sumzero quantitative analysis 2013.01.18

7/29/2019 SUMZERO Quantitative Analysis 2013.01.18

1/18

PLEASE SEE THE DISLAIMER AND DISCLOSURES AT THE END OF THIS REPORT. The information set forth herein has been obtained or derived from sources believed by Empiritrage, LLC

(Empiritrage) to be reliable. Empiritrage does not make any representation or warranty, express or implied, as to the informations accuracy or completeness, nor does Empiritrage recommend that the

attached information serve as the basis of any investment decision. This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer, or any

advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. This document is subject to further review and revision.

Turning academic insight into investment performance

Applied Quantitative Strategy www.empiritrage.com

T: +1.773.230.4727 | F: +1.216.245.3686 | 3830 Kelley Ave. Cleveland, OH 44114 | [email protected]

Quantitative Value In depth on Guess, Lockheed Martin, and AppleSummary

We generate a list of the most promising value stocks in the marketplace using the advanced algorithms outlined in the book,

Quantitative Value. The searching algorithm is optimized to identify firms with the best potential for outsized risk/reward

characteristics.

We highlight 3 names in this report: Guess, Lockheed Martin, and Apple

Guess (GES) appears to be statistically inexpensive, generating a 14.7% EBIT / Enterprise Value yield. The

stock is statistically cheap on this basis, but is also exhibiting additional quantitative quality signals that indicate

undervaluation. The company appears to have strong franchise power, and is showing statistical signs of

financial strength.

Lockheed Martin (LMT) is inexpensive, with a 13.7% EBIT/EV yield, and is showing several statistical signs

of financial strength, including ongoing share repurchases, and positive leverage and operating trends.

Additionally, the firm boasts several financial characteristics indicating the presence of an economic moat, such

as extremely high and sustained returns on capital, and margin expansion.

One can make a reasonable case that the market for Apple (AAPL) stock has gotten overly bearish, heavily

discounting earnings growth, even as the company continues to benefit from its economic moat and ongoing

growth trends. In summary, AAPL appears to be an inexpensive, safe, and high quality mega-capitalization stock

with significant franchise power, and can provide investors a good way to get exposure to the technology sector.

Quant Research Team

Wesley R. Gray, PhD

[email protected]

Tao Wang

[email protected]

Shenglan Zhang

[email protected]

Carl Kanner

[email protected]
http://www.empiritrage.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.empiritrage.com/


2/18








Idea 1:Guess?, Inc. (NYSE: GES)
http://www.empiritrage.com/mailto:[email protected]:[email protected]://www.empiritrage.com/


3/18








Guess?, Inc. (NYSE: GES)

Summary

Guess?, Inc. (GES) is a leading retailer of apparel and accessories for men, women, and children. The companys apparel

lines include collections of clothing, including jeans, pants, skirts, dresses, shorts, blouses, shirts, and others. The company

grants licenses to third parties that manufacture and distribute products that complement the companys apparel, such as

eyewear, watches, handbags, footwear, and others. GES operates over 500 stores in the U.S. and Canada and, along with

distributors and licensees, operates and additional 1,000+ stores in 85 countries; approximately half of GESs revenues were

generated outside the U.S.

It is an especially difficult time to be an apparel retailer. The retail operating environment has been challenging since the

recession. GES has been guiding lower. Sales weakness persists across GESs core markets in the U.S. and Europe, where theEuro has weakened versus the dollar. GESs core style-conscious customers between 18 and 32 are notoriously fashion fickle,

with tastes that can change on a whim. Some wouldnt touch the stock with a ten foot pole.

GESs EBIT yield on EV is 14.7%, which is in the top decile of our universe of cheap stocks (please see our Appendix for

additional discussion of the construction of this universe). The company is also showing statistical signs that it possesses an

economic moat, particularly with respect to the steadily high returns the company earns on assets and capital.

