An Informal Evaluation of $AAPL Valuation

(ADVANCE NOTE: Not intended as addressing or criticizing anyone in particular. Not like they’d even notice li’l ol me out here. Per usual, refer to the About + Disclaimer section.)


AAPL’s price/earnings multiple (ttm basis) today stands at 16.44.

The S&P 500 multiple (includes Apple, but whatever) as of last Friday was 20.03.

The NASDAQ multiple (also includes Apple, of course) as of last Friday was 22.75.

So, what of it?

Not “The One True Valuation Metric”, At All, but Still Illustrative

Just to get this out of the way, I’m well aware there’s schools of thought that dismiss the simplistic, outmoded price/earnings multiple (especially on a ttm basis). Heaven help you if that’s the only basis for your investing/trading decisions. But the fact remains, the ttm P/E number is a marquee metric whether you’re talking Yahoo! Finance, Google Finance, CNBC or Bloomberg.

And while a few companies don’t have one, and some are claimed to not be properly measured by one, I still think it to be a somewhat useful one, even as industries, and financial situations even between relative industry peers, vary widely.

Addressing Some Justifications – Not (Always) Without Justification

Let’s quickly address what I think are the top two (quite sensible) reasons why Apple is a below-market-multiple stock. More to show my awareness than for the self-selecting audience here, but whatever.

1) Apple’s the highest-market-cap publicly-traded stock trading today (as far as I know), and it’s a huge market cap to boot.

No argument there. Apple inhabits a space that no other tech company other than Microsoft occupied back when the year was…that’s right…1999. (Shame I can’t seem to find an official Prince music video.) Depending on how correct “1999-to-today” dollar calculators are, Microsoft, at $586B in market cap then, may still be the US market cap record holder. Apple was a bigger company than Microsoft was when its market cap passed $600B in 2012 (briefly), and it’s bigger and stronger than ever today.

Still, ~$700B is a massive market cap, no question about it. A definite factor in the “cautious” 16.44 multiple.

2) Apple’s “cash-trapped”, which makes it tough to give full value to the $140B+ net cash pile.

Another very good point! (See what I did there, by the way?) It’s difficult to see Apple making “full use” of its offshore cash when there’s one hundred and fifty eight frickin’ billion parked there. Sure, componentry, Retail expansion, all that CapEx jazz, but there’s zero evidence this will start reducing Apple’s international cash balance anytime soon.

Apple’s capital return program is severely hamstrung by its domestic cash balance, which “despite” all of the supplemental borrowing from Apple USA, remains at a “mere” $20B. Apparently, Tim Cook (at the Goldman Sachs event) is more than willing to amp up capital return (whatever your thoughts on it – and yes, I think it’s a good thing for AAPL longs). Unfortunately, $20B doesn’t give much breathing room considering you need free cash domestically to grow and invest, maybe even acquire in your “home market country”. And at some unknown debt level, S&P might not be so willing to maintain Apple’s AA+ credit risk rating, which in turn might raise the interest rates on Apple Bonds.

Now for what I think are…not-so-valid justifications for this top-performing company’s underperforming P/E multiple.

(3) Apple’s running up against the Law of Large Numbers. Its newfound growth can’t last.

Why don’t we unpack that as “large numbers” and “growth” and address them in that order.

“Large Numbers”

Ugh. Not that “Law of Large Numbers” again when trying to explain the increasing difficulty of growing the same percentage from a larger revenue/income base. What is with that continuous misapplication of a probability theory? The more appropriate “law” is one of Business Physics™ to me.

Ask for it by name. Or something.

All right, let’s look at one super-high-revenue company. (Financial info sourced from Yahoo! Finance, SEC 10-K filings, company websites, etc.)

WMT ($281B market cap)

One of my favorite examples. King of revenue growth? If you call analyst estimates of 2.3% for the year massive. It’s rung up a giant amount of sales, projected at almost $490B for its 2015 fiscal year. Days of growth? C’mon – long gone. You don’t get much more blue-chip, low-margin, or boring for a stock than a giga-discount-retailer.

P/E? About 18, depending on who you ask.

Ephemeral Growth

Kind of front-running a bit, considering Apple grew almost 30% in the December quarter, but fine. Want a sort-of-peer “growth” stock? Here, have two.

GOOG(L) ($367B market cap)

A healthy company, no doubt. Growing?

Well…revenue? Not bad, about 15% YOY in the most recent quarter. On the other hand, full-year YOY growth was 18.8% in 2014 ($66B full-year revenues), 20.5% in 2013, 21.5% in 2012, 29.3% in 2011. So…decelerating growth in terms of sales. Net income? Back out the one-time boost from discontinued operations, and year-over-year non-GAAP income rose in CQ4 2014 from $4.57B to $4.74B. Good for around 3.7% net income growth.

Yeah, sorry, that’s not really growth. It’s not anywhere near doom, but it’s far behind the revenue generation pace. How about the rest of 2014, same non-GAAP basis, net income YOY growth? About 6.4% in Q124.4% in Q2, 14.5% for Q3. Rather uneven. That growth translated to about $14B in net income for all of 2014.

(For comparison, Apple’s net income growth rates in CY 2014 from ~CQ1 to ~CQ4 were: 7.1%, 12.3%, 13.1%, 37.8%. ttm net income is $44.46B.)

