A Closer Look at Apple Stock 21 comments
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I stepped into an Apple store before Christmas, and I have to say that I was amazed. I hadn’t really taken the time to browse their products before that visit. I’ve admired the company since their “rebirth” almost a decade ago. They have impressed me with their strong branding and smart products. So, after visiting the store, I began to keep a close eye on their stock. It has plummeted from $200 per share at the first of the year to the $130s. Based on this information, some speculators may think it must be a bargain, while others may believe the growth story is broken. I want to take a closer look.
About the Company
My first exposure to Apple was my beloved Apple IIc that my parents purchased for our family when I was a kid. I wore that machine out with games, programming, and even plugging my baseball stats into spreadsheets (some things never change I guess :). I was disappointed when the machine stopped working. Apple had decided to focus on the Macintosh. I never really enjoyed working with the Macs. It was too distant from what I was used to, I guess.
After that initial surge of growth and success, though, I think Apple really drifted while the PC came to dominate the business world and then the home users. Today, Apple is the insurgent upstart capturing market share from the PC and creating other successful devices and services. Apple’s brand has once again become synonymous with innovation.
Apple Inc. designs, manufactures, and markets personal computers, portable digital music players, and mobile communication devices and sells a variety of related software, services, peripherals, and networking solutions. The Company sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers and resellers. In addition, the Company sells a variety of third-party Macintosh (‘‘Mac”), iPod and iPhone compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals through its online and retail stores. The Company sells to education, consumer, creative professional, business, and government customers.
Apple’s Recent History and Earnings
Apple has demonstrated some pretty amazing growth over the past several years. The iPod has been a star performer, and the Mac continues to gain market share as compared to the PC. The table below demonstrates a nice three-year trend for the company.
My first thought after looking at these numbers is “wow.” I may be wrong, but I think it is pretty rare for a company of Apple’s size to demonstrate growth rates like that. This leads to a question: how long can growth like that continue for a company of Apple’s size? This seems to be the question investors are asking.
The iPod market seems tapped out. It would be unrealistic to expect the iPod to reach another level of sales. They are beautiful and elegant devices, but who else wants one that doesn’t already have one. Maybe there’s room for additional international sales. The iPhone certainly looks like it could still have some upside, but how much? The Macs are taking market share from the PC, but there’s a ceiling on that growth as well. For Apple to continue its amazing growth, it will have to continue to innovate. That’s a difficult task, even for Apple.
Valuation
The average analyst 5-year growth projection for Apple is 22%. These seems a bit optimistic, but it is a good place to start. Assuming 22% 5-year growth, followed by 9% growth for five years, a sale at a P/E ratio of 18, discounted back at 10% results in an intrinsic value of $143 per share. Apple has $21 per share in cash on its balance sheet as well. Adding cash to the present value of the cash flows noted above results in a value of $164 per share. This value assumes more of the same from Apple with pretty steady growth from all product lines. Apple could certainly outperform this estimate, but I would not want to make a purchase based on that outperformance.
In their most recent quarter, Apple reported year-over-year revenue growth of 35% and year-over-year earnings growth of 57%. This was during a supposedly weak holiday season. This year could turn out to be 30% higher than last year, but I’m going to assume 28% growth in owner earnings this year, followed by 18% growth for years 2-5 and 9% growth for years 6-10. I get an intrinsic value of $135, only slightly lower than the analysts estimates. I would discount this value by 25% for a purchase point and then add back the $21 per share in cash. Here I purchase point of $122.
A negative scenario could assume a permanent change in Apple’s growth rate. Here I will assume 28% growth this year, followed by 12% growth for years 2-5, 7% growth for years 6-10, and a P/E of 14 at year 10. This results in a value of about $89 per share. Add back cash for a value of $110 per share. Events could certainly be more negative than this scenario, but I think a more painful situation is unlikely given how well Apple has been managed in the recent past.
Conclusion
It certainly seems that the recent sell-off in Apple shares is overdone. It would only take a couple of solid quarters of continued growth for a $130 share price to seem like a bargain. The exceptional returns are likely behind Apple, but it could still outperform the market at its current share price. I will look for a bit more margin of safety to purchase Apple shares.
Full Disclosure: No position in Apple.
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I firmly believe that this statement will prove to be diametrically opposed to what is going to happen...
