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It's very common to see articles talking about valuation of Apple (AAPL). Usually these articles will talk about Apple's earnings, cash reserves and strong brand name, among many other things. One thing that never gets mentioned when Apple's valuation is being calculated is the company's lack of debt. As of right now, Apple has zero debt. Shouldn't this be worth something?

When we look at Apple's peers, we see that a lot of them are buried under loads of debt. For example, Apple's competitor in the computer industry Hewlett Packard (HPQ) has a debt of $28 billion whereas the company's market value is $27 billion. Apple's another competitor Dell (DELL) has a market value of $18 billion and debt of $9 billion. Nokia's (NOK) market value is $14 billion, whereas the company's debt totals $5 billion. Sony's (SNE) debt totals $15 billion and the company's market value is only $10 billion. Even companies like IBM (IBM) have a large chunk of debt as that company's total debt reached $33 billion in the last quarter. Again, Apple has no debt.

Over the years, investors and analysts have come up with many formulas to calculate a company's value but I have yet to see a formula that keeps a company's lack of debt into account. Many times, analysts will look at a company's book value and extract its liabilities from this number in order to obtain the company's tangible book value. Then again, when a company has no debt, things get complicated.

Some other companies with no debt include American Express (AXP), Amazon (AMZN), Bed, Bath and Beyond (BBBY), Intuitive Surgical (ISRG), Cognizant Tech (CTSH), MasterCard (MA) and Expeditors Int'l Washington (EXPD). These companies have P/E ratios ranging from 13 to hundreds. Not having any debt allows these companies to invest more money into growth activities, and allows these companies to keep all their earnings. Imagine two companies that have the same P/E ratio with one having debt and the other lacking debt. One of these companies keeps all of its earnings whereas the other company spends half of its cash flow for paying off debt. Can you really say these two companies have equal valuations when everything else is held constant? Lack of debt not only demonstrates that a company will keep all of its earnings to itself, but also opens doors for a company to be able to get cheap credit when needed. Apple probably won't need to take credit within my lifetime, but you never know. It's always good to have that lifeline on the side. Besides, if a company doesn't have to spend a portion of its earnings to service debt, it can use this money to pay dividends or buyback shares, which is great for the investors of the company.

I would say that when a company's growth comes to a halt and it becomes a value play, the company should be looking at a fair P/E ratio of 10, excluding its cash holdings. If a company is expected to grow at a rate of 15-20% annually, it can afford to have a P/E ratio closer to 20 excluding cash holdings until the growth slows down to single digits. This is basically the situation Apple is in. Furthermore, because Apple has no debt and it can keep all its earnings to itself (excluding taxes), it should be able to afford an even higher P/E than a company that has to service debt.

Just to give an example, IBM earned $13 per share last year and the company spent nearly $8 per share on debt reduction in the same year. Because Apple doesn't have to do that, the company's ideal P/E ratio can easily stretch nearer to 30 than 20 excluding the company's cash holdings.

Warren Buffett says that when buying shares of a company, we should act as if we are buying the entire company. That is, we should study the balance book and income statement of the company as if we are buying the whole company. Apple's current price tag is $515 billion, which comes with $120 billion in cash and over $40 billion annual earnings. Because the company has no debt, the valuation of the company looks absurdly low. If I had $515 billion to spare, I would go ahead and buy Apple within a heartbeat. This is one of those giant purchases that don't come with the so called buyer's remorse.

In conclusion, Apple's fair P/E ratio looks to be around 20 when one ignores the fact that the company is debt free. After factoring in the company's lack of debt, the valuation should change dramatically. In the technology industry, many companies have large loads of debt and they spend a large portion of their income to service this debt. Because Apple doesn't have that problem, its fair value should be much higher than its current price. It is fair to say that Apple is as cheap as it gets.

Source: How Much Is Apple's Lack Of Debt Worth?