Friday, August 04, 2006

Apple's rotting core???

It's the most frustrating thing in stock investing. One does a thorough initial analysis of a stock like Apple. Then you carefully follow up, making predictions using available data and finding out that your predictions are correct. Congratulations, we're ahead of the market!

Then the company puts out a press release like Apple just did, stating that due to options irregularities "investors should disregard financial statements dating to September 2002 " and the company will be releasing earnings late.

Suddenly the stock drops ($6 in after hours trading last night, most of which it recovered today although it is still down a little since the announcement). It's enough to make you furious at those executives, after all we did everything right.

But enough anger, it's time to figure out if we need to sell or not. I think the most significant piece of data released so far is that Apple has completed its review of 97-2001, just not 2002 forward. That implies that the problem is with backdated options, a common enough habit for tech companies.

So what would the impact be? If this is an options backdating issue I would expect the problem is taxes. Backdated options are not deductible as employee compensation expenses to the extent that backdating increased their value. This would mean Apple would have to figure out the portion of the value that is due to backdating and take a tax hit on that. A little back of the envelope math reveals that this would be a pretty penny, but not enough to fundamentally change the business. It would also be rather quick to clean up, not a multi-year financial statement delay like Nortel went through a few years ago.

I think this relatively minor impact is the reason the stock has already regained much of its initial dip. If you bought when I called it you're still up 16% even after the bad news drop and I think this is still a keeper, although admittedly now we can't be sure we know what we're analyzing.

Next week the company has it's Worldwide Developers Conference in San Francisco, which is sometimes used to release new products, although the rumor mill is unusually silent this year as to what may be revealed. If they reveal anything interesting the stock may recover as soon as next week. If nothing is announced it will probably wander downward a bit.

Nothing is more frustrating than doing all the right work and still getting hit by something like this, but it's time to apply those same skills to analyzing the current situation. I'm not selling my position at this time.

Invest Well,

FW
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