Apple (AAPL) is a phenomenal growth story and its stock has rewarded the investors well over the last few years. But it appears that even with its Market Capitalization touching $330 B, and the stock having posted a 47% gain in the last 12 months, the shares are still undervalued.
The Value in Apple Lies in its Earnings Power
The shares currently trade at a Price to Book of 4.89. This cannot be considered cheap if you are looking at asset based valuation measures. However, as many tech companies, Apple has tremendous Asset leverage – it can create more shareholder value using fewer assets than companies in other industries.
The Price to Earnings ratio is a much more reasonable 14.5. If you discount the excess cash that Apple has sitting on its books (I discounted all of it except $2 B, which I think is a reasonable amount for Apple to have to support its maintenance operational expenses), the P/E ratio falls to 13.36. This is a respectable P/E for a typical manufacturing company, but Apple is not that typical.
Consider the following:
- Apple’s Return on Equity is now touching 40%
- Apple has posted EPS growth north of 60% in the last 3 years (including the current fiscal year)
- Apple has build a brand loyalty and a certain cachet around its products that allows it to protect its margins against the competition
Apple is Currently Worth at least $475/share
I projected Apple’s earnings till 2015 using partly the current estimates on the street and an EPS growth rate of around 15%. At the end of 2015, I assigned a P/E of 15. The discount rates I used to calculate the Present Values of the earnings stream and the terminal value were 10% for 2012, 15% for 2013 and 2014 and 20% for 2015. I figure that the general interest rates in the later years will be much higher than today, so investors will demand a greater return.
Two basic assumptions I made were
- Any acquisitions that Apple makes between now and 2015 using the $34 B in cash it has on its books will essentially be neutral for the shareholders, and,
- Apple will not add debt to its books. Given the history and the strength of its balance sheet, I have no reason to believe that Apple will resort to debt financing
Shares are currently trading around $360 a pop, which means that Apple can be purchased at about 30% discount to its intrinsic value.
So Why are Investors Undervaluing Apple?
There are a few possibilities. Given the encroaching competition (Google, Asian manufacturers, etc), it is hard to imagine Apple being able to sustain its competitive advantage for long. Or at least to not such a level. Apple did have a little bit of a first mover advantage with iPhone, but it will prove difficult to grow the market by getting consumers to switch to iPhone from an Android. Competition is becoming more sophisticated and has deeper pockets and is ready to move into any new market that Apple creates.
There is always a question of Steve Jobs and whether Apple will be able to continue its culture of creativity and design excellence without Jobs at the helm. Investors have seen Apple without Jobs, and it wasn’t pretty.
Ultimately, whether you choose to invest in Apple at these prices depends on how comfortable you feel with Apple’s future. A classical value investor will not find the stock very attractive but there is no way to deny the moat that the company has built around its margins and the growth it has been able to generate.
Disclaimer: Author does not own AAPL, nor plans to buy or sell in the next 72 hours.