Symbol EBIT/TEV P/E Avg. Vol (3 Month) Price Market Cap

GES 14.7% 12.0 $22 mm $27.28 $2.2 billion

Quality Metrics

8-Year ROAPercentile 8-Year

ROA8-Year ROC

Percentile

8-Year ROC

Financial Strength Score

(10pt possible)

Safety Score

(3pt possible)

13.4% 90.6% 20.2% 91.6% 6/10 3/3

Quant Research Team

Wesley R. Gray, PhD

[email protected]

Tao Wang

[email protected]

Shenglan Zhang

[email protected]

Carl Kanner

[email protected]

Source: Empiritrage, LLC Research


4/18

20 January 2013 2013 Empiritrage, LLC. All Rights Reserved.4

Franchise Power

Source: Bloomberg

The Guess brand was founded on the companys popular jeans, with the iconic Guess triangle on the back pocket. GES used black and white advertising,

and supermodels, to build name awareness during 80s, and the brand became entrenched in the culture. Many will recall that Marty McFly wore Guess

jeans in the 1985 film Back to the Future. In the 2000s, the company aimed for a more upscale and fashionable brand identity, and featured hotel heiress

Paris Hilton in an edgy series of ads. Today, the brand has evolved far beyond jeans to embrace a wide range of apparel and accessories, and an image

that is fun, fashionable and sexy. The Guess brand is now widely recognized around the world.

GES customers have high awareness of the Guess name, identify with Guess brand images, and are loyal, consistently returning to purchase the brand.

The brand is differentiated on the basis of perceived quality, and image, the companys customers will pay a premium for its products versus competing

substitute products. This contributes to the companys economic moat, as it provides the company with pricing power, enabling it to maintain

profitability, where other products with weaker brands might be rendered unprofitable.

Consider the growing role of licensing in the companys expansion strategy.

Licensing requires no investment in fixed assets, or ongoing operating expense.

Instead, it just leverages the brand, reducing the capital intensity of expanding

globally, as the company receives royalties on licensed sales with no associated

PP&E investment. This allows the company to earn higher returns on itsexisting asset and capital base, a feature of companies with economic moats.

GES has sustained strong returns on capital and assets over an 8-year period,

and this demonstrates the brand has achieved wide recognition and staying

power. GESs normalized (8-year, geometric mean) return on assets of 13.4%

ranks within the 90th percentile of our universe, while the companys

normalized (8-year, geometric mean) return on capital is also strong at 20.2%,

which is in the 92nd percentile of our universe. Long term free cash flow (8-

year cumulative FCF) / assets is 64.3%, which places the company in the 77th

percentile, a respectable outcome (See free cash flow over time in thefigure). GES scored a 22.6 for margin stability over the past 8 years, which

places the company in the 67th percentile of our universenot great, but not

bad either.

When we take an average of these franchise-related percentile scores, which

turns out to be 81.7%, and assess how that aggregate franchise score compares

to our universe, we find that GESs franchise metrics place it in the 86th

percentile overall. These strong franchise metrics scores suggest the presence

of an economic moat.


5/18

Financial Strength Score Summary

Profitability Stability Recent Operating Improvements

ROA FCFTA ACCRUAL DEBT CR NEQISS ROA FCFTA MARGIN TURN

FS_SCORE

(out of 10)

1 1 1 1 1 1 0 0 0 0 6/10

20 January 2013 2013 Empiritrage, LLC. All Rights Reserved.5 Source: Empiritrage, LLC

Profitability

GES is currently profitable, and generates an 11.0% return on assets, in the range of its long run average (see Franchise Power above), and an 11.1% FCF /

assets return. GESs cash flow exceeded its net income, indicating that the company is not currently using accruals, which would be a statistical red

flag. We award the company a perfect three out of three possible points with respect to our profitability metrics.

Stability

Stability is our next component of financial strength, and GES also scores well here. GESs leverage, scaled by its assets, is decreasing, indicating a lower

likelihood of financial distress, and earning the company a point. GESs current ratio increased by 1.8%, signaling increased liquidity and ability to meet

short-term creditor demands, and earning another point. GES was also a net repurchaser of equity, when equity is scaled by assets. Net stock repurchases

tend to demonstrate that managers are shareholder friendly, and this earn GES another point. Overall, we award GES another perfect three out of a possible

three points for its stability.

Recent operating improvements

GES does not fare as well in our operating improvements metrics. Return on assets declined versus a year earlier, which is statistically undesirable, and

we withhold a point. Return of FCF on assets also declined versus the prior year, with lower free cash flow per unit of assets, and we withhold a point here

as well. GES also experienced a contraction in gross margins, which decreased 2.4% versus the prior year, which fails to earn a point. Finally, GESs asset

turnover decreased versus the prior year, indicating a reduced efficiency of the companys assets in generating sales. We award no point here, either. The

company scores zero out of a possible four points in connection with its recent operating improvements.

