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Overview

We are all well aware that it has been an ugly couple of months for Apple (AAPL) shares as they have plummeted from a high of $705 and are now trading for just over $500. I recently penned an article regarding Apple's valuation in which I posited that, given Apple's growth expectations and some conservative estimates, Apple is a buy today anywhere below $800. Given the fact that Apple is trading for just over half that number now, I figured it was time to reassess and see exactly what the market knows that I don't.

Apple has had a slew of analyst price target cuts in the past week, most recently from Citi, in which they cut their target to just $575. The cut is based on channel checks in Apple is cutting orders for iPhone 5 for the March quarter. This is not a new story as virtually all the recent price target cuts have been the result of supply chain checks. This story is baked into the price of the shares at this point as the analysts are all saying the same thing.

On the other side, just this morning, Brian White reiterated his $1,111 price target on Apple based on iPhone sales in China over the weekend. No doubt, today will be a very interesting and volatile day of trading in Apple shares.

To find out exactly what is being priced in for Apple shares, I have modified my numbers in my DCF calculations in order to figure out what the market currently thinks Apple is going to produce over the next five years to warrant a price of $505. Keep in mind, for this DCF, I used a discount rate of 10%.

2012

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$44.15

$49.28

$51.25

$53.30

$55.43

$57.65

x(1+Forecasted earnings growth)

11.62%

4.00%

4.00%

4.00%

4.00%

4.00%

=Forecasted earnings per share

$49.28

$51.25

$53.30

$55.43

$57.65

$59.96

Equity Book Value Forecasts

Equity book value at beginning of year

$125.66

$163.81

$203.38

$244.41

$286.96

$331.08

Earnings per share

$49.28

$51.25

$53.30

$55.43

$57.65

$59.96

-Dividends per share

$10.60

$11.13

$11.69

$12.27

$12.88

$13.53

$14.21

=Equity book value at end of year

$125.66

$163.81

$203.38

$244.41

$286.96

$331.08

$376.83

Abnormal earnings

Equity book value at begin of year

$125.66

$163.81

$203.38

$244.41

$286.96

$331.08

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

=Normal earnings

$12.57

$16.38

$20.34

$24.44

$28.70

$33.11

Forecasted EPS

$49.28

$51.25

$53.30

$55.43

$57.65

$59.96

-Normal earnings

$12.57

$16.38

$20.34

$24.44

$28.70

$33.11

=Abnormal earnings

$36.71

$34.87

$32.96

$30.99

$28.95

$26.85

Valuation

Future abnormal earnings

$36.71

$34.87

$32.96

$30.99

$28.95

$26.85

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

=Abnormal earnings disc to present

$33.38

$28.82

$24.77

$21.17

$17.98

$15.16

Abnormal earnings in year +6

$26.85

Assumed long-term growth rate

4.00%

Value of terminal year

$447.48

Estimated share price

Sum of discounted AE over horizon

$126.11

+PV of terminal year AE

$252.59

=PV of all AE

$378.70

+Current equity book value

$125.66

=Estimated current share price

$504.36

As you can see, with a 10% discount rate, the market is pricing in 4% perpetual growth in earnings for Apple. I find this rather perplexing as analyst estimates are roughly 5 times that number, according to numbers complied by Yahoo! Finance. The earnings estimate for 2013 is the number pulled from analyst's estimates, also from Yahoo! Finance. After that, you can see the market thinks Apple is going to grow earnings at only 4% per year.

Conclusion

Given that Apple still dominates music and smartphones and enjoys ridiculous margins, this kind of valuation is a joke. I am long Apple and will continue to add at these levels and more if we continue to go lower. What we are seeing is panic selling and I am willing to accept the risk that is derived from this price point. The risk, I believe, is to the upside with such an Armageddon scenario priced in. Apple is not Cisco (CSCO), Intel (INTC) or Dell (DELL). These tech dinosaurs are no-growers whereas Apple's innovation machine is not dead and their margins may be squeezed at the beginning of this product cycle, but they will come out the other side in dominant fashion as they always do. If you think Apple can beat 4% earnings growth per year, you should consider a long position in Apple as well as the risk is to the upside from these levels.

Source: Apple Now Priced For 4% Growth