An Exercise Showing Apple's Fair Value To Be Around $300
Summary
- AAPL's Q2 showed sales and earnings, with strong internals for its growth products.
- AAPL has been emerging as a value stock, and now that it is regaining control of vast amounts of cash, it plans a $110 B buyback ASAP.
- With routine, 7% growth estimates (global GDP + 1-2%), AAPL can engineer its way without net debt to $22 EPS by 2023.
- An 18X P/E in 2023 of current year's EPS, in line with the P/E of the S&P 500 today, implies a $400 price and an 18% CAGR.
- Finally, the possibility is raised that AAPL can grow much larger via AR/VR breakthrough products.
Background - Apple may again lead the market up
Apple (NASDAQ:AAPL) may be doing it again, and the bears and doubters may have to watch it go much higher, in a way similar to its action several years ago.
In early 2010, Apple busted through the double top it set in 2007 (early in the year, then in mid-year). The price was around $28-29 in today's, post-split terms. By September 2012, the stock had more than tripled, peaking at $100. Even though new highs were set again in 2014/5, by June 2016, AAPL was back to the first 2012 high it had set in April. Thus, AAPL's emergence to recognized greatness, from before the Great Recession to 2010, saw a prolonged period of digestion. Then, AAPL provided leadership and led the market's (SPY) surge toward new highs, which for the SPY did not occur until 2013. As of now, something similar is happening. The SPY is churning, and AAPL is breaking out again to fresh all-time highs. AAPL's consolidation very roughly around $100 - the old high from Q3 2012 - is leaving that prior resistance level as just another stock market memory.
AAPL's leadership today is high quality: a Dow (DIA) stock setting sales and earnings records for its fiscal Q2, with ownership of the stock led by the world's most successful buy-and-hold value investor, Warren Buffett.
The calculations herein suggest that eventually, AAPL may peak much higher, and may feel the love not just from admirers of Mr. Buffett, but much more generally and with a modestly higher P/E and a significantly higher relative P/E to the SPY.
Introduction - purpose of the article
This article uses simple arithmetic to show that AAPL easily has about an 18% CAGR total return over the next 5 years if:
- it meets or slightly beats earnings expectations for the years ahead
- buys back stock aggressively year after year
- the Federal Reserve does not cause a severe recession.
The math shown below leads to a $400 price target 5 years from now, which is consistent with about a $300 fair value right now. AAPL closed just under $184 Friday, an all-time closing high. If AAPL reaches $400 in 5 years, price would provide 16.8% annual return and dividends enough to allow that 18% CAGR total return. Better, as shown by the 14% yoy iPhone growth rate in Q2 and very rapid growth in services and wearables, the growth may be front-ended; this is just what a company rushing to buy in stock it believes is undervalued needs most - cash now and soon to allow maximal buybacks when the stock is on the cheap side.
Assumptions
These include 7% annual growth in earnings (1-2% above growth in AAPL's global markets). Then, it is assumed that sales growth tracks earnings growth. I further assume that AAPL's free cash flow approximately equals its earnings, that AAPL will return all of its FCF to investors going forward, and that 80% of earnings will go to buybacks. Currently, this is more like a 75% ratio of buybacks to dividend payments ($15 B per year at $2.92 per year current dividend payout), but investors can constructively do their own buyback by reinvesting dividends. One also has to think of dilution from stock-based compensation. So one could consider that 80% number either as a tad aggressive or too low. Take your pick; the goal here is a broad-brush picture suggesting that at $184, AAPL's upside remains quite attractive, though downside risks must always be considered.
This article is in some ways an update of my October 17, 2017, article, Why Apple Is Worth $300; What Warren Buffett Sees In It, written with AAPL at $160. To simplify this analysis, further assumptions are that AAPL gets to my $400 price target in a decelerating manner, with average buyback prices per year as follows:
- 2018: $200
- 2019: $240
- 2020: $280
- 2021: $320
- 2022: $360
- 2023: $400.
I'm going to assume that buybacks occur once per year at the above average prices. Whether one uses fiscal or calendar years matters just a little bit, but not much.
Another simplified assumption is that, while Q2 sales and earnings are usually slightly less than 1/4 of AAPL's fiscal year totals, and are expected by analysts to be in that range in FY 2018 as well, I'm just going to use Q2 numbers and multiply by 4 for current projections. This leads to FY projections, whereas most companies are on calendar years.
Finally, again I hope conservatively, I assume sales and earnings march up at 7% per year every year for the next 5 years, even though per the Q2 earnings release and 10-Q, yoy sales and EPS growth were 16% and 30%, respectively. So, current momentum is above those assumed numbers.
Now, on to the numbers.
Key starting numbers and concept
The point here is to think carefully, and simply, of how AAPL's enhanced buyback program, allowable through the recent tax reform legislation, may work within a period of steady growth in profits, as after-tax profits rise in concert with:
- shrinking share count
- buybacks occurring at steadily higher share prices.
