The price earnings multiple (P/E) is an increasingly useless metric when valuing Apple Inc.’s (AAPL) stock price. The reason why is that Apple now uses subscription accounting. Therefore, Apple recognizes the sales and earnings of certain products such as the iPhone, Apple TV, Apple Care and others over a twenty-four month time frame. By deferring its sales and earnings on significant products, Apple’s understates the health of its business.
The truth about Apple’s health can no longer be found in its earnings report. The truth resides on the balance sheet by calculating the change in cash. We define “cash” as the sum of cash and cash equivalents plus short-term investments. This is the same way that Apple itself reports cash.
The recent example of Apple earnings report (see conference call transcript) totally exposes how useless the price earnings multiple has become, as it relates to valuing Apple’s stock. Apple recently reported earnings of $4.6 billion for the twelve months ending June 30, 2008. Apple reported cash generated in the same twelve month period of $7.0 billion.
The variance between reported earnings and cash generated is $2.4 billion. I believe that Apple’s “True Earnings” are the $7.0 billion in cash that it generated in the past twelve months, fully 52% higher than its reported earnings of $4.6 billion over the same twelve month period. If you divide Apple’s “True Earnings” of $7.0 billion by Apple’s 886 million shares outstanding on June 30, 2008, you get Cash Generated Per Share of $7.90 versus the reported twelve month earnings per share of $5.19.
If we use the current stock price of $160 per share, the Cash Generation Multiple [CGM] is 20.3x which compares favorably to the price earnings multiple of 30.8x. I believe that Apple is selling at 20.3 times its true earnings of $7.0 billion.
Apple’s stock price is cheap, if you use CGM as your valuation metric. The CGM will be my valuation metric for Apple inc. going forward.
Disclosure: Author holds a long position in AAPL