Apple: Valuation Vs. Sentiment

About: Apple Inc. (AAPL)
by: Oleh Kombaiev

From a fundamental point of view, Apple is clearly undervalued.

But there are reasons why it is so.

And the main one is that the company has almost exhausted the quantitative potential of its growth and is approaching the limit of qualitative potential.

Part 1: Valuation

First of all, let's look at the technical parameters of Apple's (AAPL) stock price dynamics.

As it is typical for most public companies, the dynamics of Apple's stock over a long period of time is quite qualitatively described by the exponential trend that acts as a specific average:

Apple stock price long-term exponential trend

At the moment, the actual price of Apple's stock deviates from this trend by nearly 30%. Technically, it is showing that the company is undervalued.

History of deviations of Apple

The return analysis generally confirms this conclusion. The current annual total price return of Apple is below the standard deviation:

Apple Rolling Annual Total Price Return

Now, let's look at Apple's current price in terms of its financial performance.

I single out two key approaches that help evaluate the rational price of Apple without resorting to DCF modeling.

The first one is based on the long-term relationship between Apple's capitalization and the absolute values ​​of its key financial indicators.

Within the bounds of this approach, Apple's revenue TTM in the last quarter corresponds to the company's balanced capitalization of $850 bn, which is 15% higher than the current level:

Apple Revenue ttm vs. Market Cap

As far as this model is concerned, Apple's history has known larger deviations of the actual price from the balanced level, and nevertheless, 15% is a bid for stating an undervalued state.

The model based on EBITDA demonstrates a deviation of the company's actual capitalization from the balanced level of less than 10%, which is within the scope of the standard deviation:

Apple EBITDA ttm vs. Market Cap

The second approach is based on the relationship between the growth rate of Apple's financial indicators and its multiples.

Here, it is appropriate to consider the positive relationship between the annual growth rate of Apple's revenue TTM and the EV/Revenue multiple:

As can be clearly seen, this relationship evaluates the current value of the EV/revenue multiple as extremely low, based on the revenue growth rate shown in the last quarter.

We have to make a similar conclusion when we analyze the relationship between the EBITDA TTM growth rate and the EV/EBITDA multiple:

So, based on the four models proposed, in three cases, Apple's capitalization is clearly classified as undervalued.

Let's talk about multiples a little bit more.

If we compare Apple with other companies from the FAAMG list through the P/E multiple, we will not get an adequate result since the growth rates of these companies' profits are extremely different. Therefore, within the bounds of such a comparison, it is appropriate to adjust the P/E multiple for the profit growth rates. Moreover, taking into account the psychology of investing, it is even more correct to adjust this multiple not for the actual profit growth rates, but for the expected ones. Comparing Apple in this way shows that the current price of its stock is at least $100 cheaper than the balanced level:

Now, let's look at the history of Apple's balanced value assessment through this multiple:

As we see, within the bounds of this approach, the deviation of Apple's actual stock price from its implied price reaches its maximum size in the last nine months, which is also a forcible argument in favor of the fact that Apple is undervalued.

Part 2: Sentiments

So, from a fundamental point of view, Apple is clearly undervalued. But there are reasons why it is so, and the main one is that the company has almost exhausted the quantitative potential of its growth and is approaching the limit of qualitative potential.

By quantitative potential, I mean that the global smartphone market has approached the "plateau" phase and a growth of more than 1-2 percent is not to be expected. That is why Apple has taken a very unfriendly step with respect to investors and has announced that it stops publishing iPhone sales statistics, apparently anticipating negative growth rates.

On the other hand, no one particularly expected that iPhone sales would start growing sharply in 2017 and 2018, and yet Apple's capitalization continued to grow. Everyone liked that the company is focusing on creating more expensive iPhone models, which compensates for the lack of growth in their sales and supports the company's revenue growth at a level acceptable to investors. But at the end of 2018, this confidence vanished as soon as the phantom of "recession" loomed on the horizon.

According to Google Trends, the popularity of the search query "recession" reached a five-year high in December 2018, although the global economy continues to grow. But now people believe that it can happen in the near future and take it into account. And as usual in such cases, first of all, people save on luxury items to which Apple products belong. Especially as, to say the truth, each new iPhone is not revolutionary different from its predecessor, which means you can do without updating it for a couple of years. It indicates that the tactics of creating more expensive models of smartphones will very soon prove ineffective and this will affect the company's revenue and profitability. And the most dangerous thing is that this factor is just beginning to take effect for the recession has not even come yet.

Bottom line

Apple is clearly undervalued but it's normal for now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.