Apple’s (NASDAQ:AAPL) stock is fast approaching its 52-week high of $177.50, set almost exactly 1 year ago, and seems within striking distance of its all-time high valuation near $200. I wrote at the beginning of the year about Apple’s intrinsic value and recommended buying the stock when it hit $89/share amid rumors of Steve Jobs’ declining health and Apple’s inability to continue to make hit products. The stock has appreciated almost 90% since and it would seem a good time to revisit the Company’s valuation.
My method of determining whether or not a stock is trading at a “value” is to determine the market’s implied valuation. Rather than attempt to model and predict a company’s operating performance, I use the current market value to back into implied growth rates. Then, I try to make a decision as far as how realistic the market implied growth rate actually is. In the end, we retail investors - lacking the ability to control the companies we invest in - are merely trying to determine reasonable prices at which to “buy growth.”
Calculating Apple’s Market Implied Growth Rate
Step 1: Excess asset value
The foundation for a stock’s value is the intrinsic value of the Company’s assets. Not all of the Company’s assets are distributable. Obviously, some baseline level of assets are necessary in order for the Company to operate as a going concern. As such, we’ll leave long term assets alone and focus instead on current assets and working capital.
As of June 27, 2009, Apple reported negative net working capital (exclusive of cash) of -$5.8 billion. This implies that the Company is able to generate cash through its operations. As such, it is possible that the company could finance its growth through operations and this would mean that, as a going concern, Apple has no immediate need for cash on its balance sheet. Thus, the $24.3 billion in cash and short term equivalents on the Company’s balance sheet is effectively distributable.
To be conservative, however, let’s discount this cash. After all, management has shown no intention of distributing cash to shareholders and as long as this value held at Apple, there is risk to investors' ability to realize it. Most conservatively, Apple should hold enough cash to cover the entirety of its liabilities in excess of other current assets. This implies $11.4 billion of the $24.3 billion should be reserved. Thus, Apple’s excess distributable asset value is between $12.9 billion and $24.3 billion.
Step 2: Value of Cash Flows
Now, we begin a “reverse” DCF analysis on Apple. Over the trailing twelve months, Apple has generated free cash flow (defined for simplicity as operating cash flow minus capital expenditures) of $10.3 billion.
At zero growth and a 12% discount rate, the present value of cash flows is worth $85.5 billion.
At zero growth, Apple’s cash flows in addition to excess distributable asset value would be somewhere between $85.5 billion and $109.8 billion.
This implies upwards of a 27.5% downside to Apple’s current valuation ($151.5 billion market cap) if its growth were to stall indefinitely.
Step 3: Market implied growth rate
This is where the analysis can get tricky. I typically like to make the simplifying assumption that most companies will have about 5 years of additional growth before slowing to a growth rate closer to GDP (2-3%).
Assuming that Apple will mature in five years and reach a baseline 2% growth rate, the 5-year implied growth which would justify Apple’s current $151.5 billion market cap would be 14%.
Does 14% seem like a reasonable year-over-year cash flow growth rate for Apple’s next five years? That would be the “over/under” necessary if you’re willing to invest new money in Apple today. Next time someone tells you Apple is “fairly valued,” you’ll know they don’t think significant performance beyond this level is likely.
Full Disclosure: Long shares of AAPL at the time of writing.