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Power Sheet – April 27, 2016

Tim Cook has done a superb job managing the challenges of his first four-plus years as Apple’s CEO. Now, with yesterday’s deeply disappointing earnings report, he may need to confront a sharply different long-term challenge: managing declining expectations.

Since taking over from Steve Jobs in 2011, Cook has mostly had to keep the iPhone magic going and wring maximum long-term performance from seemingly insatiable global demand for it. He has done so by introducing compelling new models and going big in new markets, most significantly China. Yesterday Apple reminded investors of something important they already knew: No tree grows to the sky. It was inevitable that one day corporate revenue, and iPhone sales in particular, would decline from the previous quarter. But at Apple it hadn’t happened with regard to overall revenue in 13 years and with regard to iPhone sales in eight years.

Wall Street analysts were prepared for a downturn, but it was worse than they expected, and now the big question is whether it was a blip or the beginning of a new trend line. Cook thus faces the fundamental question of how, or whether, to shape investors’ expectations of Apple’s future performance.

Everyone knows that expectations are the basis of stock valuations, but we sometimes forget how powerful the effect can be. For example, based on number crunching by the EVA Dimensions consulting firm, 55% of Alphabet’s $471-billion market cap as of year-end 2015 was based on expectations of future profit above and beyond anything the company had ever earned. For Amazon (year-end market cap: $328 billion) the figure was 72%; for Facebook (year-end market cap: $287 billion) it was 74%. Investors in all three companies are betting on a much, much bigger future.

But for Apple (year-end market cap: $673 billion) the percentage of market cap based on future profits was -1.5%. Investors were already expecting profits to shrink, not grow, and it turns out they underestimated the decline. The stock had been falling before yesterday, and after Apple’s announcement the company immediately lost another $47 billion of market value as investors recalibrated their expectations further downward.

So what should Cook tell investors now? Apple’s biggest market, the Americas, is economically weak, and the U.S. is largely smartphone saturated. Its second-biggest market, China, just smacked down Apple by banning its iTunes Movies and iBooks businesses. Are more restrictions ahead? No blockbuster new product category is in the offing until, maybe, the long-rumored iCar in four or five years. Apple announced yesterday it would return even more cash to investors than previously disclosed, indicating no plans for major new investments.

Slowing growth is unavoidable for a hot company. If Apple’s market value were to grow for the next ten years at the same rate as the past ten, it would be about $7.7 trillion, or just shy of the combined GDPs of Germany, France, and Italy. That obviously won’t be happening. Should Cook pivot to tempering expectations? Or should he, like Warren Buffett with Berkshire Hathaway, say absolutely nothing about future performance and let investors make their own guesses? (It has worked well for Buffett.) Or is an unimagined new blockbuster product, another one of Apple’s famously well-kept secrets, lurking behind the scenes?

Whatever the answers, Tim Cook will have to learn new leadership skills in order to continue his knockout performance.

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What We’re Reading Today

VW report from 2006 outlines how to cheat on emissions tests 

A PowerPoint presentation outlines how a piece of code added to the vehicle software could detect certain testing situations that could then activate emission controls. In normal conditions, the controls would turn off. Then-CEO Martin Winterkorn reportedly refused to upgrade emission controls on multiple occasions in following years because of costs, though the report indicates that company execs knew they faced challenges meeting U.S. standards. CEO Matthias Müller last week set aside $18 billion to cover costs for recalls and fines as the company has agreed to buy back nearly 500,000 vehicles in the U.S.  NYT

Outgoing Valeant CEO will say drug pricing was a ‘mistake’     

When Valeant Pharmaceutical’s outgoing chief J. Michael Pearson speaks with a Senate panel today, he will say that he and the company were too aggressive in hiking prices. The Senate Special Committee on Aging is investigating the tactic of buying decade-old drugs and drastically increasing their prices. Pearson, who will step down from the company in May, will also likely be questioned about the company’s accounting practices. Reuters

Comcast in talks to buy DreamWorks Animation

The world’s largest cable operator may make a big play in original content by buying DreamWorks Animation for over $3 billion. The deal isn’t done, but for Comcast CEO Brian Roberts it would be a welcome win. Regulators had blocked a deal for Comcast to buy Time Warner Cable; yesterday they approved Charter Communications’ acquisition of the business. The fate of DreamWorks CEO Jeffrey Katzenberg after a Comcast deal isn’t clear.  Fortune

Yahoo ends proxy fight with Starboard

The agreement with activist investor Starboard Value will include adding four new board members, including Starboard CEO Jeffrey Smith. Starboard had sought to replace the entire board over disagreements with CEO Marissa Mayer‘s strategies and the length of time it has taken to sell Yahoo’s internet business. Tor Braham, Eddy Hartenstein, and Richard Hill are the other three new members of Yahoo’s board. WSJ

Building a Better Leader

Chobani provides 2,000 workers with company shares

CEO Hamdi Ulukaya provided the options, based on tenure, which can be cashed out or sold if the yogurt company is bought or goes public. The average employee payout would be $150,000. ABC News

Only two U.S. companies retain the highest credit rating…. 

…after ExxonMobil was downgraded to AA+ yesterday. Microsoft and Johnson & Johnson remain on the AAA team. Fortune

Many Citigroup shareholders rebuke board on pay

Only 64% of shareholders voted for the bank’s pay package, a drop from 84% last year. WSJ

Primary Results

Trump and Clinton grab big victories

Donald Trump swept the five northeastern states holding primaries Tuesday, winning by well over 50% in each race. Hillary Clinton won four out of five, losing only Rhode Island. Trump’s most encouraging result came from exit polls, which showed GOP voters may be warming to him. Fewer Republicans – 22% – now say they wouldn’t vote for Trump in a general election. CNN

Trump calls for Kasich and Cruz to quit

Trump‘s substantial wins yesterday improve his chances of accumulating a delegate majority before the convention. In his victory speech, he said John Kasich and Ted Cruz should drop out because “they have no path to victory.”  TIME

Clinton and Trump turn their sights on each other 

As Clinton and Trump look increasingly like the nominees, they took time to bash one another. Clinton attacked Trump for accusing her of playing the “woman card,” while Trump called Clinton “crooked.” It’s an early sign that the general election will be vicious. Fortune

Up or Out

Barnes & Noble founder and chairman Leonard Riggio will retire in September. He will remain on the board, and Paul Guenther will replace him as chairman. BusinessWire

Fortune Reads and Videos

Could Janet Yellen blindside the market with a rate hike?

Maybe traders aren’t reading the Fed’s statements carefully enough. Fortune

Twitter’s response to Facebook Live

“We’ve been doing live for ten years,” said CEO Jack Dorsey. Fortune

Mitsubishi’s scandal is just like VW’s…

…in many ways. But how the two differ could cripple Mitsubishi. Fortune

Prince’s estate could become the next Graceland

Plans are already in place to turn the singer’s home into a museum. Fortune

Happy Birthday

New Jersey Senator Cory Booker turns 47 today.  Biography

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Produced by Ryan Derousseau
@ryanderous
powersheet@newsletters.fortune.com