Apple (NASDAQ:AAPL) is one of the most high profile stocks in the world. Regarding its valuation, people are often confused by its high price. Even though the price is high, Apple's valuation is significantly lower than its historical earnings growth rate and, more importantly, its forecast growth. Consequently, we believe that this high-profile growth stock that has recently began paying a dividend is undervalued at these levels.
About Apple, taken directly from its website:
Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App Store, and is defining the future of mobile media and computing devices with iPad.
Earnings Determine Market Price
The following earnings and price correlated FAST Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph, the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
Earnings and Price Correlated Fundamentals at a Glance
A quick glance at the historical earnings and price correlated FAST Graphs™ on Apple shows a slight picture of undervaluation based on the historical earnings growth rate of 35.9% and a current P/E of 15.8. Analysts are forecasting the earnings growth to continue at about 22%, and when you look at the forecasting graph below, the stock appears undervalued (it's outside of the value corridor of the five orange lines -- based on future growth).
Apple: Historical Earnings, Price, Dividends and Normal P/E Since 1998
Click to enlarge images.
The associated performance results with the earnings and price correlated graph validates the principles regarding the two components of total return: capital appreciation and dividend income. However, since Apple has just begun paying a dividend, we are not yet including any dividends in our performance calculation.
The following graph plots the historical P/E ratio (the dark blue line) in conjunction with 10-year Treasury note interest. Notice that the current P/E ratio on this quality company is as low as it has been since 1998.
A further indication of valuation can be seen by examining a company's current price-to-sales ratio relative to its historical price-to-sales ratio. The current price-to-sales ratio for Apple is 4.30, which is historically normal.
Looking to the Future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1. The rate of change (growth rate) of the company's earnings
2. The price or valuation you pay to buy those earnings
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component toward making sound and prudent commonsense investing decisions.
The consensus of 46 leading analysts reporting to Capital IQ forecast Apple's long-term earnings growth at 22% (orange circle). Apple has no long-term debt (red circle). It is currently trading at a P/E of 15.8, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 26.4. If the earnings materialize as forecast, Apple's True Worth™ valuation would be $2,563.34 at the end of 2017 (brown circle on EYE chart), which would be a 30.9% annual rate of return from the current price (yellow highlighting).
Earnings Yield Estimates
All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in Apple to an equal investment in 10-year Treasury bonds illustrates that Apple's expected earnings would be 10 times (purple circle) that of the 10-year T-Bond interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary and Conclusions
This article presented essential "fundamentals at a glance," illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Even though with just a quick glance you can know a lot about the company, it's imperative that readers conduct their own due diligence in order to validate whether the consensus estimates seem reasonable or not.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.