A companys financial strength score quantifies its ability to weather adverse business shocks and economic downturns. On our various Financial Strength

metrics, GES scores six out of a possible 10 points overall. Statistically, GES appears to be profitable, and stable. The financial weakness is obviously in

the deterioration in some key operating metrics. A human analyst could undertake a more extensive analysis of the underlying operating trends in the

business.

Financial Strength


6/18


Summary GES appears to be statistically inexpensive, generating a 14.7% EBIT / Enterprise Value yield. The stock is statistically cheap on this basis, but is also

exhibiting additional quantitative quality signals that indicate undervaluation. The company appears to have strong franchise power, and is showing

statistical signs of financial strength.

The Guess brand was established decades ago and is well-known in the U.S. and abroad. The company has extended awareness of its brand beyond

jeans and into accessories, and has created a lifestyle image that appeals to young, fashion-conscious consumers.

The market for apparel, especially among younger consumers is crowded and cutthroat, with many available substitutes across product categories. In

this environment, an apparel retailer could identify a trend, take advantage of it, and earn high returns for a brief period. Other brands offer a long-term

sustainable competitive advantage. The key is in differentiating between the flash-in-the-pan brands, and brands with long-term viability. One way to

do this is by observing a companys long-term returns on assets and on capital. GES strong normalized returns on assets and capital would seem to

indicate the brands durability.

The company is showing some signs of financial strength, scoring 6/10 our financial strength metrics. The company has good profitability, scoring a

perfect 3/3 on our profitability measures, and is stable, scoring another perfect 3/3 on our stability measures. The company is not showing signs of

recent operating improvements, however, scoring a 0/4 on this metric. Although these operating metrics are suggesting weakening operatingmomentum, it may be that the companys continued profitability and strong stability offset this, since statistically our financial strength measures do not

distinguish between profitability, stability and improvements. Regardless, a human analyst could take closer look at these and other relevant operating

metrics for more granularity on operating trends in the business.

The company passed our screens for manipulation and financial distress, scoring a 3/3 for safety. The numbers are suggesting that statistically the

company does not appear to be showing obvious signs that it is at risk of manipulation or distress.

GES scores in the 86th percentile for Franchise Power, and scores 60% (6/10) for Financial Strength; thus its overall quality score (average of these two

metrics) is 73%, which is a strong score, placing the company among the top 15 names for quality within our top decile of cheap stocks. GES is an

inexpensive small cap stock, at low risk for manipulation or distress, with a high quality franchise, and decent financial strength, and provides

reasonable exposure to a potential rebound in apparel retailing.


7/18








Idea 2:Lockheed Martin Corporation (NYSE: LMT)


8/18








Lockheed Martin Corporation (NYSE: LMT)

Summary

Lockheed Martin Corporation (LMT) LMT is the largest defense contractor in the world, and is focused on security and

aerospace, and the research, development and manufacture of defense systems and products. It serves domestic and

international markets, although the vast majority (>80%) of its sales are from the U.S. Government.

Soaring U.S. budget deficits have led many to conclude that steep cuts to the U.S. defense budget are a foregone conclusion,

particularly as the war in Afghanistan winds down, which could lead to cuts to many of LMTs programs with the U.S.

Government. For example, some analysts believe LMTs F-35 fighter jet program, long plagued by complexity, scheduling

issues, and cost overruns, is at risk. Yet, even with the stock near a 12-month high, is it possible such potential defense budgetcuts are already priced in?

LMT is inexpensive, with a 13.7% EBIT/EV yield, and is showing several statistical signs of financial strength, including

ongoing share repurchases, and positive leverage and operating trends. Additionally, the firm boasts several financial

characteristics indicating the presence of an economic moat, such as extremely high and sustained returns on capital, and

margin expansion.