Google’s Moto acquisition? Not exactly a success. Android? Still waiting on any data from Google about its contribution to financials. AOSP? Well, that’s certainly not helping “Google Android’s” cause – just look at Cyanogen. Google Glass? On the backburner, and that might be being kind. So, you’ve basically got the core search business as the key to growth, since “Other” is barely over 10% of revenues. Put it all together and what do you get? P/E of 25.5.

AMZN ($173B market cap)

Amazon’s revenues are up to $89B, but it’s a similar story to Google’s. YOY annual revenue growth rates from 2014 to 2011: 19.5%, 21.9%, 27.1%, 40.6%. You can’t exactly say that Fire Phone or tablets have really been boosting sales, eh?

As for income? Well, this is Amazon we’re talking about (full disclosure: I shop Amazon, so I guess I’m not helping :D). Best described as “sporadic” – note the $241M net loss, ttm basis. Resulting P/E? Yep, not applicable, and completely meaningless until – or if? – Amazon ever achieves (or decides to achieve, pick your theory) consistent profitability.

(4) Apple’s innovation engine will sputter at some point.

Speaking of engines, what better industry is there for reinventing the wheel than the auto industry?

F (Ford). ($62B market cap)

Plenty of revenue – $144B for 2014. But it was $2.8B higher in 2013.

Ford’s been chugging along at compound annual growth rate of 4.5% or so since 2009, when revenues were about $115B. Its current revenue level is still far from its peak of nearly $177B back in 2005 (albeit with net income of just $1.44B).

Net income – well, it’s kind of hard to tell. One-time tax benefit this, one-time charge that. Ford has yet to exceed the $8.7B in pretax income record set in 2011. It recorded $6.3B pre-tax income for 2014.

Innovation? Well, EcoBoost is pretty neat as one of the many suddenly mainstream turbocharged engine choices available to car buyers. Existing car lines from Focus to Fusion to F-150 are always up for a clean-sheet redesign every so often, and there’s apparently room for segments like extra-compact SUVs. EV vehicles are only now gaining serious popularity.

“But at day’s end, Ford still just sells cars, trucks and vans with a supporting financing business.”

Resulting P/E? About 20.

(Similarly-sized-and-financially-situated GM, with a near-identical market cap of $60B, has a P/E of about 22.7.)

(5) Apple is too reliant on iPhone.

That’s a patently silly one.

Ford – mostly auto sales. Google – predominantly search. Wal-Mart – retail. Amazon – predominantly online retail, much more than it might like to admit.

$349B market cap Microsoft – absolutely dependentupon software licensing profits. (Its P/E is about 17.2, by the way, 4.6% higher than AAPL.)

Apple – $185B+ consumer electronics (including a dash of accessories), $140B or so probably being iPhone, $45B or so being iPad and Mac, with a $15B+ side of software and services. Uh oh, problem?

(6) Speaking of iPhone, Apple’s profitability potential is tapped out.

Don’t be so sure. The iPhone 6 generation, via FQ1 2015 results as well as guidance, is already showing signs of breaking the margin bottoming cycle of iPhone 4 and 5. My wild guess: Gross margins of 41% and maybe a few percent north of that (as a near-term ceiling) are quite possible by the time iPhone 6S and/or Apple Watch start selling in volume.

I wouldn’t want to be anywhere near a tech blogger drinking something when they get the iSuppli estimated teardown price of an Apple Watch Edition (which has shocking amounts of room to “undersell” existing luxury watch brands). Or when said blogger rakes Apple over the coals for the sure-to-be-deemed “extortionate” pricing for spare Apple Watch bands. Good thing there aren’t any watchbands available in 18K gold. Yet.

The (Potential) Upside of Below-Par

Many frustrated AAPL longs’ sole solace with often-below-market-multiple intervals was the inherent strength of Apple’s financials and strong cash balances. So maybe it wouldn’t “shine through”, but it’s a valuation backstop, right? Of course, that wasn’t much solace at all during the 2 years it took between late 2012 and late 2014 just for AAPL to return to $100 per share.

Luckily, many of the factors that could have pressured AAPL so badly have dissipated or are at least somewhat mitigated.

Margins? Stable and improving, thanks to cost engineering improvements (as seen in iPhone 5C, 5S, and 6/Plus), higher unit volumes, and the temporary peak of the highly-margin-dilutive iPad.

Revenues? Wall Street’s looking for 23% YOY revenue growth in the fiscal year, higher than both Google and Amazon’s recent growth rates, from a much bigger revenue base – and “helpfully”, a large amount of skepticism is already baked into FY 2016 estimates (just 3.8% consensus revenue growth expectation).

Capital return? $102.7B thus far, 65% of which was funded by Apple’s existing cash reserves, speaks for itself.

Share price accessibility/liquidity? Hard to argue that the 7-for-1-share split didn’t have an impact.

Sentiment? At least normalized, aided by advocates like “Uncle” Carl Icahn constantly pounding the table on AAPL and looking crazy like a fox for likely buying in somewhere south of 70.

Market conditions?

Well, you never know when the next correction (or worse) will catch you off guard. Or if any given stock will participate in a broader market rally. But there are probably worse trading/investing strategies than looking for undervalued stocks – particularly if they may eventually be too undervalued to be ignored.

Is AAPL one such stock? Undervalued, on the rise, or both? You know where I stand, but time will tell as it always does. Let’s see how the next year or two goes.

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