The handheld computer/communicator/... devices that Apple will be launching are going to be the next generation of iPod. Only 10 times the size. Mac market share will continue to grow into taking on more of the Windows monopoly - it has years of spectacular growth left there after all.
No, this view is cautious and respectable. It just doesn't see beyond normality. And just now, Apple is far, far from the norm.
LOL
I think the growth rates are way understated. The Mac market is on fire growth rates of 40%. Gartner just projected that the US market share would double by CY 11. The Iphone is a whole new market area and is selling well. Apple is accounting for Iphone revenue over 24 months. How are you factoring this into your model. If we assume apple sells 10 Million Iphones in CY08 plus the 4 million already sold. Revenue for the 14 million phones will be recognized in your second year. If we assume a sale price of $400 that becomes 1.4 billion in new revenue. If we assume 75% of the phones carry a monthly carrier payment of $10 we get another 1.26 Billion in new revenue. The numbers for FY 07 understate the revenue stream from the phone because of the deferment. Also why a P/E ratio of 18. Historically Apple has commanded a much higher P/E, I would suggest using 35.
The other problem I have with the analysis is you try to project a 10 year growth rate. I bought apple stock in 1999 for 9.30 a share. I have a unrealized gain of 1355%. So maybe this is a better guess at 10 year growth rate. For folks looking at the current price and trying to determine whether they can make money on the price. I think the stock is a buy. I am modeling for 6.15 EPS for FY08 with a P/E of 35 give me a $215 price. I am assuming 30% YOY revenue growth in MAC, Software, Music and Peripherals and 10% growth in IPOD revenue and then add in the I phone revenue based on the 3.704 Million already sold and quarterly sales of 1.8M, 2.5M, 3.0M for the remainder of the year. My quarterly EPS numbers 1.76, 1.29, 1.44, 1.66
User146420, I don't think it's arrogance to assume that Apple will never come up with another hot product, I think it's conservative not to make an investment that requires them to produce multiple hot new products. I'm trying to tilt the probabilities in my favor.
Pat S, you make a very convincing bull case. I think the stock is a buy as well. I am just waiting for my price.
We have some mid sized laptops from 2005 that do not run XP that well. It's sad because the manufactures misrepresent the product when they sell it but that's not entirely MS' fault.
My $800 PC runs Vista like a rocket especially with games. The buzz from the CTP group is that the recent tuning of SP1 has significant speed improvements. Small minds forget that XP was called bloatware and everyone hated it till SP2.
And BTW Leopard was severely broken out of the gate - believe it or not Apple makes mistakes too
You paid way to much for a generic, windows-only PC if you paid $800 for it.
Out of $800, $200 was for the video card - this is a games PC I built myself not a generic PC - runs Crysis pretty good on Vista.
I hate to tell you this bud....but Vista is today's Windows ME. Most people went from 98 to XP..Don't even try to compare the Vista fiasco to XP. While XP had major security flaws, it was at least universally accepted by Windows users. I couldn't tell you the percentage, but the number of people sticking with XP with no plans of 'upgrading' to Vista is huge.
While I don't like Apple stock short term. The long term growth of Apple the company looks very strong. China is key..
Ps I too had a IIc and I also remember how some thought Apple was going away as a company, then that fella Jobs came back. Not a bad jockey to bet on. I bought the stock when they announced to sell music at a buck. Never expected to own an ipod and down load music. I now have two in my family and down load music all the time. I didn’t think I needed a MAC, but now im tired of the PC BS and will pob buy a MAC for the next home computer (keep an eye out for the PC to MAC shift for some big fortune 100 company-outside of the advertising group, that will start to jolt the market share for MAC’s). Don’t expect to buy an iPhone…yet.
ME was never a serious release since the Win9x platform was being phased out. In fact corporations were NT4 and never saw Win 98.
For high growth companies, it's quite useless.
When you can't get the basic business assumptions right, your growth rate assumptions are completely meaningless.
To value AAPL, one must follow its progress in its product lines and determine a suitable multiple for that progress. No one, including Steve Jobs, will be able to forecast where AAPL will be 5 years from now (if he did, he would not have converted his options into restricted stock units in 2003 and thus forfeited at least $2B in profits). Terminal growth rate for AAPL? Gimme a break!