Is Apple More Undervalued Than Other Tech Sector Stocks? 42 comments
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As the U.S. equity markets continue the long process of making a bottom in what is now considered to be one of the worst bear markets in history, tech investors should begin to shift their focus on a comparative valuation analysis of the leaders in the tech industry. Tech companies with solid balance sheets, large cash hoards and solid growth rates will fare a lot better in a market recovery than those whose valuations did not dramatically deflate over the past year. Of the nine big tech companies I've reviewed, Apple (AAPL) stands out as being the most radically undervalued in the tech sector on an objective basis. Apple has more net cash than each of the nine big tech stocks, zero debt, trades at the lowest price-to-cash ratio of only 3.79, grew earnings faster than every other tech company except for Research In Motion (RIMM), and is generating almost $3.00 per share in free cash flow every quarter. Just to get an idea of how undervalued Apple is compared to others in the tech sector, one need only to consider where these other tech companies would stand if they were valued in the same way as Apple i.e. if those same companies were met with the same general bearishness that Apple is faced with.
click to enlarge
Apple Compared to the Four Horsemen of Tech Below, I offer a comparison of Apple to the four horsemen of tech to help illuminate the degree to which Apple is undervalued. Apple's stock price is devalued significantly more than Google (GOOG), Research in Motion and Amazon (AMZN): Apple grew its adjusted earnings at a pace of 78.5% in 2008. Google, on the other hand, grew its 2008 earnings at a pace of only 31.33%. Apple has $24.49 billion or $27.57 per share in cash while Google only has $14.41 billion or $45.87 per share in cash. Yet, even though Apple grew its earnings at more than twice the pace of Google, Apple trades at about half the trailing P/E at which Google trades. What is even more surprising is that Apple trades at less than half the price-to-cash ratio that Google trades at. Google currently trades at 7.81 times its cash position while Apple trades at a depressed value of only 3.79 times its cash position. If Google traded at the same price to cash ratio that Apple is trading at, Google would be valued at $173.84. Yet, setting aside the price-to-cash ratio, if Google even traded at the same deflated P/E ratio that Apple is currently trading at; Google's shares would be priced at $262.91. Based on the above numbers, Apple is clearly a much better investment than Research in Motion. First, AAPL trades at almost half the price to free cash flow at which RIMM trades. RIMM also doesn't grow at a sufficiently higher rate than AAPL which might justify giving RIMM a price-to-cash ratio of 17.45 while giving AAPL a price-to-cash ratio of only 3.79. Second, RIMM's market capitalization is simply too large when compared to AAPL. When backing out cash positions from market capitalization, AAPL's net market cap is at $68.38 billion while RIMM's market cap is at $25.49 billion. Considering the fact that AAPL produces $9.69 billion in operating cash flow while RIMM produces a relatively meager $1.73 billion, Apple simply is a significantly better investment. If RIMM were given the same price to cash ratio that Apple is currently trading at, RIMM would be trading at $10.42 a share—nearly 80% lower than where RIMM is trading today. If it were given the same deflated P/E ratio, RIMM would be trading at $42.89. This comparison is an absolute joke. I simply cannot understand how the market could give a retailer such as Amazon a 39.02 P/E ratio while giving Apple, a company that has clearly demonstrated that it can withstand a slowdown better than most, a 13.97 P/E. I would not even go long Amazon with Kathryn Huberty's money. Amazon only has $1.86 billion in net cash; produces less in operating cash flow than even Research in Motion; holds one of the highest price-to-cash ratios (10.49) of any other tech giant, and grew its earnings at a rate significantly lower than Apple and RIMM. Moreover, Amazon also has the highest price to operating cash flow ratio than any other tech giant in the sector (20.66). Of the nine companies listed in the table above, Amazon presents with the least attractive valuation. The market has too much trust in Amazon and I haven't seen enough bearishness in the stock to justify an entry relative to others in the tech sector. I'm not saying that Amazon isn't undervalued on an objective basis, but it's just less undervalued than GOOG, RIMM, MSFT, AAPL and others. There is no reason why Amazon should deserve three times the P/E ratio given to Apple. Apple grows its earnings at a faster pace than