Overview
Apple (AAPL) reported earnings on the 23rd, the sordid details of which you can read any number of places, including the press release or any of the dozens of Apple focus articles here on Seeking Alpha. I am not here to comment on the earnings release as it has been done ad nauseum already and certainly will be in the coming days. However, I'd like to take a look at exactly what the market is pricing in at the current share price of about $450. Expectations have gotten so low for Apple that I believe it is now trading in the realm of a value tech play like Cisco (CSCO), Microsoft (MSFT) or even Dell (DELL). The implication is that I don't believe this is an equitable fate for the once-mighty Apple as it has fallen from investors' good graces more quickly than any other stock I can remember. So what does the market think Apple will do going forward?
Valuation
I will use a DCF type analysis that inherently requires some assumptions. They are: 1) 2012 actual, 2013 and 2014 EPS estimates are from Yahoo Finance analyst compilations 2) dividend growth rate is assumed to be 5% (I believe this is conservative given Apple's cash hoard) 3) discount rate is 10% (my number) 4) perpetual earnings growth is an anemic 3% 5) buybacks are not factored in, making the estimates more conservative. Obviously, any forecast is subject to conjecture and you may not agree with my numbers, but any forecast is imperfect.
2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |
Earnings Forecast | |||||||
Reported earnings per share | $44.15 | $47.97 | $56.44 | $56.44 | $56.44 | $56.44 | |
x(1+Forecasted earnings growth) | 8.65% | 17.66% | 0.00% | 0.00% | 0.00% | 0.00% | |
=Forecasted earnings per share | $47.97 | $56.44 | $56.44 | $56.44 | $56.44 | $56.44 | |
Equity Book Value Forecasts | |||||||
Equity book value at beginning of year | $125.66 | $162.50 | $207.26 | $251.43 | $294.98 | $337.89 | |
Earnings per share | $47.97 | $56.44 | $56.44 | $56.44 | $56.44 | $56.44 | |
-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 | $162.50 | $207.26 | $251.43 | $294.98 | $337.89 | $380.13 |
Abnormal earnings | |||||||
Equity book value at begin of year | $125.66 | $162.50 | $207.26 | $251.43 | $294.98 | $337.89 | |
x Equity cost of capital | 10.00% | 10.00% | 10.00% | 10.00% | 10.00% | 10.00% | |
=Normal earnings | $12.57 | $16.25 | $20.73 | $25.14 | $29.50 | $33.79 | |
Forecasted EPS | $47.97 | $56.44 | $56.44 | $56.44 | $56.44 | $56.44 | |
-Normal earnings | $12.57 | $16.25 | $20.73 | $25.14 | $29.50 | $33.79 | |
=Abnormal earnings | $35.40 | $40.19 | $35.71 | $31.30 | $26.94 | $22.65 | |
Valuation | |||||||
Future abnormal earnings | $35.40 | $40.19 | $35.71 | $31.30 | $26.94 | $22.65 | |
x discount factor (10%) | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 | 0.564 | |
=Abnormal earnings disc to present | $32.19 | $33.21 | $26.83 | $21.38 | $16.73 | $12.79 | |
Abnormal earnings in year +6 | $22.65 | ||||||
Assumed long-term growth rate | 3.00% | ||||||
Value of terminal year | $323.58 | ||||||
Estimated share price | |||||||
Sum of discounted AE over horizon | $130.34 | ||||||
+PV of terminal year AE | $182.65 | ||||||
=PV of all AE | $312.99 | ||||||
+Current equity book value | $125.66 | ||||||
=Estimated current share price | $438.65 |
So what is the market pricing in at $450 per share? As we can see, after 2014 earnings of $56.44, the market thinks Apple will essentially never grow earnings again. If, like me, you find this to be unreasonable, perhaps Apple is a bargain at current levels. Of course, only time will tell but I'm not willing to assume that Apple is ready to roll over and die and become an income stock. This will happen at some point in the future as it is inevitable, but I believe this is many years away. Apple is not Dell but it is being priced as though it is. After all, the company did post record revenue ($54.5 billion) and profit ($13.1 billion). Is this the top for Apple earnings? Maybe, but I seriously doubt it. Expectations have risen so high from investors that Apple cannot possibly meet them and I believe this is resulting in inefficiency in the way the shares are priced.
Some analysts are belatedly jumping on the Apple-hating train, including Jeffries' Peter Misek cutting his rating from buy to hold and lowering his price target by roughly 15%, to $600. Even the downgraded price represents roughly 33% upside from current levels so that sounds more like a buy to me, but to each his own. On the other end, Brian White from Topeka has lowered his lofty price target from $1,111 to "only" $888, representing nearly a double from current levels. While I find this PT to be a bit overzealous, I'm more inclined to side with his bullish thesis based on the belief that record earnings really aren't that bad.
At any rate, if you think Apple will never grow earnings again after next year, by all means avoid the shares. If, however, you find this to be a bit pessimistic, the shares are perhaps a generational buying opportunity. Of course, none of these dour scenarios include the possibility that Apple TV will finally come to fruition or that Apple's immense R&D budget will produce the next blockbuster product we've never heard of. I'm not suggesting either of those things will definitely happen, but I also won't discount them, given Apple's track record.
Disclosure: I am long AAPL.
