Generally, I encourage investors to review Street analyst material for data points, but do not accept opinions prima fascia.
Armed with post-earnings information, and spurred by the revised Street forecasts, I decided to re-evaluate AAPL shares' FVE (Fair Value Estimate) using various methodologies.
Results are found below.
A number of stock valuation methodologies are available. In the case of Apple, I favor various price-and-multiple approaches. These include:
- price/cash flow
- price/free cash flow
Other options (P/Book, P/EBITDA) are possible. However, I find these less instructive than the aforementioned.
I'm not a fan of determining FVEs via DCF (Discounted Cash Flow) analysis. While DCF is an excellent tool for certain applications, I do not find it especially helpful for stock valuations. Results are unduly sensitive to the selected discount rate and terminal value.
Apple reports "clean" earnings. This means there are little to no material differences between "as reported," or GAAP earnings versus adjusted, or "operating" earnings.
Here is an AAPL earnings summary:
Courtesy of ameritrade.com
Apple's TTM (trailing twelve month) earnings were $8.35 per share. FY 2017 forward EPS estimates call for ~$8.91. Since fiscal year 2013, we see management has not missed Street earnings estimates.
Next, please find below a 10-year F.A.S.T. graph illustrating AAPL price-and-earnings relationship:
Indeed, post-Great Recession, AAPL shares have exhibited a reliable price-and-earnings relationship. Over the period, a 14.8x trimmed average P/E was evidenced. See the blue box above.
One may argue the assigned P/E is too high: pointing out Apple earnings experienced a 28% annual growth rate during the stretch. No forward forecasts anticipate anywhere near that kind of continued growth. Slower forward EPS should result in multiple compression, right?
Perhaps. However, I accept a ~15x valuation multiple.
First, the great value investor Benjamin Graham advocated a formula (modified a bit) to estimate a reasonable forward P/E multiple for a given stock. It remains a useful indicator:
Estimated P.E. = (9 + 0.5g) * 4.4 / y
g is the expected forward EPS growth rate
y is the current AAA bond yield
Plug in the numbers, and we obtain the following:
Estimated P.E. = (9 + 0.5 (7.5)) * 4.4 / 3.0 = 18.7x
Since the result is significantly HIGHER than the normalized market average, I'm inclined to accept the lower, actual figure as realistic.
Second, on its face, a 15x P/E multiple is generally reasonable. Over the years, it's been considered a "fair value" market benchmark.
Next, we must recognize the market is forward-looking. Therefore, we need reasonable forward earnings estimates. Currently, S&P 500 IQ analysts' consensus suggest Apple will earn $8.91 this fiscal year, and $10.12 is FY 2018. Let's start there.
Completing the exercise, here's a forecasting F.A.S.T. Graph.
Now let's review these results critically.
From our previous work, we learned management is likely to meet analyst expectations. In addition, analysts have had reasonable success projecting AAPL forward EPS. Here's some evidence: In the lower right-hand corner of the F.A.S.T. graph, we see a small panel summarizing analysts' ability to forecast Apple earnings. Look at the figures in the green and tan boxes. Green means the actual EPS exceeded Street estimates, and tan means the actual EPS met estimates +/- 10%. Combining the figures, we see an 86% success rate when looking 2 years out.
Therefore, looking out about a year, our P/E analysis indicates AAPL shares have a Fair Value Estimate of $150.
Note: I'm disinclined to discount the figure for a factor-of-safety. Backing out Apple's $46 balance sheet cash, the FY 2017 forward P/E is just 9.7x. I contend the factor of safety is built-in.
Not to be satisfied with just one valuation process, let's try another and compare results. Generally, price-and-cash flow is another good indicator. Using the same logic as earlier, here's a 10-year F.A.S.T. graph highlighting the relationship between AAPL shares' price-and-cash flow.
Once again, we find linkage: price follows operating cash flow. In the blue box, we find the trimmed average P/CF multiple 10.6x.
Switching to a forward-looking chart:
The data supports a $155 FVE.
A glance at the lower right corner of the chart indicates S&P IQ analysts and management aligned on cash flow per share projections and results. Over the past 8 years, Company management met or exceeded consensus Street estimates.
Price/Free Cash Flow
Let's check one additional ratio analysis. This time we'll check AAPL's stock price and free cash flow.
Free cash flow (also referred to as "owners' earnings") is defined as operating cash flow less routine capital expenditures. When evaluating companies, especially those with high capital requirements, good investors often place strong emphasis upon this free cash flow growth and margins.
Indeed, FCF is the bottom line: I liken it to a look at the checkbook balance. Accounting interpretations and management operating earnings' adjustments don't matter. Free cash flow is simply how much cash a business has left over after paying all cash expenses.
Remarkably, Apple generates more free cash flow than profit!
Here's a historical F.A.S.T. graph capturing price and FCF:
Despite the Company recording greater FCF/share than EPS, the market nonetheless assigned the stock a lower average normalized multiple: 12.6x versus 14.8x. This is atypical. It bolsters a perception the market assesses Apple shares quite conservatively.
Following on, here's the forward-looking P/FCF chart:
We arrive at a $140 FVE.
Running three standard valuation ratios suggest AAPL shares offer investors Fair Value Estimates of $150 (P/E), $155 (P/CF) and $140 (P/FCF). Post-Great Recession trimmed average multiples were used to calculate the aforementioned. S&P 500 IQ analyst consensus forecasts for FY 2017 and 2018 were accepted as reasonable.
A simple average of the trio of results offers a $148 per share Fair Value Estimate. Looking behind the figures, a 14.8x average P/E multiple appears reasonable given AAPL stock's forward growth trajectory. Several related indicators support this:
The 2-year PEG ratio is ~1.4x; likewise reasonable. Furthermore, Street analysts have demonstrated a propensity to predict the Company's forward earnings accurately. In addition, a modified Benjamin Graham "rule of thumb" P/E estimator offers a considerably higher prospective multiple.
Likewise defensible is a 10.6x average P/CF multiple. Generally, price-and-cash flow ratios ranging ~10x are associated with modest valuations.
Evaluating price-and-free cash flow, Mr. Market assigned AAPL stock an 8-year, normalized average 12.6x multiple. This is lower than the average P/E; despite the fact the Company generates more free cash flow per share than EPS. One could reasonably expect the FCF multiple to be higher, not lower than the profit multiple.
Off a current baseline price of $132, including the post-earnings 10% run-up, AAPL shares still may offer a one-year forward total return (including the dividend) of about 15%.
That's not bad.
Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2017 investments.
Disclosure: I am/we are long AAPL.
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.