Any sane investor that looks at Apple's (AAPL) current valuation around $430/share has to at least ponder this for a while. Apple is trading only at 6.8 times its expected 2013 earnings excluding cash and investments. This kind of valuation implies a company in a rapidly declining business.
Fortunately for its investors though, Apple's situation isn't remotely close to something like that. Its main product the iPhone is still thriving all over the world and has still a long way to go. In particular it is just beginning to expand to China and India, the world's two biggest countries by population and the two biggest untapped markets for Apple.
In China the estimated market for smart-phones is bigger than the US and consists of approximately 330 million smart-phone users. Furthermore, it is expected to grow to 500 million by the end of 2013. Despite this fact, China represents only 15% of Apple's global revenue leaving plenty of room for Apple to grow.
India is another big market with great potential. Although it's smart-phone market penetration is only 10% of its population of 1.2 billion people, Apple's rumored new cheaper model could help increase penetration and increase Apple's market share in this country.
However growth isn't a necessary component to my investment thesis about Apple. Yes you read correctly I won't take growth into account as we examine Apple's valuation.
Instead I will assume that Apple's earnings will stagnate at $44 per share. In a scenario like this Apple should trade in my opinion around 10 times its earnings offering a 10% earnings yield. However, to correctly calculate Apple's no-growth price we have to discount its cash of $145 per share. Doing so we find that Apple's no-growth value of 10 times earnings plus cash, is around $600 or 40% higher than its current price.
And the picture stays the same with other valuation methods as well. Assuming EPS of $44, 0% growth and a 5% risk free rate, DCF analysis gives as a net present value of $365. Adding the $145 of cash we get a fair value around $500 or 25% higher than its current price.
And so far we are assuming no growth for the next decade. If we change that to a moderate 5% EPS growth rate over the next 10 years then Apple's fair value is significantly higher. Its net present value would rise to $630 including cash or 45% higher from the current price. Furthermore, from an earnings yield perspective the appropriate P/E ratio would be around 15 giving us an even higher fair value of $800 ($44 X 14 + $145) or 85% higher than the current price.
So, let's do a recap. The market is valuing Apple as a no-growth company that is worth 6.8 times its EPS excluding cash and investments. However even in a 0% growth scenario the company is worth 25% to 40% higher, offering investors an excellent margin of safety. I believe that this is one of the most blatant mispricings I have ever seen.
What do you think? Is Mr. Market right or wrong in his opinion about Apple?