I begin with these numbers:
- net income in Q2 of $13.8 B, or $56 B annualized
- aggressive share count reduction as projected by the CFO from 5.07 B diluted shares to 4.5 B this year (I assume this calendar year) at an average price of $200.
The reasoning for the key second bullet point comes from some specific CFO Luca Maestri's comments in his prepared remarks in the conference call:
- We ended the quarter with... a net cash position of $145 billion.
- We have now completed... $200 billion in share repurchases against our cumulative $210 million buyback program. We will complete the $210 billion program during the June quarter, three full quarters sooner than initially planned.
- Apple's... board has authorized a new $100 billion share repurchase program which we will start executing during the June [i.e. current] quarter. Our intention is to execute our program efficiently and at a fast pace.
In other words, AAPL is going to spend $110 on buybacks, as soon as it reasonably can.
Presumably, the board is impressed that the allegedly overpriced iPhone X was the top-selling iPhone every week since it was released, at least up to the end of the March quarter. That's without augmented reality being much of a reason to buy this device... yet.
AAPL bulls may enjoy, as I did, a trip down iPhone-bashing memory lane at iPhone Death Watch. Reports of its death have been greatly exaggerated. The iPhone is gaining strength, while Android is losing market share. For all we know, the iPhone might be generating over 90% of all smartphone profits globally by now.
Next, on to what Elon Musk might call boring - but ultimately cool - numbers.
Getting to $400 by 2023 - Part 1
Here is what I get, with AAPL beginning 2019 with 4.5 MM diluted shares outstanding, $56 B in 2018 earnings (= FCF), a growth rate of earnings (not EPS) of 7%, and 80% of earnings/FCF devoted to buybacks. Most numbers presented have been rounded for further simplification. If you are interested in this approach, please fine-tune as much as you want.
2019: 80% of $60 B earnings = $48 B for buybacks. Assuming an average price of $240, 200 MM shares are bought back, lowering share count to 4.3 B.
2020: $51 B available for buybacks (80% of $64 B earnings). Average price $280 means 182 MM shares are repurchased. Share count = 4.12 B.
2021: $55 B available for buybacks (80% of $69 B earnings). Average price $320 means 172 MM shares are repurchased = 3.95 B shares outstanding.
2022: $59 B available for buybacks (80% of $73 B). Average price of $360 means 163 MM shares are repurchased = 3.79 B shares outstanding.
2023: $63 B available for buybacks (80% of $79 B). Average price of $400 means 157 MM shares are repurchased = 3.63 B shares outstanding. Market cap would be up to $1.45 T despite all the money being returned to shareholders.
Getting to $400 by 2023 - Part 2
If the above numbers are correct, here's what it means for AAPL's valuation, which shows how 7% growth can lead to normal valuations and great compounded returns. Remember this is using fiscal year numbers. In 2023, FY earnings are projected at $78.5 B (rounded to $79 B for discussion purposes above but more detailed numbers were used in calculations). Let's now normalize to calendar year 2023 and, assuming the usual big Q1, call it $80 B in CY 2023 earnings. Divided by 3.63 B shares outstanding, we get $22.04 EPS.
Is $400 reasonable for an average buyback price in FY 2023 given expected EPS of $22 the same year?
Yes, clearly. It's a P/E of 18.2, completely normal for the world's most successful company. And, especially normal if a company is demonstrating that it is friendly to shareholders.
So, all this can easily work in the real world - not that the future ever ends up as modeled (please be careful; nothing is guaranteed).
The next question is about:
Estimating fair value today for a $400 target 5 years out
If $300 is indeed fair value for AAPL today and then rises 33% to $400 over 5 years, the CAGR is 5.92%. Add in dividends and one gets to 7%+. That strikes me as fine, given competing yields on 5-year debt instruments and a SPY with a higher P/E than AAPL and, I think, worse risk-adjusted growth prospects.
If one demands a higher yield of 7.4% plus dividends, then $280 would be fair value under the above assumptions.
As a check, adjusted for excess liquidity, AAPL at $300 right now provides an above-4% FCF yield (reciprocal of the forward P/E in this case). So that's reasonable, as well.
I sum, AAPL stock looks highly attractive to me at $184, with lots of room to move to fair value, however one thinks of fair value with a 5-year target price of $400, or even a lower target price.
What's driving this prospective alpha is the benefit of value investing
AAPL is not "really" at $184. If it has $145 B in net cash or cash equivalents as the CFO says, then that $145 B is available to come back to shareholders as soon as possible. If we assume 5 B shares outstanding, then $145 B/5 B shares = $29/share in excess capital. Thus, the $184 share price reduces to $155 T.