LMT 13.7% 10.7 $181 mm $93.24 $30.2 billion

Quality Metrics

8-Year ROCPercentile 8-Year

ROC

8-Year Margin

Growth

Percentile

8-Year Margin Growth


(10pt possible)

Safety Score

(3pt possible)

27.4% 95.9% 1.9% 78.0% 7/10 3/3

Quant Research Team

Wesley R. Gray, PhD

[email protected]

Tao Wang

[email protected]

Shenglan Zhang

[email protected]

Carl Kanner

[email protected]


9/18


Franchise Power

Source: Bloomberg

The defense industry today consists of a small number of market participants. The end of the Cold War resulted in significant DoD cuts and the

consolidation of the industry, which continued due to economic and other factors, resulting in the handful of prime contractors that remain today. LMT is

itself a product of such consolidation, the result of a 1995 merger between Lockheed and Martin Marietta. The structure of this oligopolistic market, which

consists of a few large, experienced, well-capitalized market participants, creates a barrier to entry by new participants.

Scale alone is a significant barrier to entry. Smaller, less well-capitalized entrants cannot meet high R&D costs, or achieve scale efficiencies.

Defense contractors typically have established a reputation in the industry and are familiar to and trusted by military customers. Consider LMTs long

history in the industry the company just turned 100 years old. The intangible value of this reputation and experience is difficult to reproduce.

Defense markets are highly regulated, and often require specialized expertise

and/or facilities that are equipped to manufacture unique military systems and

products. Weapons systems can have specifications requiring technical staff

with specific backgrounds unique to defense applications. Additionally,

interacting with the Government as a customer requires familiarity with

sometimes unusual considerations, such as requirements to certify cost data,

uncommon cost accounting practices, or the handling of classified information.

These features of LMTs franchise are reflected in our economic moat

measures. Most impressive is the firms normalized (8-year, geometric mean)

return on capital, which at 27.4%, ranks in the 96th percentile of our universe

(see chart). LMTs normalized (8-year, geometric mean) return on assets of

8.3% is also strong, within the 69th percentile. Long term free cash flow (8-

year cumulative FCF) / assets is 59.1%, which places the company in the 73rd

percentile, another respectable outcome. LMT has grown its gross margins at a

1.9% yearly rate over the past 8 years, which places the company in the 78th

percentile of our universe. When we take an average of these franchise-relatedpercentile scores, which turns out to be 79%, and assess how that aggregate

franchise score compares to our universe, we find that LMTs franchise metrics

place it in the 83rd percentile overall.

LMT scores consistently well across our franchise metrics, but especially well

on normalized ROC. The companys high returns on capital and assets, and its

growing margins all generate percentile scores ranging from the 60th percentile

to the 96th percentile. LMTs aggregate 83rd percentile score for franchise

power suggest the presence of an economic moat.


10/18


Financial StrengthProfitability

LMT generated a 7.5% return on assets, which is in line with its long run ROA average (see Franchise Power above), and the company also generated a

respectable FCF / Assets return of 8.0%. LMTs cash flow exceeded its net income, which is a statistically positive sign, since this demonstrates the

company has not used accruals over the past year. We award the company a perfect three out of a possible three points with respect to our profitability

metrics.

Stability

Our next measurements of financial strength relate to stability. LMTs leverage, scaled by its assets, declined versus the prior period. This demonstrates a

statistically reduced risk of financial distress, and earns a company a financial strength point. LMTs current ratio decreased by 4.6%, however, which

suggests some reduced liquidity and ability to meet near-term creditor demands, and we therefore withhold a point here. LMT was also a net repurchaser of

equity, when equity is scaled by assets. This scaled shrinking share count is worth a financial strength point. LMT has earned two out of three possible

points for its stability.


We turn next to an analysis of some of the companys recent operating improvements. Return on assets decreased slightly versus a year ago, which is a

negative statistical sign and so we withhold a point. Return of FCF on assets increased versus a year ago; this additional free cash flow per unit of assets

demonstrates assets are being used more efficiently. LMTs gross margins increased versus the prior year, and this is worth a financial strength point. Note

that this continues the long-run growth trend in the companys gross margins (see Franchise Power above). LMTs asset turnover ratio decreased versus the

prior year, for which we withhold a point. The company scores two out of a possible four points in connection with its recent operating improvements.

On our measures of financial strength, LMT has scored 7 out of a possible 10 points, a strong showing. LMT is not using accruals and is profitable, based

on ROA and FCF / Assets. The company appears to be stable, with leverage declining, and a shrinking share count (both scaled by assets). A human

analyst could review the drop in the current ratio to determine if this is a cause for concern. The company is showing some recent operating improvements,

including higher FCF / Assets, and increasing gross margins. A human analyst could review the declines in ROA and the asset turnover ratio, in order toassess whether these represent an longer term issues for the company.




