Apple’s (AAPL) 12-month forward PE is currently at 11.92x. This is calculated by dividing AAPL’s price per share at the close of August 15 divided by the consensus estimate of 12-month forward earnings per share of $32.16.
At first glance, this valuation appears quite cheap considering AAPL’s superior projected growth rate. Indeed, AAPL’s PEG ratio of 0.61 is amongst the lowest amongst stocks in the S&P 500.
For many analysts, this analysis apparently does not go far enough to prove the attractiveness of AAPL’s valuation. Many analysts argue that Apple’s stock is even cheaper than it appears at first glance. These analysts claim that investors should subtract the value of AAPL’s cash and marketable securities per share from its share price when calculating its PE. Calculated in this way AAPL’s “adjusted PE” is 9.55x and its PEG is 0.42. These almost ridiculously low valuations presumably “prove” how attractive AAPL’s valuation truly is.
The rationale for this procedure of subtracting AAPL’s cash per share from the share price in order to arrive at an “adjusted PE,” is that it presumably reveals AAPL’s true value – i.e. what investors are paying for AAPL’s core business net of cash.
Is such a procedure sound?
Subtracting Cash From the Price Doesn't Yield a Legitimate PE
The procedure of subtracting a company’s net cash and marketable securities position from its share price is the financial equivalent of adding a company’s net debt to the share price. This calculation yields a company’s “enterprise value” or (EV). Companies that have more cash than debt are said to have negative net debt. Thus, in an EV calculation, companies with more cash than debt have their net cash per share subtracted from the share price – which is the same as saying that the company’s net debt (in AAPL’s case its negative net debt) is added to the share price.
Thus, subtracting AAPL’s cash from its share price and dividing it by its earnings does not yield a PE ratio; it yields an EV/E ratio.
Such a ratio is nonsensical and it is not used in financial analysis.
In financial analysis, EV is compared measures of cash flow such as EBITDA and FCF.
An EV Calculation Doesn't Bolster Apple's Investment Case
Investors interested in calculating AAPL’s EV by subtracting cash and marketable securities per share from its share price must compare this metric with various measures of cash flow and then use these cash flow multiples for comparative purposes against other stocks.
As it turns out, this methodology does not bolster AAPL’s investment case based on valuation.
APPL’s EV/EBITDA and EV/FCF multiples are considerably higher (i.e. more expensive) than the averages for the S&P 500 as a whole as well as the NDX. By contrast, AAPL’s PE is roughly in line with the average for the S&P 500 (^SPX) and the Nasdaq-100 (^NDX).
Having said this, it must be recognized that if AAPL’s EV/EBITDA or EV/FCF multiples are divided by their projected EBITDA or FCF growth rates respectively, the valuation gap closes considerably and the relative attractiveness of AAPL’s valuation increases. However, it must be stressed that AAPL looks better relative to the S&P 500 and the technology sector on a PE and/or PEG basis than on the basis of EV/EBITDA or EV/FCF multiples, even when these latter metrics are divided by their respective estimated growth rates.
Transforming AAPL’s “P” into an “EV” by subtracting AAPL’s cash and marketable securities per share from its price per share does absolutely nothing to bolster AAPL’s investment case based on relative valuation. To the contrary, AAPL’s relative valuation becomes relatively less attractive when AAPL’s EV is properly related to its EBITDA and/or FCF and then compared to peers – even if projected growth rates are factored in.
Let me be clear: I am not arguing that AAPL is “expensive,” by any means. What I am saying is that subtracting AAPL’s cash and marketable securities is not a legitimate way to calculate a PE ratio. Furthermore, I am asserting that such a procedure necessarily leads to an EV analysis that is much less flattering to AAPL than a simple PE analysis.