I am a huge supporter of Apple's (AAPL) stock. I believe that it is currently undervalued and although I can name some stocks that are even more undervalued, analysts can all make a very strong case to buy the stock. The purpose of this article is not to justify its current value, but to determine how high Apple's shares can be in three years.
Apple's revenue increased by 52% in 2010, and is expected by analysts to increase 66% in FY 2011 and another 23% in FY 2012. With revenues increasing at this rate, Apple will become the revenue leader of the technology world by 2013, beating the likes of HP (HPQ), Samsung (OTC:SSNLF) and Hitachi (HIT). Their EPS is expected to increase by 81% in FY 2011 and 17.5% in FY 2012. Using classical valuation techniques on Apple is extremely difficult because all of the growth numbers are far above the required return. However, it is realistic to expect Apple's earnings to stagnate around $40 per share by FY 2014 and then grow at a reasonable rate for the foreseeable future. At this rate, AAPL will trade around $600 three years from now, giving investors an annual return of about 17% annually. This assumes that Apple's P/E will remain around 15, but that is highly likely.
I tend to value shares using earnings valuation as opposed to cash flow variation, which fails to include financial assets. Apple reported over $76 billion in cash, short term investments, and long term investments on their June 25, 2011 balance sheet. The remarkable thing about this cash is that it contributes almost nothing to Apple's bottom line, thus being completely left out of my valuation. Apple reported $172 million in non-operating income last quarter, which contributes to 1.8% of its net income. There are plenty of articles about what Apple can do with all of this cash, but in the end the company can hold it, pay it out as dividends, or invest it. What matters now is that if Apple paid out a $70 billion dividend tomorrow, it would not have a major effect on earnings.
Apple also has no debt. If Apple levered itself, it could instantly increase shareholder value via tax savings from interest expense. The risk of course is bankruptcy due to a company having an added expense on the balance sheet, where paying dividends on equity is optional. However, Apple's liquidity and earnings put it at almost zero risk of going bankrupt. I am not suggesting that Apple borrow money to increase shareholder value, but it is good to know that an easy financial move could make your holdings worth more tomorrow.
What Apple shares are doing is truly unique. With my estimates, Apple will have a market cap of about $600 billion in three years, which is remarkably higher than any other company in the technology sector has gotten. Apple is known for creating high quality products, creating new markets, controlling the markets it competes in, and making consumers want its products. Because Apple does this so well, it can demand high prices, higher margins, and ultimately more income. Since earnings are what generate value for a company, Apple's high value is very plausible. To illustrate this, I wrote an article that values Apple's competitors if they had Apple's profit margins, which can be viewed here. It is truly amazing what Apple as a company and as a stock has done over the last few years and I believe that it will continue for the foreseeable future.