While many analysts believe Apple's market cap will eventually top $1 trillion, more and more big money players are stepping up to take a shot at the short side for at least a medium-term decline. Apple (NASDAQ:AAPL) is no doubt the most exciting company in a generation but what's it really worth? Keeping in mind that all valuation techniques are somewhat subjective, I will be looking at Apple's valuation through my Buffett lens, an approach I've used many times in past on these pages.
Apple vs. Uncle Sam
We'll be assessing the valuation from three different angles. The first is only a comparative value look and doesn't result in a firm price target. It pits the current earnings yield against the long-term treasury bond. Apple's trailing twelve-month earnings per share is $35.13. Dividing EPS by the current market price of $585.87 equates to an earnings yield of 6%, which handily beats the 30-year bond yield of 3.4%. In addition, while a bond yield is static, the 6% yield offered by Apple grows along with earnings. Based on analysts' projections, the yield could grow 13% annually. Shares of Apple are currently considered a preferred investment over treasuries.
Good Ol' Fashioned Earnings Growth
Another way to look at valuation, and the one most likely employed by a majority of investors, simply takes the current EPS of $35.13 and multiplies it by analysts' five-year growth projection of 13%, which equals earnings per share in the fifth year of $64.72. Multiply this by the current P/E of 16.7 to get a price target of $1080. If we were only interested in entering a position offering a CAGR of 15%, we could discount 1080 back to the present and only buy Apple under $530.
This valuation method assumes a future Price to Earnings ratio in line with the current P/E. One of the most remarkable things about Apple is that it carries such a low P/E ratio, especially when compared with its peers earning a third as much. For investors, this means income could slow substantially while the shares continue to offer a positive real return. Remember, I'm assuming 13% earnings growth, which is quite conservative given Apple's stellar history of blowout quarters.
The Incredible Expanding Coupon
The final and most eye-opening way Buffett values a stock is by viewing it as an equity/bond with an expanding coupon. Looking at Apple in this fashion, the initial investment of $585 a share would be seen as a bond yielding 6% (just like the first example above), but rather than grow at the EPS growth rate, the "coupon" would increase at the rate management is growing the equity base. This is where return on equity comes in.
Apple's shareholders equity value, or book value, is $96. Dividing by the EPS of $35.13 equates to a return on equity of 37%. It follows that five years later we can expect a book value of $463 ($97 grown at 37% annum). Multiply EPS of 35.13 by the ROE of 37%, and you get projected earnings per share of $170. Multiple $170 by the current P/E of 16.7 and you obtain a five year price target of $2800. This would mean a CAGR of 33.8% and represents Apple's true potential for building shareholder wealth.
Some will argue that no company can maintain returns on equity of 37% for any length of time and this objection has merit. Let's use 25% so our price target doesn't become too aggressive. This sets upper end of the five-year price target at $1787.
My five-year price target for Apple is $1080 - $1800 representing a CAGR of 13 and 25% respectively from current levels. Apple is widely held by the fast money crowd and will absolutely sell off in times of distress. But the shares are nowhere near over-valued. Apple is a strong buy on any pullback.