This is how the stock of Apple Inc (NASDAQ:AAPL) has performed in the last 52 weeks.
Performance | 52 Week | ||
Month | -5.05% | Price Range | $374.35 - $701.87 |
Quarter | -25.02% | Change from High Price | -27.37% |
Year to Date | 26.99% | Change from Low Price | 36.18% |
As per Reuters, there are 57 analysts covering Apple and here is how they are rating Apple right now:
Rating | Rating % | Number of Ratings |
Buy | 47% | 27 |
Outperform | 40% | 23 |
Hold | 9% | 5 |
Underperform | 2% | 1 |
Sell | 2% | 1 |
Total | 57 |
There have been many discussions on seekingalpha.com and elsewhere to explain the possible causes of the recent stunning underperformance of the most valuable brand in the world which most analysts agree has a long growth runway ahead of it.
Without repeating what has been discussed earlier, we'll try to find an intrinsic value for Apple, with the help of a very simple Discounted Cash Flow - i.e. DCF - analysis.
We shall use the free cash flow per share as the starting point.
Part 1: Here we'll quickly see what stock price is indicated by the current analyst estimates.
In the year 2012, Apple generated a free cash flow of $45.40 per share.
As per Yahoo finance, the analysts expect Apple to grow its EPS by 20.67% per annum during the next 5 years. Just for reference Apple has grown its EPS by CAGR of 98% since 2003 and by a CAGR of 62% since 2007. During these years, free cash flow per share has grown at 86-87% of the EPS growth rate. Assuming the same FCFPS/EPS growth ratio for the next 5 years, FCF/share can be expected to grow at a CAGR of 18% (87% of 20.67%).
Let's assume that after 5 years, Apple is able to grow its FCF/share at 3% per annum which is a GDP type of growth rate.
10 year Treasury notes, which are arguably one of the safest investments in the world, are yielding 1.71%. Instead of that, let's assume we can get an investment return of 10% per annum, without taking any risk. In other words, we'll use 10% as the discount rate which is about what the stock market as a whole has returned in the long term.
Here is the summary of the inputs for our DCF analysis:
Discount Rate | 10.00% |
Growth Rate next 5 years | 18.00% |
Growth Rate year 6 onwards | 3.00% |
FCF/share FY 2012 | $45.40 |
Using these as inputs, the following table shows the future free cash flows Apple is expected to generate.
FCF/Share | |||
Year | Actual | Discount Factor | Present Value |
1 | $53.57 | 0.91 | $48.70 |
2 | $63.21 | 0.83 | $52.24 |
3 | $74.59 | 0.75 | $56.04 |
4 | $88.02 | 0.68 | $60.12 |
5 | $103.86 | 0.62 | $64.49 |
6 onwards | $948.95 | 1.00 | $948.95 |
Present Value of future free cash flows | $1,230.55 |
You see, based upon what the analysts are expecting from Apple, its intrinsic value is ~ $1230 and for reference the stock on Friday December 14, 2012 closed at $509.79, well below the intrinsic value.
Part 2: Now we shall do a reverse type of analysis, i.e. try to see what the current price assumes about the future growth of Apple. So let's try our DCF analysis with the following inputs and see how it affects the intrinsic value.
Discount Rate | 10.00% |
Growth Rate next 5 years | 2.00% |
Growth Rate year 6 onwards | 1.00% |
FCF/diluted share FY 2012 | $43.87 |
Note:
1. We have retained the discount rate at 10%.
2. We now assume that Apple will be able to grow its FCF/share at 2% annually during the next 5 years and after year 5, FCF/share will grow at 1% per annum in perpetuity. (I should also add here that if I seriously believe that a premium brand like Apple will grow at these rates, I need to get my head examined but for the sake of being ultra conservative, let's go with these rates for now.)
3. We are now using the diluted number of outstanding shares to calculate the FCF/share. For year 2012, it comes to $43.87.
With this, here is what the future looks like:
FCF/Share | |||
Year | Actual | Discount Factor | Present Value |
1 | $44.75 | 0.91 | $40.68 |
2 | $45.64 | 0.83 | $37.72 |
3 | $46.56 | 0.75 | $34.98 |
4 | $47.49 | 0.68 | $32.43 |
5 | $48.44 | 0.62 | $30.07 |
6 onwards | $337.51 | 1.00 | $337.51 |
Present Value of future free cash flows | $513.40 |
You see, even our draconian assumptions indicate an intrinsic value of $513.40 for Apple. The current stock price is trading at a discount to this value too. By no means is this article a very detailed investment thesis for Apple but sometimes a few simple checks can be eye opening in making a decision about an investment or digging in further. Apple to us looks substantially undervalued right now. Mr. Market can still push it down further but we remain a buyer at this point.
Disclosure: I am long AAPL. 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.