companies which appear next to each other, or nearly so, on the stock-exchange list we hope to bring home in a concrete and vivid manner some of the many varieties of character, financial structure, policies, performance, and vicissitudes of corporate enterprises, and of the investment and speculative attitudes found on the financial scene in recent years.”

I will extend this model to show these attributes for three companies. All three of them are household names in 2020. Google became part of Alphabet in 2015. The companies, therefore, are not far apart on the alphabetical list of companies, something which Ben Graham looked for in Chapter 18.

Alphabet and Apple: A comparison

I gathered information about the two companies, trying to closely replicate the format Ben Graham uses in his book.

Table 1. Ben Graham style company attributes

Here’s a table reflecting the companies’ EPS growth and price range (year open to year close), again staying true to the original Ben Graham format.

Table 2. Earnings growth and price ranges of Alphabet and Apple.

The Alphabet stock price growth you see in Table 2 includes one stock split in 2014 with a split ratio of 1998/1000 while Apple’s price growth includes a 7-for-1 split in 2014. Apple also announced a 4-for-1 split, which went into effect on Aug. 31, 2020.

The growth history throws an interesting light on large cap companies in USA. Apple was incorporated in 1976, while Google was formed in 1998. Google is about 22 years old, while Apple is 44 years old. Alphabet has diversified into independent subsidiaries which do several things — Google, Google Fiber and Fi, DeepMind, Calico, CapitalG, GV, Jigsaw, Loon, Sidewalk Labs, Verily, X, Waymo and a few others. Apple designs, manufactures, and markets smartphones, personal computers, tablets, wearables and accessories, and sells services. We know those devices (iPhone, Mac, iPad and some wearables). Their services include Digital Content Stores and Streaming Services, AppleCare, iCloud, licensing, and a few other services in certain geographies such as Apple Arcade, Apple Card, Apple News and Apple Pay.

Here’s the strange bit: Alphabet pays Apple billions of dollars each year, just to be the default search engine on Apple devices. (Source) The estimates are about 5% of Apple’s total revenue. But, let’s not get into that here.

The earnings figures from Table 1 are interesting too. Alphabet has a steady and brilliant 4x growth in earnings (from around 13 to 52 a share), while Apple has had an amazing 5x earnings growth in the last ten years. This is not surprising because this decade has seen the most incredible bull run in history with the S&P 500 starting at 1,132.99 and ending 2019 at 3,230.78.

The unforeseen Coronavirus pandemic led to the prices sinking to a low of 1,013.54 for Alphabet and 52.77 for Apple (after the effects of stock-split in August 2020). They were however quick to rebound and grow about 57% and 129.22% as of September 6, 2020.

Here, I present my table (this format is not in the original book) to show the return ratios of the companies over the past 4 years.

Table 3. Past four years’ approximate return ratios for Alphabet and Apple

This table and a few other factors, like durable competitive advantage, a steady stream of dividends, can attempt to explain why the likes of Warren Buffett (via Berkshire Hathaway) own such large chunks of Apple.

There’s clearly momentum in the market for these stocks, and Apple and Alphabet are, and will be steady earners, no doubt. However, at these prices, even if the securities advance to unforeseen levels, which they are likely to, it’s hard for anyone to recommend purchasing these securities. This is mainly because of the margin of safety principle espoused by Graham and others. My DCF model didn’t show a significant margin of safety for Apple or Alphabet at the early September 2020 prices. However, things can change. Even a small increase in the projected future growth of these companies, can increase the margin of safety. The current cost of capital and hence the discount rate used in these valuations is fairly low.

Tesla:

I want to end this article by talking about a recent stock market darling, Tesla.

Table 4. Ben Graham style company attributes for Tesla.

Table 5. Earnings growth and price range of Tesla over ten years.

The growth is staggering. The stock has advanced an incredible 100x from its 2010 starting price of 4.778, most of the growth coming in the year 2020. As of 2020, Tesla produces some of the best electric cars in the world and provides associated services for electric cars such as charging and autonomous driving. This American company sells as much electric cars in China as its nearest rival BYD and is an undisputed leader there. [Source]

There is also incredible speculation about this stock. There are now “stock-market experts” who produce 15-second to 1-minute clips on TikTok and claim to have become incredibly rich by trading the Tesla stock and urge their followers to pick up the stock or its related options as soon as possible. There was a TikTok video that was liked over a hundred-thousand times, in which this twenty-something expert speculated that the stock was going to hit USD 2500 before the five-for-one split. Surprisingly, the stock did hit that number. (Of course, this price increase may have nothing to do with individual buyers. Around 58% of Tesla stock is owned by institutions compared to about 71% for Alphabet and 62% for Apple.) After that however, it has declined over 16% in a matter of few days. The things cited as reasons by these Internet stock peddlers for its growth are that Tesla was going to be part of the S&P 500 soon and the company’s yearly presentation called ‘battery day’ was going to blow the competition away when they showcase their new technological advancements. There was also the idea of Tesla being part of the larger energy market and a fully autonomous self-driving fleet. None of these reasons can justify the current price of the stock.

I do not wish to comment (or speculate) on its growth prospects. However, I wanted to present the tables as Graham would have presented, and let you draw your own conclusions.

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