- Apple is my largest position, by far.
- However, after poor bottom-line performance, I don't think the recent rally is justified.
- I'm not selling my shares, but I believe that AAPL is roughly 28% overvalued.
- This idea was discussed in more depth with members of my private investing community, The Dividend Kings. Get started today »
As many of you know, Apple (NASDAQ:AAPL) is my largest position, by a long shot. In my portfolio, a "full" position carries a weight of roughly 2%. The vast majority of my positions are smaller than this. I own a handful of overweight names in the 3-5% weighting range. However, Apple stands head and shoulders above the rest of my portfolio with its current overall weighting of 12.9%.
As I write this, the S&P 500 is down roughly 7.2% year-to-date whereas Apple shares are up roughly 7%. Furthermore, the S&P 500 is currently down approximately 11.4% from all-time highs set back in late February while Apple shares are only down roughly 4% from their all-time high mark. In short, Apple has outperformed the market in 2019, in 2020, and throughout the COVID-19 environment. It seems as though this stock is an unstoppable force at this point in time.
Personally, I couldn't be more thankful due to my own very large stake in the company. However, putting aside my personal position and my long-term bullish stance with regard to the company, I feel compelled to voice the opinion that it appears as though AAPL's share price has become disconnected from its fundamentals and therefore, in the short-term, at least, this stock appears to be rather expensive.
I don't say this with a mind to sell/trim my position. At this point, I've essentially become resigned to maintain a heavily overweight Apple weighting because every time I consider trimming and think about potential replacements, I cannot find another company that I'd rather own.
And, while I am confident enough to say that I think the stock appears to be expensive, I also acknowledge the fact that the market is oftentimes irrational (sometimes, for very long periods of time) and with that in mind, I have no desire to attempt to trade out of and back into this stock.
Over the long-term AAPL shares have shown a propensity to move ever higher and if I were to sell now, hoping to buyback at a lower price later, I imagine the risk is fairly high that I would never have such an opportunity.
That's not a risk that I'm willing to take with these shares due to their strong cash flows, balance sheet, and most importantly, shareholder returns. So long as AAPL continues to raise its dividend at an acceptable pace, I am content to sit on my hands and cope with abnormally high single stock risk.
I simply write this article because I'm sure that there are others who would like to increase their AAPL weighting and might be feeling a bit of FOMO (fear of missing out) with regard to the overall market's rally off of the March lows. While the majority of Apple opinions that I read out there are positive (and rightfully so, when looking at the long-term strength that this company has shown), I thought it was worthwhile to play a bit of devil's advocate, with regard to purchasing shares in the short-term, at historically high valuations.
China, then COVID, Creating Problems for Apple
This overvaluation story doesn't start with the COVID-19 crisis, or even in the year 2020. Although AAPL has been on a huge rally for a couple of years now, much of the capital appreciation that we've seen in the share price is based upon improved sentiment and multiple expansion rather than fundamental growth. To me, this represents a problem for conservative, value oriented investors.
As you can see on the F.A.S.T. Graph below, although AAPL's share roughly doubled in 2019, its EPS growth was flat. That's a pretty amazing occurrence, isn't it? Granted, we were coming off of a pretty low base due to the significant sell-off that AAPL experienced in late 2018; however, the rise from ~$140 to well north of $300 appears to be a bit of an overshoot, fundamentally speaking.
During 2019, we saw AAPL's price-to-earnings multiple rise from roughly 12x earnings at the lows to nearly 26x earnings at the highs. While I think it's fair to say that AAPL shares were irrationally cheap when they were trading for just 12x earnings, I think it's equally as fair to say that a company with Apple's fundamental growth does not deserve to carry a 25x+ multiple.
Historically, the market has had a really tough time evaluating Apple because of its high exposure to hardware (and namely, the iPhone in particular). For years, bearish analysts have been calling this stock a one-trick-pony, waiting for iPhone demand to fall off. This hardware exposure is why the company traded with a near-single digit multiple for years in the earlier part of this decade, even though it boasted the world's largest cash position and cash flows that made every other stock in the market envious.
In recent years, we've seen AAPL attempt to move away from its iPhone dependence via an expanded hardline line up (in a very short period of time, AAPL has become the world's leader in wearables due to the success of the Apple Watch) and more importantly, its hyper focus on increasing its services offerings.
For years, I've made the argument that AAPL's ecosystem was where the value of the company lies. While some where focused on iPhone cyclicality, I was focused on the company's growing active handset count. In the early days of the iPhone's dominance, we saw Apple generate revenues with services. Yet, as things like iTunes began to deteriorate, it appears as though Apple's ecosystem lost its luster (in the market's eyes, anyway).
Today, Apple's service revenues are a $50b/year business. This still dwarfed in comparison to its hardware sales figures, but these high margin, reoccurring revenues have changed the market's opinion on Apple...in a heartbeat.
Prior to 2019's run-up, I argued that AAPL deserved a higher multiple for years. This the twenty-second focus ticker article that I've written about AAPL over the years here at Seeking Alpha and in the vast majority of them, the argument that AAPL was irrationally cheap was a common theme. However, when I said higher multiple, I was talking somewhere in the 18-20x range, not 25x.
Simply put, while AAPL's balance sheet, cash flows, and growing dividend make it an attractive long-term hold, the company does not have the growth prospects to justify such a high multiple.
Even if you discount 2019's zero growth results because of the Chinese trade war headwind and 2020's likely flat/low single digit growth due to COVID-19 (and continued Chinese issues), we're not talking about a stock that regularly posts 20%+ growth here.