Amazon, has 12 times the amount of cash of Amazon, makes far more in net income than Amazon, trades at less than half Amazon's operating cash flow ratio, trades at roughly 1/3 the price-to-cash of Amazon and is better situated than Amazon going forward. While the market might not figure this out over the next few months, eventually the market will realize that Apple is a far better investment and will likely revaluate the companies accordingly. I'm not arguing that Amazon is not undervalued, but that it is far less attractive at current levels than others in the sector. The data above merely indicates that the market is extremely bearish on Apple. Yet, it does not explain why the market happens to be bearish and whether the market is right in its assessment. There are several reasons why the market happens to be particularly bearish on Apple. Yet, some of those concerns are very overblown, and some are outright irrational. Below is a list of reasons why the market is bearish and whether the market is right in its assessment. The main reason that the market is particularly bearish on Apple has to do with overblown fears regarding a consumer-led slowdown affecting Apple's business. The idea here is that since consumer spending and sentiment are hitting multi-year lows, Apple's business cannot function at any reasonable level. Many in the market have argued that since Apple is "supposedly" entirely consumer discretionary, that the consumer is going to cut back its spending on products such as iPhones and iPods. Many have asked how anyone can possibly afford to buy an iPod when they can barely afford consumer staples. Said another way, the analysts believe that Apple is only going to make $1.958 billion in new revenue in 2009. That is a bold statement considering the fact that Apple just sold 6.9 million iPhones in Q4 2008 amounting to $3.787 billion in revenue. If Apple sells just 10 million iPhones in all of fiscal 2009, the deferred iPhone revenue from those sales alone would result in Apple earning the $1.958 billion in revenue difference even if Apple's growth rate was flat across all of its operating segments and in all of its primary operations for the year. As I argued earlier this week, iPod sales made up only 14.2% of Apple's total revenue in Q4 2008. In fact, iPod revenue is making up an ever-decreasing portion of Apple's overall revenue. Moreover, even if Apple were as dependent on the iPod as many would have investors believe, iPod revenue actually accelerated in 2008 indicating that the consumer opted to buy more expensive iPods in 2008 than it did in 2007. In addition, it did so with more enthusiasm than between 2006 and 2007—hence the revenue acceleration. Most market participants invested in Apple know so little about the company that they automatically assume that all Apple does is sell iPods. Nothing can be further from the truth as indicated by the 14.2% number for Q4. Most of Apple's recent fall in share value from $180 in August to $85.00 in October can be attributed to four particular events. While the stock would have undoubtedly been beaten with the rest of the broader market in this recent crash, it was far more beaten down due to events outside of the general correction. First, Apple's September iPod event amounted to nothing more than a sell the rumor, sell the news happening. The stock was hammered and dropped from $170 from the date of the press release of the event to $152 on the day of the event itself—concerns over Steve Jobs's health trumped an otherwise average media event. The broader market barely started to correct at that time. In fact, the DJIA was actually flat during that week. Apple's stock price took a blood bath gapping down from $128.24 to $119.00 before collapsing into a death spiral where panic selling took the shares down $28.00 before it rebounded to $115.00 in inter-day trading. Unfortunately, for Apple, Congress decided not to pass the bailout bill that day which led to another $10.00 drop in the stock price before the close of trading. So in all fairness to Huberty, Apple would have probably taken a bath, but I doubt it would have collapsed $23.00 due to the failed bailout plan. Most stocks fell around 10% while Apple fell close to 20% that day.
Apple vs. Google
Based on these metrics, Apple is far more undervalued than Google on an objective basis. There is no reason why Google should have a larger market capitalization than Apple especially when Apple is producing more in operating cash flow ($9.69 billion v. $7.42 billion) than Google, grows its earnings at more than twice the pace of Google, has almost twice the cash position of Google, and makes more in revenue than Google does. Wall Street is certainly irrational when it comes to comparative valuation, and this case is certainly no different.
