Seeking Alpha

I Have To Admit: Apple Is Undervalued In The Long Run

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

The current trend allows one to expect that Apple's revenue CAGR won't exceed 4% in the coming 10 years.

Apple's operating margin for the next 10 years will gradually reduce to 23%.

And despite this, the DCF model indicates considerable growth potential for the company’s capitalization.

Investment Thesis

The DCF valuation of Apple (NASDAQ:AAPL) reveals that the growth potential of company's capitalization is around 30%.

The quality of any DCF model is largely determined by the quality of the long-term company's revenue forecast included in it. And, in the case of Apple, building such a forecast is not an easy task.

Talking about a ten-year perspective, any opinion on the future growth rate of Apple's revenue is always subjective. Therefore, I did the following. To forecast Apple's revenue for the next 10 years, I used a polynomial model that most closely matches the average expectations of analysts:

Source: Seeking Alpha

Based on these expectations, I assume that, starting from 2020 FY, Apple's revenue growth rate will continue to gradually slow down at a CAGR of 3.6%:

Apple revenue forecast Now, let's go through the rest of the key parameters of my model.

I proceed from the assumption that the operating margin of Apple will gradually decrease from the current level to 23% in a terminal year due to increased competition. Given the history of this indicator in Apple, I find this acceptable:

Chart Data by YCharts

The model involves maintaining the tax rate at the level of 25%, which corresponds to Apple's average indicator over the previous 10 years and which is very close to the world average:

Chart Data by YCharts

The relative size of CAPEX is assumed to be 5%, which is close to the medium historical indicators of Apple:

Chart Data by YCharts

Now, let's have a look at the model itself.

First of all, here is the WACC calculation:

WACC of Apple

To calculate the WACC, I used a one-year rolling beta coefficient:

The current value of Apple's beta coefficient is 1.18%, which is objectively very high. Accordingly, in the model, I proceed from the assumption that Apple's beta coefficient will decrease in the long term. All other things being equal, this will reduce the WACC.

And, finally, here is the model itself:

DCF of Apple

The DCF-based target price of Apple's shares is $291, offering a 29% upside.

Bottom Line

DCF modeling is exactly the right tool that makes it possible to objectively (not subjectively) estimate a company's rational price solely on the basis of its development trend. At the same time, the result of DCF modeling is subject to high error. But, in this particular case, the model has shown not weak growth potential, and at least, this means that Apple is not overvalued in the long run.

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.

Additional disclosure: I don't have a trade position regarding Apple. And I believe that to be an advantage in terms of analysis because I am able to consider indicators impartially without subliminal motivation to see positive or negative sides even if they don't exist