Historically, AAPL's EPS has been on a bit of a boom/bust cycle. And, while I think the rising service revenues will help to decrease bottom-line volatility, that doesn't change the fact that AAPL doesn't offer the same sort of growth prospects as many of the similarly valued mega-cap tech brethren.
Comparing Apple to Other Mega-Cap Tech Names
Right now, AAPL is expected to produce a 10.1% EPS CAGR over the next 3 years ((using current analyst consensus EPS data for 2020, 2021, and 2022) and trades with a forward P/E multiple of 25.7x. This represents a PEG ratio of ~2.5x during this forward looking period.
Facebook (FB) is expected to generate a 23% EPS CAGR over the next 3 years and currently carries a forward P/E multiple of ~31x. This represents just a 1.35x PEG ratio over the same forward looking period.
Alphabet (GOOGL) is expected to generate an EPS CAGR similar to AAPL's 10% over the next 3 years. GOOGL trades for roughly 34x its forward looking EPS figure, but this multiple is thrown off a bit by -15% expectations for 2020 due to digital advertising slumps related to COVID. For the sake of this comparison, GOOGL's PEG during this time period if ~3.4x.
However, I don't think GOOGL is a great example to use with regard to the valuation/PEG comparison to AAPL right now because of these short-term hiccups. Furthermore, while GOOGL's bottom-line growth has been solid over the years, this company appears to be more focused on growing the top-line and being aggressive with its cash flows rather than allowing them to trickle down to the bottom-line. Regardless, GOOGL is a mega-cap tech name so I wanted to mention it when comparing AAPL to its peers, even if I don't think it's much of an apples to Apple comparison.
Microsoft (MSFT) is expected to generate a roughly 15% CAGR over the next three years and currently carries a forward P/E of 29x. This represents a 1.94x PEG ratio over the forward looking period that we're discussing.
And finally, we arrive at the last mega-cap tech name that I'll use in this comparison: Amazon (AMZN). AMZN is expected to generate a 32% EPS CAGR over the next three years. Shares currently trade with a forward P/E ratio of 130x. Like GOOGL, this high multiple is derived, in part, from the fact that AMZN is expected to post negative EPS growth of roughly 20% in 2020, skewing the figure higher than normal. Regardless, I have to use the numbers that the consensus estimates give me, which result in a ~4x PEG ratio.
I think it is worth noting that prior to the COVID crisis, AMZN was trading for ~60x forward, which would have represented a 1.9x PEG (similar to MSFT's and lower than AAPL's).
So, what are investors to make of all of these comparisons? Honestly, make of it what you will. AAPL is cheaper than certain peers on a forward looking PEG basis and more expensive than others. However, what sets AAPL apart from names like MSFT, GOOGL, FB, and AMZN, in my mind at least, is the runway of its double digit growth.
I think that all of the names on this list have longer, stronger growth runways than AAPL due to AAPL's reliance on the consumer rather than enterprise clientele. And, with that in mind, I'm simply not willing to pay the same premium for AAPL shares as I am for the other popular big-tech growth stocks in today's market.
Conclusion: Focus on the Fundamentals
But, what I think is even more important than these peer comparisons is simply looking at AAPL's recent results and asking yourself, does this stock really deserve to be up more than 100% over the last couple of years?
How many other mature stocks in the market have posted similar results while also struggling to grow their bottom-lines? None that I'm aware of.
And while I do think that AAPL will get out of the EPS malaise that we've seen for the last 18 months or so, the major issues that have been holding the stock back (namely Chinese trade and now COVID-19 hurting the global consumer) are not expected to go anywhere, anytime soon.
Sure, analysts remain exceedingly bullish on 2021 as a bounce back year. This bounce back thesis contributed heavily into the strong CAGR figures that we discussed above. But, when I look at the dire economic figures being presented to the market, I'm not so sure that 2021 will be all sunshine and rainbows. We've got a long recovery ahead of us, that's for sure.
While I remain highly confident that AAPL will come out of the COVID crisis as a very strong player in the technology space, that doesn't mean that I'm willing to ignore valuation in the meantime.
Like I said before, I think AAPL's fair value lies somewhere in the 18-20x area. This implies a fair value estimate of roughly $230/share. This nearly 28% lower than today's share price.
As the services segment continues to grow, that my target multiple will likely continue to rise as well. However, it's going to take awhile for services to make up the majority of AAPL's sales. And, I don't think that it makes sense to place a ~25x+ multiple on these shares until that is the case.
At the end of the day, I think it's important for investors to realize that both quality and value are important aspects of a prudent investment decision. Without a doubt, AAPL checks the quality boxes. Yet, after its recent run-up, I don't think the company's valuation is attractive. And, with that in mind, I don't feel compelled to add to my position. There are other names that check both boxes and that is where the best returns are likely to be had.
This article was previously published for subscribers to The Dividend Kings.
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This article was written by
Nicholas Ward is a Senior Investment Analyst with Wide Moat Research and the former editor-in-chief and portfolio manager at The Intelligent Dividend Investor, The Dividend Growth Club, and The Income Minded Millennial.
Nicholas is a contributor to the investing group The Dividend Kings where he shares analysis on dividend growth stocks. The Dividend Kings is a group of analysts, led by Dividend Sensei, that teach members how to invest more wisely in dividend stocks. The focus is on helping investors safeguard and grow their money in all market conditions through the highest-quality dividend investments. Features include: 13 model portfolios, buy ideas, company research reports, and a thriving chat community for readers looking to learn how to invest more intelligently in dividend stocks. Learn More.
Analyst’s Disclosure: I am/we are long AAPL, AMZN, FB, GOOGL, MSFT. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.