Another way to think about this is to consider which of these companies an investor would buy if he or she had $110 billion in cash. Which seems to be a more obvious investment: Is it Google at $103.54 billion, or is it Apple at $92.9 billion? Remember, Google has only $14.4 billion in cash while Apple has $24.49 billion in cash. This means it would literally cost the investor only $68.38 billion to buy Apple while it would cost him/her $89.13 billion to buy Google. It would take that investor seven years to pay off his/her investment in Apple while it would take over 13 years to pay off his/her investment in Google. Such an investment would make no sense considering the fact that Apple produces more in free cash flow than Google and produces more in cash earnings.
Apple vs. Research in Motion
Apple vs. Amazon
In terms of a comparison, Apple has $24.49 billion in net cash versus Amazon's $1.86 billion. Apple trades at 3.79 times its cash position while Amazon trades at 10.49 times its cash position. Apple trades at 7.06 times operating cash flow while Amazon trades at over 20.6 times cash flow. Amazon has a net market cap of $22.54 billion while Apple has a net market cap of $68.38 billion. Amazon grew earnings at a pace of 67.82% in 2008 while Apple grew its adjusted earnings at a pace of 78.5% in 2008.
Why the Market is Bearish on Apple
1. Major Concerns regarding the Health of the Consumer
This concern is obviously overblown beyond epic proportions. First, while economists have been drumming the recession 2008 beat, Apple's Mac sales, iPhone sales, Mac revenue, iPod revenue, total revenue, EPS, net income, free cash flow, cash growth and iTunes revenue have all been accelerating. Not just growing, but also accelerating. Nothing in Apple's 2008 quarterly earnings reports indicate that the consumer has slowed down. At best, the 2008 "recession" has had only a negligible, if any, impact on Apple's business. The market destroyed Apple's stock price in January over these very same concerns, which never materialized. Even in Q4, analysts were extremely cautious on Apple's earnings taking the stock down from a high of $180 to a low of $148 post Q3 earnings due to concerns regarding Apple's fourth quarter—concerns, which once again, never materialized. In June, while the market was busy falling off a cliff over concerns of stagflation, people were lined up around the block to buy iPhones—not tickets into homeless shelters as the media had investors believe.
Moreover, the market has already priced in a complete destruction of Apple's business. So any slowdown that may or may not occur is already fully priced in. This is clearly evident by the analyst consensus estimates for 2009. The analysts are modeling for Apple to earn $5.36 in EPS on $37.61 billion in earnings for 2009. Apple earned $5.36 in EPS on $32.48 billion in revenue in 2008. Thus, the analysts are literally modeling for 0.00% growth in earnings for 2009. As an analyst, I have never seen more irrational consensus estimates in my career.
First, the numbers are not even consistent. The analysts are modeling for Apple to earn $5 billion more in revenue for 2009, but nothing more in EPS. This has largely been the result of overblown concerns regarding Apple's gross margin for 2009. Gross margins will probably rise rather than fall in 2009 as discussed in Turely Muller's article entitled "Apple's FY09 Gross Margin Expectations Are Too Low." Turley Muller, a chartered financial analyst, makes a persuasive case that Wall Street cannot seem to wrap their heads around this idea.
Second, the revenue estimates for 2009 are simply out of touch with reality. For starters, Apple entered into 2008 with only $346 million in currently deferred revenue from sales of the iPhone and Apple TV. That means that Apple got an $86.5 million revenue boost each quarter in 2008—current deferred revenue is recognized over the course of the year. Yet, entering into 2009, Apple has a whopping $3.518 billion in current deferred revenue that it gets to recognize in its earnings reports. That's $880 million in revenue that Apple gets to automatically recognize each quarter in FY09.
2. The false perceptions regarding Apple's dependence on iPod Sales
3. Particular Events leading to Apple's Stock Collapse: A Week-by-Week Detail
After Apple's 5-day sell-off from $170 to $152, it headed into the next week with the bankruptcy of Lehman Brothers (LEHMQ.PK) on Monday and the imminent, collapse of AIG on Wednesday. Apple was just the victim, as was every other stock in the market, of general liquidations, bearishness and panic selling. The stock price fell from $152 on Monday to a low of $120.00 that Thursday before participating in a two-day market rally sparked by a ban on short selling, which helped bring Apple's stock price back up to $140.92 that Friday. That $12.00 fall in share price that week was due to general bearishness in the market and was part of the process of Apple's correcting itself with the indices.
