What Apple's Valuation Could Be in 4 Years

| About: Apple Inc. (AAPL)
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My previous article on Apple (NASDAQ:AAPL) presented various reasons why Apple stock is undervalued. In this article I will give possible outcomes of what Apple's stock valuation will be for the next four years. You can choose which outcome you expect and proceed accordingly. Remember, never fall in love with any stock and diversify your holdings.

What does Apple management need to do to get its stock fully valued? First, every time the stock exceeds two hundred and forty dollars a share, the company should split it either two for one or one for two shares, depending on the projected growth rate and the current price earnings ratio. This has been the tried and true method to get growth stocks fully valued on Wall Street for at least the past fifty years. For whatever reason, Apple has not followed this course of action. Once a stock gets over one hundred dollars, many people do not want to buy it. This affects stocks even more once the price is over two hundred dollars a share. However, with Apple this may add a little cachet if it trades between one hundred and two hundred dollars a share and is split once it reaches two hundred and forty dollars a share.

Next, the board of directors needs to implement a detailed plan of action to deal with Steve Jobs' health issues. This should include Steve Jobs' vision for Apple during the next ten years. However, the board does not need to announce the details on CEO succession. They could give an in-depth plan to keep the company and management moving in a direction that will ensure it continues to grow and prosper without Steve Jobs as its CEO.

Third, Apple should start paying a twenty-five cent to fifty cent dividend a quarter. There will still be a majority of the cash flow that Apple currently generates in the company to expand operations. This will enable some pension plans and other institutional investors that cannot invest in companies that are not paying dividends, to invest in Apple stock.

Finally, I think Apple needs to move into as many services and non-hardware sales as possible to support its current hardware products. As part of these support services, Apple needs to consider buying or building a communications backbone like Sprint (NYSE:S), AT&T (NYSE:T), Comcast (NASDAQ:CMCSA), and Verizon (NYSE:VZ). The communications companies expanded the capacity of fiber optic cable so only about ten percent of it was being used in the early 2000's. However, with the advent of mobile phones, tablets, portable computers and increased video use, this excess capacity is disappearing fast. For the services and non-hardware sales to remain viable, it is important to have communication capacity available for the internet server operations in the future.

The table below gives the current price earnings ratios, earnings growth and stock appreciation of various companies. I will compare some of the other stocks in the table with Apple.

Compare Companies to Apple

Company Name Symbol Stock price Current P/E Future P/E Total 3yrs Earnings Growth percentage Stock %
price appr 3yrs
Apple OTC:APPL 360 20.07 15.74 285 172
Microsoft MSFT 26 11.2 10.28 49 -5
DELL DELL 16 11.65 9.22 12 30
Intel INTC 23 10.84 10.5 60 5
eBay EBAY 32 24.21 6.57 92 -16
Amazon AMZN 172 67.85 49.97 125 155
Exxon/Mobil XON 85 13.65 11.87 -14 -1
Google GOOG 601 22.83 17.4 98 30
McDonalds MCD 76 16.6 15.15 59 39
H/P HPQ 43 10.9 8.12 4 -11

The earnings growth rate is for the three years ending with the 2010 corporate year end. The stock appreciation period is from February 28, 2008, to February 28, 2011. The earnings growth rate is calculated from Schwab's normalized diluted earnings per share. Stock prices, current P/E and future P/E are from the Schwab quotation system as of the close of business on March 4, 2011.

I have prepared two tables below for Apple stock's valuation for the next four years. The first table is Apple's valuation based on the world economy remaining in its current growth mode. Smartphones represent approximately 22% of total industry cell phones, which is up from 14% last year. The global smart phone market grew by 70% in 2010. In trying to determine the increase for 2011, I used a 40% growth rate or roughly an 8.8% market share gain which compares to an 8% gain last year. This would mean that smart phones would have approximately a 29% share of the total cell phone market at the end of 2011. The current smart phone industry sales show that Apple has a 16% market share, which has held fairly steady for the past year. The other parts of Apple - iPad, apps, and associated services are growing at faster rates; the computer line is growing at a 20% rate. So after blending all this, I used an earnings growth rate of 40% for the year 2012, for Apple.

For the years 2013 and 2014, I used the same method to determine the growth rates. In my opinion, based on the growth rates, the stock valuation should be at least between the P/E ratios of 25 and 30 times earnings for 2011 and 2012 and then decline and become valued between the 25 and 18 times the P/E ratios for the last two years.

second table valuation is based on the world economic growth rate slowing down from what it is currently, but still maintaining growth through September 2014. This table also projects a slowdown in the switch from regular cell phones to smart phones. I believe the valuation should be between the upper two P/E valuations during 2011 and 2012. After that period of time, it should trend between the 20 and 15 P/E valuations as the earning growth starts to decline.

Under both tables, I expect Apple's computer line to move up to 10% of the personal computer market and the iPhone and iPad to have a 15% to 25% market share by Apple's corporate year end 2014.

The future valuation of Apple's stock will depend on five things:

  1. The earnings growth rate

  2. The price earning ratio

  3. Steve Jobs' health issues

  4. World economic growth rate

  5. Market valuations

These valuations are based on my best estimate of economic conditions and growth rates for Apple's product lines. You can see from the table above that I have lowered the growth rate of Apple from the previous three years by over half, and these earnings growth rates appear very conservative to me. If the world goes into a global economic recession or depression, then these valuations will not be realized. In addition, if Apple's current products' technology somehow becomes obsolete, then the stock's valuations will not be realized. Neither of these things appear likely to happen at the present time.

Apple Stock Valuation Next Four Years

Corporate Year End 2011 2012 2013 2014
Projected Earnings $23.04 $32.25 $41.93 $50.31
High P/E ratio 30 $690 $965 $1,255 $1,510
Middle P/E ratio 25 $575 $805 $1,045 $1,255
Low P/E ratio 18 $415 $580 $755 $905

The earnings per share for 2011 are from mean estimates for the year end of September 2011. The growth rates are 40% for 2012, 30% for 2013, and 20% for 2014.

Apple Stock Valuation Next Four Years

Corporate Year End 2011 2012 2013 2014
Projected Earnings $23.04 $32.25 $40.31 $46.35
High P/E ratio 27.5 $635 $885 $1,105 $1,275
Middle P/E ratio 20 $460 $645 $805 $925
Low P/E ratio 15 N/A N/A $605 $695

The earnings per share for 2011 are from analysts' mean estimates for the year end of September, 2011. The growth rates are 40% for 2012, 25% for 2013, and 15% for 2014.

The valuations could also be much higher in the tables above if Apple develops another revolutionary product between now and 2014 and world economic growth rates were to accelerate from current growth rates. This would increase the earnings' growth rates from those in the tables above and should increase the corresponding P/E ratios and the stock valuations.

My expectation is that Apple will continue to trade at lower multiples than growth stocks like Amazon, eBay and other technology stocks - see first table above, but its P/E ratios will increase somewhat from current levels until its growth slows down.

Disclosure: I am long AAPL.

Additional disclosure: I may buy or sell at any time some or all of these companies shares mentioned in this article based on world events or specific news about the company. Also remember that you should not fall in love with any stock and you need to diversify you portfolio. Not all stocks are appropriate for all individuals and you should consult your advisers and brokers before purchasing any stocks for a second or third opinion regarding these stocks.