A Simple Look At Apple's Cash Flows

| About: Apple Inc. (AAPL)

When a stock is in freefall, the noise can get a little out of control. The last 7 months in Apple (NASDAQ:AAPL) have been about re-writing the expectations of the future as well as the psychology of the present.

It's clear now that both of those factors were swung too far towards the pole of optimism and it's not unreasonable to think they'll swing too far towards the pole of pessimism.

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For the sake of today's thought experiment, let's ignore all of the noise and just look at on simple data point: cash flow. It won't tell us whether the stock is a clear buy or sell, but it will frame nearly every other discussion one can have about Apple right now.

Today's market cap is roughly $380 billion. If you had $380 billion would you buy the whole company?


$137 billion comes back immediately in the form of current cash. Apple will generate just over $40 billion of cash by the end of this year, bringing 2013 total cash to around $180 billion.

Consensus estimates assume Apple will generate around $45 billion of cash in 2014. Let's be conservative and say those estimates are 10% too high even though estimates are always low with Apple because Apple is good at gaming analysts. So say they generate $40 billion of cash next year.

That's $220 billion of cash by the end of 2014 which means that you're now only out of pocket around $160 billion for Apple's core business.

Apple has other assets, too. It's got roughly $15 billion of property and equipment. Since it's your company now and the only thing in the world you care about is cash, let's say you fire sale those at a 33% discount. So now you're out of pocket $150 billion for Apple's core business and brand. For today's analysis, assume that that little Apple logo is worth nothing.

So imagine you own all of Apple and it's December 2014. You just paid $150 billion. What do you now possess?

Well, to start, you have a business that will generate $50 billion of profit in the coming year (2015) even if current forecasts need to be slashed by 10%. And it's not unreasonable to think that the business will generate at least average $35 billion in earnings in the three years after that.

So by 2018 you own Apple for free. You will have been paid back -- more or less -- everything you put into the company.

Is Apple still around in 2018? Are people still buying iPads and iPhones? Are we buying Apple TVs? Watches? Are we still buying music and movies from iTunes? Are we buying some other product of theirs that we don't even know exists yet?

Because this is what the market is effectively saying right now. It's saying that, "No, this is it for Apple. This is a company that's going to generate $15 billion a year starting right away and may not even be around by the end of this decade."

That may be right. I don't know.

But what I do know that the business isn't going to blow up before the end of next year and that after you do some basic adjustments for the cash and assuming no change in price, the stock will be trading at a 3x ttm PE in December 2014.

You read that correctly: a 3x PE.

Apple will report earnings next week. I'm not saying that that'll act as a catalyst. But the current fear and depressed valuation in Apple right now is the kind of thing that can be completely erased in a single earnings call. Even if it's a disastrous report and sales are down and they're only going to earn $30 billion this year and next instead of $50b. The core business still will have a ttm PE at the end of 2014 of around 6x. How much lower can a stock with that kind of valuation go?

I'd say zero if it had a lot of debt or was an obscure player in its product segments or was crippled by fixed costs. But Apple isn't any of those things, nor will it be in the next 18 months.

The market hates Apple. And it could even be hating it with legitimate reason. But unless the cash flows change quickly and dramatically, the core business will be almost improbably cheap at current prices.

If you're a short-term investor, this obviously means nothing to you. But if you're a long-term investor, the idea is intriguing. In February, I added Apple to my Dividend Model Portfolio because I think it's an income stock now and there's a lot of potential for continued dividend hikes. The mandate for that type of portfolio is less concerned with capital growth and more interested in the under-appreciated combination of capital preservation + dividend increases.

In mid-March, I also added it to my Aggressive Portfolio while pairing it with a short-S&P position. That's not a long term trade. It's a 12-18 month contrarian play. The world loves the market and hates Apple and there's substantial data that suggests it should be the other way around. I wrote about this extensively right here.

Apple can make a lot of sense in portfolios like those. During times when emotions and newsflow are running high, it can be refreshing to take a step back, look at some basic data, and remember that stocks like this are merely tools to accomplish specific objectives.

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. Full disclosure available here.