# Apple's Valuation Is Very Reasonable

When you want to know whether or not you should buy something, you need to know what a good price is to pay. You could be buying cereal during your weekly grocery run. If \$2.99 is the price at which you would buy a box, you probably won't buy it if it is \$4.49, unless you either really need it or have to have it. The same logic can be applied to stocks. If you think X is a good price to pay, you probably won't buy it at X plus 20 percent.

When you write about a stock as large and popular as Apple (NASDAQ:AAPL), you are bound to get plenty of questions. Obviously, everyone wants to know if Apple is a buy now, a sell now, etc. Well, it comes down to valuation. Today, I will look at some valuation metrics for Apple, and determine if now is a good time to buy.

Price to Earnings, Ex-Cash

This is the one metric I always get a ton of questions on, and it's one that Apple bulls always like to talk about. Apple is trading at X times trailing earnings after subtracting out the huge cash pile. Well, I put together a table below showing Apple's price to earnings, excluding cash the last two years, as well as the current quarter. Everyone might calculate this number in their own way, so here is how I did it.

1. Used 12-month trailing net income figure. For Q1 of 2012, I adjusted the net income figure for a 13-week period.
2. Cash pile includes cash and equivalents, short-term investments, and long-term investments.
3. Used outstanding share count at end of previous quarter.
4. Calculated a high value, based on highest trading price during quarter; low value, based on lowest trading price during quarter; average price, based on average close during quarter.

So for example, let's look at Q1 of the 2011 fiscal year. In the four quarters prior, the company's net income was a combined \$14.013 billion. Going into that quarter, the outstanding share count was approximately 915.97 million. The cash pile was over \$51 billion. During that first quarter, the high share price was \$325.72, the low share price was \$275, and the average closing price was \$308.94. So the high market cap (before cash) was more than \$298 billion, the low cap was a little under \$252 billion, and the average was around \$283 billion. Subtract out the \$51 billion, and dividing that by the trailing net income of \$14 billion plus, you get your three P/E ex-cash values. The following table shows the results.

Except for Q4, the year over year trend was for the P/E value to go lower. Now, that means investors on average have been willing to pay less for Apple, which might make sense if growth is slowing down. So far this quarter, the high is 12.61, the low is 8.67, and the average is 10.83. That means that both the low and average value are the lowest of the nine quarters in this analysis. Based on Friday's close, Apple is trading at a 10.52 value, meaning about 3% below this quarter's average so far. That implies investors are a little bearish on Apple, evidenced also by the fact that the current value is less than last quarter's (Q4 of 2012) low value. That might have something to do with investors fearing Apple because they don't understand the company's math.

So the question asked is what is a good value? Well, given how Apple's growth has slowed down, and this is expected to be a bad quarter for margins, you really can't make an argument for like 15-17 times ex-cash. However, the company is currently paying a dividend, yielding 1.81%, that it wasn't a year ago. Also, in this current quarter, Apple started buying some shares back. That might provide some "value" to Apple investors, so that might make a higher premium viable. So maybe Apple is worth roughly 11-12 times, the average to high value we saw in last year's Q1. I'm using those numbers because I believe there is a little bit of fear in Apple right now because of the margin numbers, and I think that's pressuring shares a little. The lower growth and margins argument would be offset by the dividend and buyback argument. Based on today's price, that means Apple would be about 4.5% to 14% undervalued currently.

Looking Forward

Before we can look at the current and future quarters, I recommend that you read my latest Apple article first. This article breaks down Apple over the last couple of years, as well as looking forward. The article forms a good base in terms of financial projections and numbers we can use on the valuation side.

So let's look at this quarter. Apple guided to \$52 billion in revenues, and analysts are currently at \$54.52 billion. That compares to \$46.33 billion in last year's period, or about \$43.02 billion if you normalize the period for 13 weeks. Remember, last year's first quarter was 14 weeks. But despite the increased sales, Apple's margins are expected to come down quite a bit. That is because their new products are lower margin, the iPad mini sales will take away from a percentage of iPhone sales that carry higher margins, and this was the biggest product release quarter probably in Apple's history.

Apple guided to 36% gross margins, down a lot from Q1 last year which saw 44.68%. However, we know that Apple gives conservative guidance, and most expect gross margins to be a bit better. There still will be a bit of a decline. When it comes to earnings per share, Apple guided to \$11.75, and analysts are currently at \$13.30. That compares against \$13.87 in last year's period, or about \$12.88 for a 13-week period.

