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From October 2008 through April 2009, Apple’s stock price was below $100. Despite the recession, it was a screaming buy. Now, $150 later at $250 per share and in the midst of the European debt crisis, it is time to re-evaluate investment risk. To do this, I use my projected earnings for 2010, 2011 and 2012 and recent trailing twelve month P/Es to develop some target price ranges.

Before the “Great Recession”, Apple's P/E was averaging about 35 with a lot of volatility. During the period of October 2008 to March 2009 when Apple was trading below $100 its average P/E was 13.2. From October 2008 to present the average P/E has been 17.3. Since last September when Apple started making new highs above $200, P/E has averaged 21.2. Assume the good old days of high P/Es for Apple are in the past and the “new normal” P/Es are; 13 during market crisis, 21 during market booms and 17 on average, future price brackets can be made based on earnings estimates.

My current EPS estimates are $15, $20 and $25 for FY10, FY11 and FY12, with each fiscal year ending in September. I evaluate the FY10 estimate of $15 as fair and likely. The FY11 and FY12 estimates are actually conservative because:

  1. I held back on iPhone sales growth, the work-horse behind Apple’s earnings growth. I used 50M and 66M units for FY11 and FY12, but when you look at the trajectory of world smart phone sales and assume Apple plateaus out at 17% market share, you get 58M and 80M units for FY11 and FY12. This conservative margin accounts for future unknowns such as how the EU debt crisis will affect EPS.
  2. Earning contributions from the new iAd platform are not included.

What do I really think? Apple EPS should be as high as $23 in FY11, and $29 or $30 in FY12, but the farther I project the more conservative I like to be.

From the above EPS estimates, here are my price ranges for September 2010, 2011 and 2012:

P/E

September 2010

September 2011

September 2012

13

$195

$260

$325

17

$255

$340

$425

21

$315

$420

$525

The associated gain/loss from Friday’s close of $242 would be:

P/E

September 2010

September 2011

September 2012

13

-19%

7%

34%

17

5%

40%

76%

21

30%

74%

117%

For the historical P/Es I used Apple’s restated earnings. Actual P/Es at the time of the crisis were higher due to subscription accounting supressing the E in P/E. Cash flows were always the same under either accounting method, but investor perception was probably different. Therefore, a lower limit of 13 on P/E is still reasonable.

I’ve made no assumptions associated with Apple’s cash. Currently Apple has $45/share in cash. If the hoarding continues, cash should be well over $80/share by the end of FY12. You can argue that the cash should be taken into account when valuing Apple, but lacking any clear dividend or stock re-purchase policy, the cash is a dead asset on the balance sheet. Right now, I look about 2 years out and I have no expectations that Apple will employ their cash during that time. For now, the cash is nice to brag about, but is contributing very little to earnings/cash flow, which is the driver for market valuation.

Apple’s sentiment should remain as solid as ever over the next 9 months with:

  1. International release of the iPad on 28 May.
  2. New iPhone on 7 June with rumors of a Verizon or Sprint deal getting stronger. Additionally, a CDMA iPhone should lead to a China Mobile deal.
  3. The July earnings release will include, for the first time, the iPad.
  4. I expect an iPod Touch refresh in September, which should include the new iPhone look and features (except for the phone of course).
  5. October earnings release will include 2 full quarters of iPad sales and a full quarter of new iPhone sales.
  6. iPad refresh next January.

The difficulty comes when Apple is looking great while rest of the market is falling apart. The uncertainty surrounding the EU debt crisis represents near-term risk, but should also provide some buying opportunities. And, if you feel like you’ve already missed the boat on buying Apple, just wait for the next crisis (Japanese debt, Chinese real-estate, California debt etc). Bubbles are everywhere and emotions are will be flying high on the EU crisis for a while.

Even if you went all-in at $242, volatility may cause some near term anxiety, but, if you are willing to wait a year or two, the upside potential is very compelling given the low down-side risk.

While writing this, Katy Huberty of Morgan Stanley published her price ranges for Apple, and since I am also publishing price ranges, I felt compelled to compare results. Not many analysts publish price ranges around their target price. A point estimate by its self provides insufficient information on the potential down-side risk and understates the upside opportunities. I think more analysts should follow this method.

While I have similar top and mid-range target prices, my worst case scenario for May 2011 is $245 vs. Huberty’s $210. Our approaches are also different. Huberty assumes that price cuts will be a driver for iPhone sales growth. With Android phones similarly priced, I do not view the current iPhone price structure as an issue with consumers and I can’t see the service providers cutting the monthly fees. Have you seen the debt load of the service providers? They could start their own debt crisis. Building networks is not cheap.

Disclosure: Author holds a long position in AAPL

Source: Apple: Still a Low-Risk Buy