Since I own Apple (AAPL) stock, I always like to know whether the stock overpriced or underpriced on a fundamental basis. The simple analysis below shows me that, fundamentally, AAPL is a great buy right now and would remain a good buy if the price was $1,000.
When I look at a growth stock like AAPL, I like to look at how the price-to-earnings ratio (P/E) compares to the company's expected growth. This produces a ratio (PEG) that is very commonly used to measure the worth of a growth stock, and a common rule is:
- If the PEG is less than 1.0 (P/E is less than growth), the stock is a strong buy.
- If the PEG is more than 2.0, the stock is richly priced and I'll be looking to reduce or eliminate my holdings.
- If the PEG is between 1. 0 and 2.0 (the most likely situation by far), I look to increase my position when the PEG is close to 1.0 and look to reduce my position as the PEG goes up.
I use forward earnings for this PEG analysis. For me, forward earnings are the estimated earnings for the current year, or for the next fiscal year if more than two quarters of the current fiscal year are already known. AAPL pays a dividend, so I also adjust the calculation by adding the dividend yield to the growth. The ratio produced is often called the PEGY ("Peggy").
Finally, I use the consensus analyst numbers available from Yahoo Finance to make my calculations (after all, they are easy to get, they're free, and the market will believe those numbers more than any that I derive). Using Yahoo Finance numbers, I get a PEGY this way:
- AAPL 2012 earnings are estimated to be 44.10/share
- AAPL 2013 earnings are estimated to be 52.45/share
- Growth for the next year is (52.45/ 44.10), or 18.93%
- Using an AAPL price of $680/ share, the forward earnings P/E is (680/ 52.45), or 12.96
- AAPL's dividend is 10.60/ share, the yield is 10.60/680, or 1.56%
- The PEGY is P/E divided by (Growth Plus Yield), or 12.96/ (18.93 + 1.56) or 0.63
None of the above analysis is particularly sophisticated or controversial, but the results are astounding. AAPL is not only cheap, but it's cheaper than other high-priced tech titans (e.g., Google (GOOG), whose PEG is 0.86). If I run the numbers above again but I use a share price of $1,000, I get a P/E of 19.07 and a PEGY of 0.93, which is still cheap.
However, it's important to keep in mind that a cheap stock can get cheaper (or at least stay cheap for a very long time). This is particularly true of AAPL because of the following:
- AAPL is up more that 65% this year alone, and many investors are selling some of their stock to lock in their gains.
- There are a great number of option players betting on the price of the stock at the end of each week. These bets have nothing to do with AAPL's fundamental value, and they often keep the stock price close to it's current level for a long period of time (weeks, months, or even years).
- For the second time in 16 months, AAPL is almost 20% of the Nasdaq. When hedge funds sell the Nasdaq, they also sell a lot of AAPL. In addition, the Nasdaq rebalanced itself last time so that AAPL would only be 12.3% of the index. If that is done again, there will be more downward pressure on the stock price.
It's also important to think about what could happen to AAPL's fundamentals. The company is firing on all cylinders right now. Its growth has been tremendous (more than 70% per year for the last five years) as it has created products (iTunes, iPod, iPhone) that have generated their own demand. The Yahoo Finance numbers do not expect growth like this to continue, but even the 19% growth they show could be too much. For example:
- Much of AAPL's future growth is likely to come internationally, particularly in China. A further slowdown in China growth could slow down AAPL's sales.
- GOOG android could reduce AAPL's market share in music and apps.
- It is much harder for a big company like AAPL today to grow as fast the smaller company AAPL was five years ago.
Despite these concerns, I feel comfortable that AAPL can grow 19% over the next year, especially since the analysts consensus (taken from Yahoo Finance) expects AAPL growth of 22% a year over the next five years. I'm more concerned how the stock- and option-related factors will adversely affect the stock price. Even so, AAPL's current price is so fundamentally cheap that I'm happy to own it for as long as it takes to realize it's proper fundamental value. It's even more comforting to know that even at $1,000 a share, AAPL would remain fundamentally cheap.