FS_SCORE

(out of 10)

1 1 1 1 0 1 0 1 1 0 7/10


11/18


Summary LMT is a large, well-capitalized, experienced, and well-known participant in the oligopolistic defense market. It is the largest defense contractor in the

world and relies on U.S. Government for the majority (>80%) of its sales

The firm is statistically cheap, with a 13.7% EBIT / EV yield, which is in the top decile of our universe of cheap stocks.

LMTs long history in defense markets has enabled the company to develop a reputation among military customers as a competent and trusted supplier.Potential entrants into LMT's markets operate at a reputational and credibility disadvantage versus LMT, and discourages them from entering LMT's

markets.

The markets in which LMT participates are highly-specialized with technological and technical barriers that pose challenges for new entrants, who lack

relevant expertise from other industries that can be adapted to new defense markets. This forms a barrier to entry that discourages competitors.

LMTs competitive position in the defense markets is one that can only be reproduced at significant cost. The advantages LMT derives from such

attributes as its scale, financial resources, reputation, and experience, combine to form an economic moat for the company.

LMT appears statistically to be financially strong, scoring 7/10 our financial strength metrics, which cover profitability, stability, and operating

improvements. The company is not using accruals, and has good profitability, scoring a perfect 3/3 on our profitability measures. The company appears

to be stable, and repurchasing shares and reducing leverage, and scores a 2/3 on our stability measures. The company also shows signs of operating

improvements, including increasing YoY returns of FCF / Assets, and expanding margins; the firm scored a 2/4 on this metric.

The company passed our screens for manipulation and financial distress, scoring a 3/3 for safety. The numbers are suggesting that statistically the

company does not appear to be showing obvious signs that it is at risk of manipulation or distress. Please refer to our Appendix for additional discussion

of these metrics.

LMT scores in the 83rd percentile for Franchise Power, and scores 70% (7/10) for Financial Strength; thus its overall quality score (average of these two

metrics) is 77%, which is an exceptional quality score and within the top 10 names in our universe, which consists of our top decile of cheap stocks. In

summary, LMT appears to be cheap, financially strong, with low risk of manipulation or distress, and a durable franchise that is reflected in its sustainedreturns on capital and growing margins.


12/18








Idea 3:Apple Inc. (NASDAQ: AAPL)


13/18








Apple Inc. (NASDAQ: AAPL)

Summary

Apple Inc. (AAPL) designs, manufactures and markets a variety of mobile devices, such as the iPhone, iPad, and iPod,

along with Mac products, operating systems, cloud products, related software and services, and many other products.

Indeed, its products are ubiquitous, and act like catnip on the consumer, driving what some believe is the most valuable

brand in the world. So why has the company shed approximately 30% of its value since peaking at near $700 per share in

September of 2012?

In short, this former hedge fund darling has suddenly become the company that everyone loves to hate. iPod and Mac sales

are down from last year. The media has pounced on reports on weakness in the sale of the iPhone 5 and whether it will be

competitive with the newest smartphones. In its last call, AAPL reported a big earnings miss, and dozens of analysts have

reduced their price targets over the past few months. With earnings coming out on January 23, many eyes will be watching

AAPL closely.

Yet today AAPL offers exceptional franchise characteristics and is statistically cheap, with an EBIT yield on EV of 16.0%,

which is above the median of our top decile of cheap stocks in the market (please see our Appendix for additional discussion

of the construction of this universe. We believe AAPL merits a closer look.


AAPL 16.0% 11.0 $9,623 mm $485 $475 billion

Quality Metrics

8-Year ROAPercentile 8-Year

ROA8-Year ROC

Percentile

8-Year ROC


(10pt possible)

Safety Score

(3pt possible)

16.9% 96.7% 26.6% 95.4% 5/10 3/3

Source: Empiritrage, LLC Research

Quant Research Team

Wesley R. Gray, PhD

[email protected]

Tao Wang

[email protected]

Shenglan Zhang

[email protected]

Carl Kanner

[email protected]


14/18


Franchise Power

Source: Bloomberg

AAPL has developed a reputation for developing high quality, easy to use products, and this has contributed to its powerful brand, which people trust, and

which enables AAPL to charge a price premium versus competing products. AAPLs unique brand is a sustainable competitive advantage that drives high

returns on capital and margin strength over long time frames. Apples return on capital (left graph) and gross margin (right graph) have been nothing short of

extraordinary.

