Apple (AAPL) is in a state of flux, a downward, seemingly never-ending spiral that began after reaching a high of just over $700 in September. The stock, now down nearly 40% since then, does not appear to have a bottom in sight. With that in mind, how is Apple currently valued, and does the current valuation make sense?
Gordon Growth Model: Apple's current market implied value is approximately $425, which led me to question how one arrives at that number from an intrinsic value perspective. Utilizing the Gordon Growth Model (GGM) and Free Cash Flow to the Firm (FCFF), one can break out the components and establish implied values. In this case, the model proves useful in assessing the market based implied growth rate. Utilizing a cost of capital of 10%, FCFF of $40b, and a stock price of $425, we arrive at an implied growth rate of 0.52%. Question, is this actually Apple's growth prospects? According to the sustainable growth model, this is not the case.
Sustainable Growth: The sustainable growth rate states that a company's growth (G) is a function of its return on equity (ROE) and plow back ratio (B), in the form g = ROE*b. Solving for g, equates to a sustainable growth rate of 4.5%. Now, moving back to the GGM, using the same variables as above and a growth rate of 4.5%, results in a stock price of $761.33, which is closer to the share price before it fell off the cliff in September. Albeit, I am not suggesting this is the actual intrinsic value of Apple, just valuing it as a perpetual zero growth stock is incorrect. Apple will certainly not grow at 0.0% per year nor will it grow at 4.5% into perpetuity; however, maybe Apple will grow at a declining rate over the next five years.
The H-Model: If Apple were to grow its FCFF at 4.5% for the current year (even though it has grown it at a far greater rate in the past) and level off in 5 years at 2%, the implied price of Apple would be $542.20. To further expand on this, and in an attempt to establish a downside price for Apple, I also utilized 4.5% initial growth declining to zero growth in the long run, which implies a price of $445.78 (approximately 4.5% higher than the price today).
Conclusion: Apple's downside risk seems limited, in fact it appears to have already surpassed it on a discounted cash flow basis; however, the market is not always rational, which results in opportune times to buy undervalued stocks. Is now the best time to initiate a large position in Apple? Probably not; however, this is likely a good point to start building baskets of Apple stock as the price continues to fall until Mr. Market wakes up and properly values Apple. With a strong balance sheet, an ever growing stable of products, and continued growth in FCFF, I repeat the initial question … How is Apple a zero growth stock?