While the following Monday was largely uneventful for the market, Apple's stock took a $10.00 tumble after Morgan Stanley’s Kathryn Huberty cut her price target on Apple from $192 to $179 citing general weakness in the global economic environment. After struggling to stay afloat, Apple closed the week at $128.24. The following Monday, just one week after Kathryn Huberty cut her price target on Apple from $192 to $179, she allegedly felt that something fundamentally changed in five days that would warrant a second downgrade of Apple in as many weeks. She cut her price target from $179 to $115 citing the same nonsense she cited the week before.
The rest of the sell off from $105 to $85 was largely due to the collapse witnessed in the market in the ensuing weeks where 800 point down days in the DJIA became a thing of the norm. The reason I outline the specific details regarding the fall in Apple's stock price is that it's important to parse out exactly how much of the breakdown was due to the sell-off, P/E contraction and revaluation in the broader market. It is also important to see how much of the collapse was due to specific identifiable selling events, which might have pushed Apple's stock price lower than where it would have otherwise landed if not for those events, and then compare the results. It's important because Apple's current stock price might not be a general reflection of the market sentiment regarding Apple's fundamentals, but rather the adverse result of a series of identifiable extra-market selling. If much of the fall was due to selling events rather than to revaluation and general contraction, then the current stock price might simply be the result of Apple's inopportunity to retrace losses against broader market selling rather than the result of a bearish valuation. A case can be made here considering the fact that Apple has outperformed the market for the month of October. On a market rebound, one might expect the stock price to rally harder than the broader market. Whatever the case might be, Apple's current valuation presents one of the best investment opportunities for 2009. There’s still more to come.
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This article has 42 comments:
with your truth finding analysis. Thank you!
Keep up the good work.
Hedge fund forced liquidation certainly contributed to the extreme overselling of Apple. Volume suggests this may be coming to an end
If the economy continues to tank, toy purchases will decline, and AAPL will suffer from that, since it sells expensive toys. In your next article I'd like to see you write about how AAPl fared in previous downturns.
Good Analysis. Keep it up.
BTW I'll take Fremont in a heartbeat, all things considered.
And that's why I think Apple shoud do bargain buyback to eliminate this kind of market manipulation. Steve may be thinking about some buyback seriously.
Firs: A growth company is NOT valued on the amount of CASH it has lying in its coffers. Unless the company issues a dividend or buys back shares, there cash is nothing but a safeguard against going out of business.
Second: The valuation metrics used by the pros is always forward-looking! Your analysis is simply looking at the past.
The following is a copy of a previous post where I compared AAPL & RIMM:
VALUATION: RIMM's EPS for next year is conservatively expected to come in at $4.74 giving them a yr/yr earnings growth rate of 32%. Meanwhile, AAPL's earnings for next year are only expected to grow 24%. RIMM is trading at a fwd-PE of 10 versus AAPL's 15.7. That means RIMM would have to rise 50% just to match AAPL's fwd-P/E, even though they are expected to grow FASTER.
Now, AAPL's cash position is nice to have, but it doesn't really help an investor. Take a look at a company like OVTI that makes the lenses and cameras for the cell phone industry. It has a net cash position of nearly $5.50/share and it was trading at around $7.00! It is poised to earn nearly $1.00 next year, so why is it trading so low?? Because of the expected growth rate. There are many other examples, but the point is that when you are supposed to be a tech growth company, the cash position is an afterthought....unless you're a novice retail investor like Andy. ;o)
anon, i dont know how you can discount 25 billion in cash, growth company or not. as for rimm, a stock that i do like, there's simply no comparison to apple as apple sold more phones than them in the third quarter and rimm's advertising costs are gonna go way up just to compete with the iphones thus hurting their margins....and lets see them deliver a phone on the release date for a change too...
Infact, the article above is questioning the incomprehensible stupidity of analysts and the investor community to assume that Apple Inc. will not continue to show accelerated growth based on all overwhelming evidence against that likeleyhood. Not just how much cash Apple has. . Most available indications for the future are, however, based on the past and present. Andy's article seems to be pleading to reason: HERE'S THE FACTS - HERES WHAT HAPPENED, WHEN AND WHY. DOES IT MAKE SENSE?