The company has a well-established mobile device platform with strong market share. The growth in sales of notebooks, tablets and other mobile devices,which consumers increasingly prefer to personal computers, has enabled AAPL to establish its iOS software as a leading mobile personal computing

operating system. The primary competitor for iOS is Android, a Linux-based, Google-supported open source operating system. AAPL does not license its

iOS operating system, and bundles it with its hardware, which requires iOS to function. AAPL also tightly controls the development of high quality Apps on

its iOS platform. It is notable that Apple App Store revenues are a multiple of those for Google Play, the app store for Android.

David Einhorn observed that AAPL can be thought of as a software company (iOS, OS X, the App store, ITunes, iCloud) that drives earnings through

recurring update/upgrade cycles for its hardware products that access that software. The companys wide range of products, united by their reliance on the

iOS operating system, creates an economic moat for the company, since users are reluctant to leave the AAPL product ecosystem, due to high switching

costs. This arrangement is an additional source of pricing power as it enables AAPL to maintain or grow margins for its hardware, based on captive demand

for the software platform. The typical AAPL customer might have an array of applications, and a content library that includes music and photos, and it is

expensive and challenging to migrate these to another platform. iCloud may be a natural extension of this strategy, as the consumers hard drive contents andlibraries and share them across all of AAPLs devices.


15/18


Financial StrengthProfitability

AAPL is currently profitable, generating a 23.7% return on assets, which is higher than its long run average (see Franchise Power above), and FCF / assets

is 24.2%. AAPLs cash flow exceeded its net income, indicating that the company is not currently using accruals, which would be a statistical red

flag. Overall, we give the company three out of a possible three points with respect to our profitability metrics.

Stability

Turning to our stability measures, our next component of financial strength, AAPLs leverage is unchanged, remaining at zero. Although this is not a

negative development, the company must be showing improving leverage (scaled by assets) to earn a point. Additionally, AAPLs current ratio decreased

by 11.3%, which signals decreased liquidity, and ability to meet creditor demands; we cannot award a point here either. AAPL was also a net issuer of

equity, when equity is scaled by assets. The company should be a net repurchaser of equity to win a point here. APPL achieves zero out of a possible three

points for its stability.


Next we review the companys recent operating improvements across several key statistical metrics. Return on assets increased slightly versus a year ago,

which is a positive sign and worth a point. Return of FCF on assets decreased versus a year ago, and thus we withhold a point, as less free cash flow per

unit of assets is statistically undesirable. AAPLs gross margins increased YoY, which earns the company a financial strength point, and is consistent with

the long-run strength of the companys gross margins (see Franchise Power above). Finally, AAPLs asset turnover ratio decreased versus the prior year,

indicating a less efficient use of the companys assets. Overall, the company scores two out of a possible four points in connection with its recent operating

improvements.

On our various Financial Strength metrics, AAPL scores 5 out of a possible 10 points overall. Statistically, AAPL is not using accruals and is profitable,

and is also showing some recent operating improvements. A human analyst could dig deeper on the question of trends in equity issuance, asset turnover

and return of FCF on assets. While there are some questions here, the company has no debt, grew its gross margins, and enjoys improving returns on assets.




FS_SCORE

(out of 10)

1 1 1 0 0 0 1 0 1 0 5/10


16/18


Summary AAPL is a cheap company, with an EBIT yield of EV of 16.0%, which places it comfortably within our top decile of cheap stocks. On this basis alone,

the company appears to be worth owning.

AAPLs brand is one of the strongest and most recognizable in the world; the iPhone, iPad, and iPod and other popular AAPL products have changed

the way people interact with technology. AAPLs success at innovating and maintaining quality and customer trust so that they keep returning to

purchase new products, has enabled the company to continue to command high price points, and thus grow margins over time and maintain strongreturns on capital.

AAPLs mobile device platform, based on its iOS operating system, has become a market leader, and is a formidable competitor to Android. It is not

unreasonable to think that iOS could eventually dominate the market.