So when it comes to net income, it could be close to last year's \$13.06 billion, or \$12.13 billion adjusted. Now, net income is the first line in cash flow from operations, so this number is important. Also remember that Apple was not paying a dividend or buying back stock in last year's Q1. So when Apple had a monster Q1 last year, the cash pile increased by about \$16 billion. If you factor in a dividend payment of about \$2.5 billion and some share buybacks, you would figure the cash pile won't rise by as much as it did in last year's Q1.

Even if Apple only produces net income of say \$12 billion and the cash pile increases by \$10 billion, the valuation gets even lower when using the adjusted net income for last year. Based on those two numbers, and a rough share count of 941 million, the P/E ex-cash based on Apple's current price would be 10.3, even more reasonable than the 10.5 or so we are currently at.

Looking at Other Metrics

Some may ask me how Apple's numbers I've shown above compare to some other names out there, like Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), and Microsoft (NASDAQ:MSFT). Well, there are a few reasons why I won't make those comparisons here. First, Amazon doesn't really have much net income, so the numbers would look completely outrageous. In terms of Google, the numbers don't make sense either because of the Motorola Mobility acquisition, which has killed margins. You can't really compare Google's numbers over the last year or two because of the impact of that acquisition. In terms of Microsoft, there are two issues. You have the huge goodwill write down for aQuantive as well as the Windows 8 upgrade numbers. Also, certain product releases make their revenues fairly uneven over time. There are just too many GAAP versus non-GAAP numbers. Which one would you actually compare to Apple?

So how can we compare Apple to these three? Well, one method would be to look forward, not backward. Let's look at the price to sales ratios, looking forward a bit. For Apple, we'll use the current fiscal year, ending in September 2013, and for Google and Amazon, we'll use calendar 2013, their fiscal years. For Microsoft, we'll use the current fiscal year, ending June 2013. Apple is trading at 2.85 times projected revenues, and revenues are expected to grow at about 26% when you normalize last year for the extra week. Amazon is trading at 1.44 times expected sales, and sales expectations are for almost 28% growth. But Amazon gives you no dividend, no buybacks, very low margins, and almost no profits, plus a terrible balance sheet. Now with Google, it gets a little tricky due to the GAAP and non-GAAP estimates thanks to traffic acquisition costs, which are included in the GAAP results. Analysts use non-GAAP numbers, and on the current estimate, Google trades at 4.43 times sales, with growth at 25%. If we project out to next year and approximate \$65 billion in GAAP revenues, that would imply a price to sales of 3.53. Microsoft's forward looking price to sales is 2.78, but again, Microsoft is growing a lot slower, buying back more shares, and paying more of a dividend.

Since analysts look at the non-GAAP numbers for Google, we'll use that number for Google. If you average the three names, the price to sales figure is 2.88 times, meaning Apple is about 1 percent undervalued.

Other recent news to consider

One thing that could tip the scale even more in Apple's favor is the recent announcement of product launches in China. Apple's iPhone 5 will go on sale in China on December 14th, and the 4th generation iPad and iPad mini will go on sale December 7th. That gives Apple slightly more than two weeks in the current quarter to sell the iPhone in China, and three plus weeks on the iPads. These product launch dates seem to be slightly ahead of schedule according to analysts.

There may be a couple of impacts here. You might see a few analysts raise their forecasts for the current quarter. However, the full year impact should be rather negligible, as you'll probably see future quarter numbers taken down by roughly the amount Q1 is taken up by. With the China launches being late in the quarter, it will provide a bit of a safety net to Q2. That is, that you'll have a full Chinese selling quarter then, instead of just a few weeks during Q1.

Final Thoughts

Apple's valuation is very reasonable, even after the recent \$80 rally. Apple is trading at the lower end of its P/E ex-cash range, and while the company isn't offering the same amount of growth, a nice dividend and buybacks do compensate. On a forward looking price to sales basis, Apple seems fairly priced to other names out there.

It was about this time last year that Apple started its historic rally. It could happen again, but investors do need to be watchful of three things. First, the fiscal cliff discussion. Second, the November jobs report will be out this week. Finally, investors who bought Apple more than a year ago might sell Apple before year's end if they think tax rates are going up. All three of these issues could negatively impact Apple's share price. Apple still remains a great long-term name to be in, but investors do need to realize there are plenty of short-term items that could push shares lower. I don't see Apple falling back to last year's \$400 level, but I think \$525 to \$550 is possible before the next leg up. Apple seems primed for a great quarter and year in terms of sales.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.