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This Apple Is Golden And Delicious!

|Includes: Apple Inc. (AAPL)

Few companies are discussed more frequently than Apple (NASDAQ:AAPL) and it's clear why...their products are high functioning works of art (elegant in look, feel and usability) and they've developed visionary software and hardware combined with an integrated model, whereby everything works best together (although highly logical, this approach is unique as compared to the competition).

Apple's visionary creations have driven a "King Midas-like" transformational change to everything they've touched in recent years - the entire music industry, graphics/video/photo editing, apps, cell phones and the mobile web. During the past 7 years, my home has also transformed - from a disparate combination of PC's and disconnected devices, into a family powered by Apple. My ikids will soon be receiving their iPhones, we view content and read on the iPad, when we travel, I bring the "iBag" - a knapsack, which carries all our Apple devices, earbuds and power cords. Suddenly, we cannot live without biting the Apple every day!

I typically focus on value stocks whom are steady dividend growers, but I went long on Apple during fall 2011 due to the compelling risk/reward and upside potential. Interestingly, I purchased Apple for the value at the time and since, they've announced a dividend. Although the gains have been quite good to date, I believe much upside still exists - let's look at what the numbers are telling us.

($ in billions except for eps)

(source: Apple 10-K's and Morgan Stanley analyst report dated 7/24/12)

  2008A 2009A 2010A 2011A 2012E 2013E 2014E

Margin %

Total Revenues 32.5 36.5 65.2 108.2 154.6 191.2 229.6  
Macs 14.3 13.8 17.5 21.7 23.0 24.4 24.7 27%
iPod 9.2 8.0 8.3 7.5 5.7 4.7 4.2 27%
iPhone 1.8 6.8 25.2 47.0 76.9 101.0 133.0 57%
iPad n/a n/a 5.0 20.4 34.6 45.2 50.7 32%
iTunes & Peripherals 5.0 5.5 6.8 8.6 11.0 12.0 12.8 27.5%
Other 2.2 2.4 2.6 3.0 3.4 3.7 4.1 50%
Gross Profit 11.1 13.1 25.7 43.8 67.6 84.4 104.4  
NOI 4.8 5.7 14.0 25.9 41.0 51.1 64.3  
NOI % 14.9% 15.6% 21.5% 23.9% 26.5% 26.7% 28%  
EPS $ 5.36 6.29 15.15 27.68 43.37 53.9 67.84  
EPS growth n/a 17.4% 141% 82.7% 56.7% 24.3% 25.9%  

As Apple gets larger, its profits are accelerating. Why? New products, such as iPhones and iPads, are now the main drivers of revenues, but at higher margins than Apple's historical business. In FY '12, 72% of revenues will come from iPhones and iPads - these high margin revenues did not exist just 5 years ago. Analyst's estimates demonstrate mobile device upside ahead in number of global units. Providing Apple continues to capture their piece of the market, this should provide several years of continued rapid sales growth, while continuing to widen margins (per the chart, iPhone and iPad revenues will expand to 80% of sales by FY '14). This compounding effect will show up in EPS, which corresponds to a higher stock price. Should market share expand, this rise will occur even faster and farther.

Right after Q3 FY '12 earnings in late July 2012, Apple sold off, down to $575, which was another great opportunity to go apple picking. Since the sell off, the stock has risen by about $125 or 22% (crossed $700 on 9/18/12). Based on historical information, analyst consensus estimates and a few market observations below, I believe the stock will be trading at a minimum of $1,200 a share during FY '15. That's a gain of 70% in less than 3 years. How? this time, EPS should almost double and reach the low-to-mid-$80's.

Here's the math:

Apple has traded at a current p/e low of 13 (summer 2012) and a high of 16 ($700/$43.37) in Sept 2012. Interestingly, Apple is also currently trading at a forward p/e of 13 ($700/$53.90).

The chart above only goes out to 2014, however, if we are conservative and assume only a 15% eps growth rate in FY'15, we get eps of $78, 20% gets $81, and 25% gets to $85. New product updates alone should achieve 15%-20%, but based on several observations below, I believe the growth rates will be more aggressive.

The middle assumption of $81 will drive our estimates for a 2015 share price:

Low scenario: 13 current p/e x $81 = $1,053

High scenario: 16 current p/e x $81 = $1,296

Average = $1,174.50

Below are several market observations and accelerants, which could help propel Apple stock even higher than the above simple math.

1) Products are replaced more frequently. Recent (since 2010) growth is fueled by new products (e.g. the iPad didn't exist just 3 years ago and the iPhone was launched in 2007). These new products are much higher priced than iPods (which fueled the initial stock acceleration from 2001-2006), are owned in multiples by households and being replaced every few years. In fact, the sum of a household's newer Apple products could easily exceed the price of a Mac desktop, and most likely is being replaced more frequently.

2) The mobile web (video, social media, commerce, payments) encourages greater need for Apple's products and the mobile web is still just getting warmed up.

3) 4G for iPhone 5 is here. This is the last device my local Verizon store to convert to the faster network. Pent up demand is huge. Need I say more.

4) Remember in grade school there was an apple on the teacher's desk? A different Apple will be there soon. Apple is slowly entering the education market at an opportune time. More to come in a future article but here's a hint at the upside...the K-12 education market in the US is an $8B content business annually. That's nice, but nicer are the 50 million students in public schools. That's one big Apple tree with many branches!

Despite the $700/sh price today, there could be an additional $500 upside ahead in under 3 years.

But...and there is a big one, after studying the numbers in the chart and noticing 80% of revenues coming from just two products within 2 years, one can't help being concerned about future innovation and the product pipeline. Without the brilliant visionary Steve Jobs, how much confidence does an investor have in Apple's ability to continue creation of "insanely great" products? Will they continue to surprise consumers with innovation, or will something new appear all of a sudden and dethrone Apple from where they are today? Time will tell.

Disclosure: I am long AAPL.