At Valuentum, we often use a discounted cash-flow model as a means to back into the current share price of firms in order to ascertain whether the market is unfairly pricing their stock relative to reasonable long-term growth and profitability assumptions. In Apple's (AAPL) case, it appears that the market is certainly concerned about future growth rates, almost to the tune of merely expecting inflation-like expansion beginning toward the middle of this decade.
Although in the land of technology, competition adapts quickly and a few years from now can be viewed as the distant future, Apple represents a compelling risk-reward opportunity at these levels based on our analysis. Often, evaluating a firm via a discounted cash-flow model and re-engineering its stock price can provide a better picture of a company's investment potential on a risk-reward basis than even the most clearly written prose. For interested investors, a user-friendly discounted cash-flow model template to apply to Apple and other operating companies can be found here.
Below, we display our valuation model and the forecasts that generate a fair value for Apple in the $320 to $340 range. Needless to say, Apple would need to hit some major speed-bumps in terms of growth beyond year 4 (fiscal 2014) in order to justify its current share price level. And while metrics such as the trailing P/E, PEG ratio, and P/S are valuable to some degree, there's probably no better perspective gained in terms of valuation than viewing a company through its future free cash flow stream. In doing so, investors also get a better understanding of the key drivers behind a firm's business (which factors to pay attention to and which ones to de-emphasize).
The forecasts below assume that Apple achieves consensus growth rates for revenue during the next two years (perhaps a conservative outcome given the accelerated traction the iPhone has had against Research in Motion's (RIMM) Blackberry, with expansion then slowing to 3% by year 5 (fiscal 2015). Earnings are expected to hit consensus during the next two years and then slow dramatically in the years beyond, largely due to this declining revenue growth. As it's probably worth repeating, these are the forecasts that would drive Apple's valuation to roughly equal its current stock price. Though maintaining double-digit growth rates for each of the next five years may be difficult for Apple (given the law of large numbers and the burden of constant innovation), we think the market's current expectation for inflation-like top-line expansion at Apple in year 5 (fiscal 2015) and beyond is too conservative.
The box below reveals what fair value we targeted by adjusting our intermediate-term and long-term forecasts for Apple -- $320 to $340 per share ($335 specifically). As mentioned before, the model assumes Apple achieves consensus estimates for both top-line and bottom-line this year and next.
To arrive at a $320 to $340 per share fair value, Apple's top-line growth would have to fall to a mere 3% by fiscal 2015 and beyond, a forecast we believe to be too conservative.
The steady build of cash can be seen on Apple's balance sheet in the years ahead, even under a scenario of considerably slower top-line growth.
Cash Flow Statement
Apple's cash flow generation goes unmatched by a lot of firms, despite the conservative intermediate- to- long-term growth expectations the market seems to have placed on the firm.
Savvy investors may be able to pick up Apple at lower prices than today's, but on a risk-reward basis and viewing the firm through a discounted cash-flow model, Apple's equity has tremendous upside potential, as growth rates well in excess of inflation-like expansion beyond year 4 (fiscal 2014) seem very achievable.