My question to you, or anyone else is: why should one assume that Apple Inc. wont beat the street in Q1? Or continue to show accelerated growth? Because Kathryn Huberty downgraded the stock based on fantasy? Because of Apple's low guidance game? Rumours will destroy the company? Because no one will have enough money after stocking up on dry goods and bullets to buy an iphone?
Or maybe you think people will not buy MACs anymore?
Just for example, numbers show that portable divice purchases are slowing, but not for Apple:
blogs.barrons.com/tech...
Overall, this article was terrible. if Andy worked for me and gave me this analysis, i would probably fire him. Or at least send him back to an elementary econ class.
if you're going to make up ratios that favor aapl, may as well say Apple has the lowest Price / Ear Bud ratio (P/EB) of any company in history.
Comparing Apple to Google and Amazon and IBM is insane. Even comparing Apple to MSFT and INTC is pretty off. Apple is more like a Cisco / HPQ / Dell / Rimm. Compared to those companies, it is richly valued (except in the P/EB stat).
But unlike Cisco (and to a certain extent HPQ and Dell and even Rimm), Apple is subject to the whim of the consumer. Today Ipods and Iphones are hot. Tomorrow, who knows? Personally, I think the ipod franchise is fine. I think the iphone franchise is going to get destroyed by Rimm / Google - Android / other competitors.
On the computer side, Dell has announced a slim version to compete with the air that is just above 1/3 the price of the air and provides better specs. Apple's computer division is having success because Vista was a total debacle. But Ubuntu is pretty awesome for net books and as the economy falters people will rather pay half the price for better hardware with Dell or HP.
Of course, Vista is so crappy and can't be fixed for years, that Apple may be ok. Plus, Android may be not be all that for some time. So I can see Apple doing ok in the short term.
What i'm confused about is why you all think this is one of the best articles you've read? i found the analysis down right silly. For example comparing Apple to Amazon or Goog - may as well compare Mattel to Walmart or the New York Times and the price to cash is embarassing. I'm not saying Apple is mispriced here, i don't feel strongly, but i do feel strongly that this article was horrendous.
Seriously, good article, especially about what to do with $110 billion.
I don't believe the $3.518 billion will all be recognized over the next year.
Actually it will. That is current deferred revenue. Current in that it will be recognized within 1 of the date of the statement of deferred revenue. It will be recognized from September 28, 2008 to September 27, 2009.
Actually it will. That is current deferred revenue. Current in that it will be recognized within 1 of the date of the statement of deferred revenue. It will be recognized from September 28, 2008 to September 27, 2009.
Do you have any insight into why they were so far out of phase with the consensus estimate?
Do you have any insight into why they were so far out of phase with the consensus estimate?
Not only today, but for the last 7 years Apple has been hot! It is computers and the ecosystem around those computers that Apple has created that will carry future earnings.
I am an Apple fanboy, a Dexter fanboy and dumpling fanboy.
The products are great, but you're buying the business when you purchase the stock and there's a big different between the two.
Great article.
I really like your articles. Good insights and data.
If I could make a recommendation to improve this comparison to other tech companies. Instead of focusing on the static price/cash metric - I think it would be more interesting to focus on the dynamic price/expected cash flow metric.
Cash on the balance sheet is a static asset that should be deducted from market cap to get enterprise value, but it is not a metric that investors are willing to pay a multiple for. Just because apple is 4x cash doesn't tell me much. I'm not going to pay apple $4 for every $1 they have on their balance sheet.
However, I am willing to pay a multiple (10x?, 20x?) the $12B in cash they will generate over the next 12 months, because I expect that to continue to grow year over year. Apple's cash flow going forward is so different from other tech companies (and GAAP earnings), that it provides interesting insight.
Anyway, just a suggestion. I appreciate the time you take putting these articles together. Helps me on my appl investing.
1. "I think the iphone franchise is going to get destroyed by Rimm / Google - Android / other competitors."