One does need to think of the lost income from that $145 B, currently returning 2% to AAPL and rising. That's $3 B off of pre-tax earnings. That plus stock-based compensation provides one reason I went with 80% capital return rather than 100%.
Some P/E details: ETrade shows AAPL's consensus EPS at $11.51 for this fiscal year, $12.33 for this calendar year, and $12.59 for the 4 quarter period through the quarter ending March 2019. I have been above consensus on AAPL since the successful launch of the iPhone X, so I will go with forward EPS of $13 through the March 2019 quarter. If AAPL adjusted share price is $155, then the stock is only at 12.3X forward EPS.
This is P/E uses GAAP EPS, and includes all stock-based compensation costs and amortization charges. The S&P 500 is projected by the S&P team to have GAAP forward EPS, through 3/31/19, of $158.69. At Friday's closing value of 2663, that puts the '500' at 16.8X forward earnings; and the companies in the S&P, after removing AAPL, are almost all neither especially rich in net cash, and many are big net debtors. So the adjusted AAPL P/E is directly comparable with the stated P/E of the SPY, and despite AAPL's earnings momentum, positioning in growth sectors of the economy, and many strengths, and despite trading at a record high, it remains at about a 27% discount to the market.
Thus, AAPL is cheap to the market, and the buybacks will accentuate that cheapness.
Thus, I see AAPL as a well-above average projected source of alpha for some prolonged period or price move relative to the SPY.
Please don't forget about risks, which AAPL discloses in its 10-K and in other filings.
Last, there is:
One more thing (or two)
None of the assumptions mentioned above are exceptional; of course, they may be incorrect in either direction. But they project the present trends onto the future and further project today's P/E's into the future.
However...
What if the "black swan" risks are asymmetrically tilted toward AAPL and its shareholders? What if AAPL is unlikely to just collapse as BlackBerry (BB) did when the iPhone destroyed it, but it could very possibly leapfrog the iPhone and provide product solutions with much more commercial upside than the iPhone ecosystem has, just as the iPhone did the same to the iPod?
What could do this?
Augmented reality, or more broadly AR/VR. What if AAPL is about to first supplement the iPhone, then surround and replace it with something better, more comprehensive, more superior to the competition than the iPhone is to Android phones? (And this time, no CEO of a competitor is on AAPL's board to make AAPL threaten thermonuclear war.) What if AAPL is using its wearables and evolving iPhone (and even HomePod) technologies to develop two types of products that could together be much more commercially successful than the iPhone? One could be a system for AR while people are on the go. It could utilize AirPods and the Apple Watch, or next-gen products derived from them, and whatever else is needed to eliminate the limitations of AR solutions provided on a hand-held iPhone. In other words, a breakthrough heads-up display or some other solution to make AR just work.
A second solution could provide a next-gen, comfortable, preferably wireless headset for virtual reality, mostly for home use; rumors abound regarding this.
The goal with these concept products would be for AAPL to dominate, virtually create, the markets and thus dominate in units, not "just" in profits as has turned out to be the case with the iPhone.
We shall see. But AR is a topic Tim Cook has been talking up for some time. Thus, I think that AAPL could have the lion's share of an expensive set of solutions that do much more than the iPhone, just as the iPhone did much more than the iPod. Plus, as a potentially important part of the upside, AAPL could leverage that control of the customer to snarf up control of media provided to its customers; i.e. extend its provision of services in a very big way: the App Store gone wild.
Big as the iPhone has been, and it's still growing, the AAPL of the future, creating a new mega-breakthrough - this time in AR/VR - might be AAPL itself.
Just a thought.
Thanks for reading and sharing any comments you wish to contribute.
This article was written by
Analyst’s 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.
Not investment advice. I am not an investment adviser.
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Comments (240)
- they prevent shareholders to invest profits in shares of other companies or just spend it. This way, the share buyback program increases the demand for AAPL shares, and therefore the shareprice.
- they improve the PE ration, a key metric many investors use to value stocks.
- they reduce the dividend expense.
ratio is 18 then your valuation relative to growth is well overstated. This
is revealed by an age old metric called a PEG which in this case should be
1 and is 2.5. And 7% growth when your key product (the iPhone) is
actually declining is difficult. But suddenly it is all about services, I forgot!
Not to mention...with each month we inch closer and closer to more info trickling about about future potentially blockbuster endeavors including movie/music content, self-driving, AR/VR and glasses.
- designing out Intel's X86 chips from its Mac line, and by using ARM architecture entirely, it could very, very closely integrate its iOS with OS X, providing an even better closed eco-system;
- since 5G standards are more open than LTE and previous generations, it could design substantially its own modems, and get away with just paying a much humbled QCOM a simple royalty for the priviledge;
- as gaming becomes more and more prevalent, I wait for the day when Apple decides its own graphics design capability can be extended further into inhouse chip design, and in which case, it could easily boot out AMD's GPUs currently in some Apple products.