All three companies, Apple, Inc. (NASDAQ:AAPL), Amazon.com, Inc. (NASDAQ:AMZN), and Google, Inc. (NASDAQ:GOOG) have solidified themselves with strong and successful businesses. Of course depending on how we attempt to make money investing in them creates an added bias as to what we think of this statement. But from a revenue growth perspective, all three have scaled to very respectable levels.
This article's intent is not to delve into the details as there are too many sides and debatable topics to cover. Much has already been discussed regarding why Amazon is overvalued based on a P/E ratio, or why Apple is always trading at too low of a discount, or why Google is still the best digital advertising business out there irrespective of Facebook Inc.'s (NASDAQ:FB) ascent.
As a long-term investor obsessed with building the world's best portfolio as an amateur (to all my rivals, I still have much to learn), I would like to share my observations as I have been reviewing all three of these companies of late. I have a roughly 25-year time horizon before retirement so my natural inclination has been to find high-growth companies. Unfortunately, this has led to a high expense ratio and more trading transactions than I would like to admit. But it has also taught me much during the past couple of years.
The two most important takeaways I have learned is that diversification is a must and owning large cap companies for growth is not necessarily a bad thing. When considering diversification it is imperative to know one's amount of capital that is reasonably available in order to efficiently maintain cash with the ability to build a portfolio, but enough on the structure and back to the topic.
I am fortunate to have a lot of free time outside of work, despite being married. Luckily I have a very understanding wife who does not attempt to rationalize, but can accept that I'm a nut! During this time I have built many, many databases of companies with updated quarterly and annual information beginning from 2000 to current. So as I have reviewed Apple, Amazon, and Google much more closely, I would like to offer investors my perspective on the price targets that I have set for possible entry positions for all three companies. I am looking to enter positions with the potential to achieve a 10% or greater return on average over the next decade. Additionally, I would like to provide some insight on a simple tool I use which is by no means perfect, but none-the-less, valuable to interpret long-term potential.
My entry price targets are as follows:
- Apple $550/share,
- Amazon $290/share, and
- Google $475/share
At these prices, I will have the potential to realize average returns of 10% or higher over the next decade based on different growth assumptions. These price targets are not based on fundamentals of existing valuations.
Only short-term traders will most likely have lower price targets than I'm displaying here. I know for a fact that Paulo Santos has mentioned previously that he wouldn't touch Amazon at even $100/share. I understand why and do not disagree from the traditional sense, but when considering long-term growth potential, we need to include historical data, near-term estimates, and long-term assumptions. Some investors may wish to stick with historical trends and only short-term growth estimates. I would disagree as it is important to have some sense of where a business is headed long-term. And with larger more established businesses, long-term assumptions can be somewhat in line with respective potential returns to investors.
This is not meant to justify any particular company's present valuation by assuming that in 10 years everything will work out just fine. It directly relates rather to defining a price level where it makes sense to consider a long-term position. Depending on one's viewpoint or level of conservatism, the value in assumptions is that they can be adjusted to one's level of comfort.
Before getting into the methods, I first want to state that these are very rudimentary assumptions which only focus on P/E ratio valuations. There are much more sophisticated models (did I mention I was an amateur) and/or detailed discounted cash flow analysis, among many others. For my personal uses, this tool is a quick snapshot that is flexible and can be adjusted for every quarterly update or event that would impact any of the factors.
P/E RATIO-BASED ASSUMPTIONS
The method as stated is quite simple. There are five key line items and assumptions that need to be considered. They include revenue, net income, diluted EPS, diluted shares outstanding, and an assumed P/E ratio. I have enough information historically to reflect growth rates for basically any financial line item that is publicly available since 2000 for annual data and since March 2011 for quarterly data. I also have data for financial notes and other operating metrics for similar time periods in the same format.
To illustrate, I have included snipped data for all three companies:
Source: Proprietary Data
Source: Proprietary Data
Source: Proprietary Data
The beauty with these tables is that they nicely display annual data which makes reading filings or articles a snap for reference purposes. The blue highlighted column displays the most current YTD information and the pink highlighted column provides key analyst estimates for both current and next-year information.
This historical data and short-term estimates can be combined to generate rough concepts for long-term growth potential. I would stress the word potential (everyone's favorite word right?) as it is apparent that no one knows what will really happen. But again, having a sense of where a business is headed based on these factors is equally important.
In the blue column, the stock price reflects my previously mentioned target prices. The only other information that is not an analyst assumption in the pink highlighted columns are the diluted shares outstanding and in some cases, adjustments need to be made on profit margins or diluted EPS because we all know that analysts love to base some company's earnings on EBITDA or adjusted metrics. Apples' table is the best example of a one-one diluted earnings estimate and historical trend comparison.
Now that it is clear as to where the data comes from for historical and short-term information, the next step is to determine what assumptions need to be made, to frame the long-term growth potential and corresponding potential future returns to investors. The core assumptions that need to be factored for the 10-year time frame are revenue growth rates, share dilution growth rates, profit margins, and P/E ratios.
My primary method to develop the next 8 years of growth (analysts have already forecasted the next 2-year time frame) includes a step-down approach and a comparative average rate of growth expected versus the previous five and ten-year trends.