Destroyed, huh? That's what they said would happen to the iPod when competitors and MS with the subscription model attacked--but it didn't happen. Rimm's Blackberry Storm lacks WiFi and is saddled with a partner, Verizon, that has higher service charges and more annoying service than AT&T (according to comments on a blog thread I read). Android has better battery life, but otherwise isn't quite ready for prime time, according to a couple of lukewarm reviews I've read. In a month or so the illusion that these competitors are poised to sweep the iPhone aside will fade away.
2. "On the computer side, Dell has announced a slim version to compete with the air that is just above 1/3 the price of the air and provides better specs."
It doesn't have Apple's OS X, which is its key advantage and is worth paying extra for. Anyway, the Air is a niche product whose sales hardly amount to much. If Dell outsells it, the effect on Apple's earnings would be trivial.
3. "Apple's computer division is having success because Vista was a total debacle."
Even XP users have become exasperated by the comparatively worse number of glitches and malware and overhead and awkwardness of Windows. That's what converted me to the Mac. It's not just Vista's fault. Windows 7 won't solve the basic problem.
4. "But Ubuntu is pretty awesome for net books ...."
True--but that's only an indirect threat to Apple, because it doesn't currently compete in that segment. But it easily could. If Apple were to release a large-screen iPod Touch, it would take share from existing netbooks. Further, if Apple's laptop sales suffer from low-price netbook competition, it could regain the same amount of profit by lowering prices as far as needed, because of its high gross margins.
5. "and as the economy falters people will rather pay half the price for better hardware with Dell or HP."
"Better hardware"? You're showing your bias. "More hardware for the buck" would be an accurate way of putting it. Anyway, Apple's iPhone can serve as a poor man's netbook. A recent thread on SA described how this is already happening: lower income families are disproportionately acquiring the 3G iPhone and dropping Verizon's broadband service to save money, according to recent user-surveys.
"VALUATION: RIMM's EPS for next year is conservatively expected to come in at $4.74 giving them a yr/yr earnings growth rate of 32%. Meanwhile, AAPL's earnings for next year are only expected to grow 24%. RIMM is trading at a fwd-PE of 10 versus AAPL's 15.7."
But AAPL's non-GAAP earnings (or "cash flow") are growing far faster than RIMM's. Click on the link at the bottom of the page to Andy's article, "Apple's 'Real' Earnings: Up Almost 125%"
First off the deffered revenue is recognized over 24 months, not 12 months. So it will be recognized between now till Oct 2010(not till 2009 as Andy has posted). Also it isn;t a straightforward calculation wherein you can take the 3bil and assign it to 2009 and 2010.
Second I agree the Air is a niche product. It was really funny when Steve Jobs introduced it as the thinnest notebook and compared it to a Sony. what he conveniently forgot the Sony X505 introduced way back in 2004 (which failed to gain traction...it's too much of a niche market).
www.mackable.com/blog/.../
Someone should come uip with the PE, etc based on non-GAAP numbers i.e ones wherein the Iphone revenue is not deffered revenue over 24 months. These will probably be awesome and blow the charts/stats. But even matching this going forward next year will be difficult. Why? Because of the economy Mac/Ipod sales will not increase significantly. A huge postion comes from Iphone wherein there is increasing competition from RIMM, Google/Android and Symbian/Nokia. Prices will come down. Hopefully they will expand into aproduct line like what they have done with the Ipod and come out with Iphone Nano, etc.
Andy's statement about the deferred revenue being recognized in 09 is correct. Zaky says CURRENT deferred revenue. "Current" means less than a year.
The iPhone revenue is recognized over 24 months, yet the portion that will be recognized within the next year is recorded in "Current" and the other portion is recorded in non-current .
On Nov 04 03:44 PM anon99 wrote:
> A couple of points:
>
> First off the deffered revenue is recognized over 24 months, not
> 12 months. So it will be recognized between now till Oct 2010(not
> till 2009 as Andy has posted). Also it isn;t a straightforward calculation
> wherein you can take the 3bil and assign it to 2009 and 2010.
I truly appreciate the way Mr. Zaky presents his thesis, then shifts his viewing angle to make the point again, e.g., "said another way..."
What a pleasure to read, what a great teacher, and he is funny.
Thanks!
dr.a