Traditionally, investors value growth stocks by placing a multiple on earnings per share that is heavily determined by a company's expected growth rate. However, this valuation methodology has not worked for Apple (AAPL) in a long time, despite sales and earnings growth of 20-50% in recent years. Even with such huge growth rates, Apple stock has been trading near or below the P/E multiple of the S&P 500. The reason is that investors understand that Apple has gotten so lp;loooarge that eventually the law of large numbers will restrict their ability to grow at above-average rates.
So now that Apple's market value has reached a level (over $600 billion) never before seen in stock market history, the question for investors is how to approach determining how the market will likely value the stock over the next several years and beyond. In my view, from the perspective of an investor determining fair value, Apple is now simply a company in the mega-cap arena with one of the leading consumer brands in the world. In such terms, Apple is joining a group that includes the likes of Coca-Cola (KO), McDonald's (MCD), PepsiCo (PEP), Procter & Gamble (PG), Kraft (KFT), Johnson & Johnson (JNJ), Nike (NKE), and Anheuser Busch (BUD).
I am sure that skeptics will point out that Apple is growing much faster than the aforementioned group of consumer brands, and their free cash flow margins are better as well, both of which are true. However, again, the market long ago stopped giving Apple a premium valuation, despite the company's strong financial picture and growth rate. I simply do not believe those points, while correct, are relevant to valuing the stock any longer.
Now for the really interesting point, to me anyway. Of the eight consumer companies mentioned above, all but one of them (Coca-Cola) currently trades between 10 and 12 times trailing cash flow. Coca Cola trades at 15 times cash flow, which to me signals the stock may be overbought right now. Going forward, I think investors will value Apple like a McDonald's or a Nike. Since blue chip U.S. companies typically fetch 10-12 times cash flow, that is probably where Apple will settle in longer-term.
So where does Apple trade now on a cash flow basis, in the $650 per share price area? About 9 times trailing cash flow. Accordingly, the stock looks slightly undervalued at current prices, which makes the $700s a very reasonable expectation for current fair value. All in all, the market for blue chip stocks these days seems to be both reasonable and consistent, which is good news for investors trying to make sense of things and get a handle on the future potential for Apple shares.
Disclosure: I am long AAPL, BUD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.