We know that past performance is no indication of future performance. So this is where some conservatism is a good practice. To illustrate this we can look at the table below:
Source: Proprietary Data
The time frame for the above table is between 2014 and 2023. The step-down approach basically assumes that the growth rates of companies like Apple, Amazon, and Google will decline moderately over time. This is predicated on the fact that businesses such as these have strong recognition and customer loyalty as well as significant market share. Over the longer term both Amazon and Google have growth assumptions 50% or lower than their previous historical growth. Apple displays the most significant drop-off for revenue growth.
Based on the 5 and 10-year trends, it is clear that Amazon is the strongest performer as growth has recently increased, although just slightly. Based on trends and information, it is not a far stretch to assume that Amazon will outpace Google, while Apple will remain at a much lower level. From today's starting point, Apple is already much farther ahead.
Diluted Shares Outstanding
The second focus area includes an assumption for diluted shares outstanding. Apple is already in the process of buying back shares with its program in place so diluted shares outstanding have been declining since 2012. The company has also recently increased its buy back amount. Neither Amazon nor Google currently buy back shares, but I would tend to believe that Google will be implementing a program in the near future. I would not suspect Amazon will do so anytime soon, but within the decade the company will probably end up implementing a program. The table below illustrates diluted share growth. All numbers are expressed in millions.
Source: Proprietary Data
Apple's assumed declining rate of share dilution is 2% per year. For Amazon, it is assumed that the company will implement a share buyback program in 2022 with a 1% declining rate per year. It is assumed that Google will similarly buy back shares with a declining rate of 2% per year beginning in 2015. Google will need to perform this sooner rather than later to benefit shareholders.
The next assumption is the profit margin. This is a tricky item to make a long-term assumption on as there are many variables which impact this metric. However, historically each company has witnessed increasing and decreasing margins to some extent. For example, post-recession Google's profit margin has declined from near 30% to just over 21%. Part of this is due to acquisitions. On a quarterly basis, the company is still generating profit margins above 22% so we should not assume that this margin will continue to decline based on the recent 5-year trend.
Apple has also witnessed an improving profit margin of late and analysts expect the company to maintain this margin near 22% during 2014 and 2015. Amazon is the most controversial company in this group when it comes to profit margins. Last year, Amazon finished with a 0.4% margin. The company is a serial disappointer when it comes to downward revisions for profits and has a history of underperformance.
The most important margin assumption for this exercise is the 2023 number. For brevity, the following profit margins are assumed:
- Apple 22%,
- Amazon 4%, and
- Google 20%
I don't think it is a far stretch to assume that Apple and Google will be near the 20% level. I know Amazon's future is expected to be dark and dreary when the topic of earnings comes to the table, but the company has displayed that a 4% profit margin is attainable. As the company scales much higher, this is not an unreasonable estimate.
Lastly, we need to provide a P/E ratio to apply to each company. Current P/E ratios are as follows, Apple 15 times earnings, Amazon 485 times earnings, and Google roughly 30 times earnings. Based on growth potential of revenues and diluted EPS, I am assigning the following P/E ratios with the additional caveat that we should expect them during a similar economic cycle as we are currently in.
- Apple P/E 15,
- Amazon P/E 35, and
- Google P/E 20
Amazon's P/E may seem high, but if the company is able to attain a 4% profit margin long-term and generate anywhere near the previously assumed growth rates, the company would have an average annual diluted EPS growth rate of 44%. Considering the above assumptions Apple would have a similar growth rate of 7% and Google would have a growth rate of 13%. This justifies the higher P/E assumption.
When putting all of these pieces together we get the following table below.
Source: Proprietary Data
Comparatively, stock performance during the past 10 years for these companies is as follows:
- Apple 47% per year,
- Amazon 22% per year, and
- Google 22% per year (9-year trend)
For the purposes of my portfolio, I do not currently own any of these companies. I bought Apple a while back at $333/share and bought Google a while back at $265/share. Unfortunately, I did not hold these two at those solid prices. I did buy some Amazon earlier this year near the $370/share level but sold it before it plummeted to today's $312/share level.
It should also be noted that the P/E valuation tool is not meant to be interpreted one time as a static snapshot. As each quarter progresses, the assumptions will adjust based upon revised short-term estimates and historical trends. When the markets become volatile as they did in April/May, investors should always consider the macro risks as well as industry and competitive factors.
The intent of this tool is to serve as a guide in identifying reasonable price targets to achieve an above 10% return over the long-term. As any tool, it should be applied for its value of identification and other combined quantitative and qualitative analysis should be performed.
Other things to consider include Google may similarly follow suit to Apple and begin paying a dividend at some point during this time frame, which could add more value for returns to investors. The uncertainty surrounding when/if Google will begin implementing a share buyback program is the biggest risk to the current estimates. There would be significant differences if such a program is implemented much later or not at all. The estimates do not account for dividend increases for Apple, so there is additional value return to investors there. Amazon's biggest risk is a perpetual 0.5% to 1.0% profit margin.
All three of these companies are good companies for an investor to have in their portfolio, and weighting and diversification are important considerations as always. Most all major institutional investment companies own these three companies. The key is to make sure to get in at a good price. Based on the assessment of the P/E valuation tool, I will be looking to consider an entry at the identified target prices.
Disclosure: I am long FB. 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.
Additional disclosure: I have no positions in Apple, Amazon, or Google, but may initiate a position in Amazon if it declines 7% or more.