AAPLs software is bundled with its hardware, which requires iOS or other AAPL operating system. This dependence of AAPL hardware on its

software creates an interdependent and integrated product suite that makes it more difficult for customers to switch away from AAPLs product

ecosystem. This provides AAPL with ongoing pricing power, and enables the company to grow its margins and generate sustained high returns on

assets and capital.

The company is showing statistical signs that it possesses and economic moat. Normalized returns on assets of 16.9% and on capital of 26.6% earn

scores in the 97th and 95th percentiles, respectively, within our screening universe. These are higher returns than the vast majority of companies are able

to achieve and demonstrate the strength and durability of AAPLs franchise.

The company is strongly profitable, with strong returns and free cash flow, and it is not currently using accruals, which would be a red flag. Although

AAPL has no debt, a human analyst could take a closer look at AAPLs dilutive trends. The company is showing some recent signs of operating

improvements, including increases in ROA and in margins. While our overall Financial Strength score of 5/10 is not spectacular, neither is it

particularly weak.

AAPL scores in the 96th percentile for Franchise Power, and scores 50% (5/10) for Financial Strength; thus its overall quality score (average of these

two metrics) is 73%, which is a solid score.

Additionally, the company passed our screens for manipulation and financial distress, scoring a 3/3 for safety. The numbers are suggesting that

statistically the company does not appear to be showing obvious signs that it is at risk of manipulation or distress. Please refer to our Appendix for

additional discussion of these metrics.

One can make a reasonable case that the market for AAPL stock has gotten overly bearish, heavily discounting earnings growth, even as the company

continues to benefit from its economic moat and ongoing growth trends. In summary, AAPL appears to be an inexpensive, safe, high quality, mega-

capitalization stock with significant franchise power, and can provide investors a good way to get exposure to the technology sector.


17/18








AppendixSearching Algorithm Background:

1. Quantitative Value by Wesley R. Gray and Tobias Carlisle,

John Wiley & Sons

2. Analyzing Valuation Measures: A Performance Horse-

Race over the Past 40-years by Wesley R. Gray and Jack

Vogel,Journal of Portfolio Management3. Empiritrage, LLC Internal Research

Our Screening Universe

Minimum $1.4B market capitalization.

US exchange traded.

Common equity only.

No financials or utilities.

Top 10% cheapest stocks: based on EBIT/EV yield.

Must have total capital and total assets value for the past 8 years.


18/18

DISCLAIMER


The views expressed are the views of the authors and are subject to change at any time based on market and other conditions. This document shall not

constitute an offer to sell or the solicitation of any offer to buy any security and should not be construed as such. References to specific securities and

issuers are for illustrative purposes only and not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.

While all the information prepared for this document is believed to be accurate, Empiritrage, LLC makes no express warranty as to the completeness or

accuracy, nor can it accept responsibility for errors appearing in the document.

Performance figures contained herein are unaudited and prepared by Empiritrage, LLC. They are intended for illustrative purposes only. Past performance

is not indicative of future results, which may vary.

There is a risk of substantial loss associated with trading commodities, futures, options and other financial instruments. Before trading, investors should

carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when

trading futures, commodities and/or granting/writing options one could lose the full balance of their account. It is also possible to lose more than the initial

deposit when trading futures and/or granting/writing options. All funds committed to such a trading strategy should be purely risk capital.

Hypothetical performance results (e.g., quantitative backtests) have many inherent limitations, some of which, but not all, are described herein. No

representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown herein. In fact, there are

frequently sharp differences between hypothetical performance results and the actual results subsequently realized by any particular trading program. One

of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading

does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example,

the ability to withstand losses or adhere to a particular trading program in spite of trading losses are material points which can adversely affect actual

trading results. The hypothetical performance results contained herein represent the application of the quantitative models as currently in effect on the date

first written above and there can be no assurance that the models will remain the same in the future or that an application of the current models in the

future will produce similar results because the relevant market and economic conditions that prevailed during the hypothetical performance period will not

necessarily recur. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which

cannot be fully accounted for in the preparation of hypothetical performance results, all of which can adversely affect actual trading results. Hypothetical

performance results are presented for illustrative purposes only.

There is no guarantee, express or implied, that long-term return and/or volatility targets will be achieved. Realized returns and/or volatility may come in

higher or lower than expected.

sumzero quantitative analysis 2013.01.18

Documents