Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) are both widely followed technology companies. Google's stock price has risen more than 75% in a little over an year (14 months), whereas Apple's stock price has not moved much. This has resulted in Google trading at an enterprise value of $22 billion more than Apple. This is ironical, since Apple's net income of $37.03 billion dwarfs Google's net income of $12.92 billion. Additionally, Apple's free cash flow is almost 4 times that of Google's. This article focuses only on the financial metrics to showcase the huge disparity in valuations between Apple and Google.
I will start by computing the Enterprise Value (EV)for both Apple and Google, and then provide 3 metrics that exhibit why Apple looks undervalued in comparison to Google.
Enterprise Value is a measure of a company's worth. Think of it as the theoretical takeover price of the company. It is defined as:
Enterprise Value = Market Capitalization + Total Debt - Total Cash and Cash equivalents
The table below computes the enterprise value for both Google and Apple:
Total Cash and Cash Equivalents
Enterprise Value (EV)
*Market capitalizations are computed as of March 4, 2014, and rest of the numbers are based on the quarter ending in December 31, 2013. All numbers are in billions (US$), unless stated otherwise.
As can be clearly seen from the above table, Google is trading at an enterprise value of more than $22 billion in comparison to Apple.
(1) Comparison of Free Cash Flow (FCF)
Free Cash Flow is a measure of how much cash a business generates after accounting for capital expenditures such as buildings or equipment. FCF is essentially the money that the company could return to shareholders if the company was to grow no further.
The graph below shows how the FCF for both Google and Apple has been tracking over the past 5 years.
Apple's FCF has increased at annual growth rate of more than 30% compounded annually (from $10.76 billion in 2009 to $44.24 billion in 2013). On the other hand, Google's FCF has increased at a growth rate of about 6% compounded annually (from $8.50 billion to $11.30 billion) over the past 5 years. Considering Google's peak FCF of $13.35 billion (ttm to December 31, 2012), the growth rate is still a modest 10% compounded annually.
Importantly, the FCF growth at Apple has closely tracked its revenue and net income growth, each of which have also grown at 30% compounded annually (revenue has increased from $46.71 billion to $173.99 billion, where as its net income has increased from $9.36 billion to $37.03 billion). However, for Google, the FCF growth has lagged both the revenue growth (at 20%) and the net income growth (at 15%). See graphs below.
Apple and Google's trailing twelve months revenue over past 5 years:
Apple and Google's trailing twelve months net income over past 5 years:
(2) Hypothetical Scenario: 0% growth for Apple and 20% growth for Google over next 7 years
Now, let us assume a hypothetical scenario where Apple shows 0% growth in net income and FCF where as Google's net income and FCF grow at 20% compounded annually over the next 7 years.
Below is table showing total FCF generated by Google and Apple over the next 7 years:
Year 1 (Year 2014)
Total of all 7 years
We can clearly see that even after 7 years, Google's FCF will not match Apple's FCF.
Additionally, Apple would have accumulated around $309.68 billion in cash. Taking into account its current EV of $332.12 billion, and assuming no change in Apple's stock price, the new EV at end of year 7 will be $22.50 billion, or simply put Apple will be trading at almost its cash value. On the other hand, Google would have accumulated $175.05 billion in cash, and its EV at the end of year 7 would be $179.75 billion (354.80 - 175.05). This is a difference of almost 9 times in valuations.
EV at end of year 7
(3) Comparison of Enterprise Value to Free Cash Flow Ratio (EV/FCF)
Enterprise Value to Free Cash Flow Ratio (EV/FCF) is a very interesting number. Assuming no earnings growth, it indicates the time (in years) it will take the company to generate enough cash, such that its stock is trading at its cash value. As can be seen from the table below, it will take Apple 7.5 years to start trading at its cash value, where as it will take Google 31.40 years. That is a significant difference.
In conclusion, Apple looks quite undervalued in comparison to Google. Even assuming a growth rate of 20% for Google and 0% for Apple over the next 7 years, Google will still not be able to match Apple in FCF generation. Moreover, the current difference in EV of $22 billion will balloon to $157 billion (179.75 - 22.50), making Apple more attractive.
Finally, I must note that I am not betting against Google. I like Google services and all the interesting technologies they are investing in. But the current valuation disparity between Apple and Google is too huge to ignore.
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.