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AAPL Is Cheap

By Jason Born, CFA

Ahh nostalgia. Remember when Will Smith had America "Gettin' Jiggy Wit' It?" Or do you remember when Aerosmith, in one of their multiple reincarnations told us they, "Don't Want to Miss a Thing" as Liv Tyler wept and Bruce Willis and Ben Affleck saved the planet? We do recall these seminal events in world history for the year was 1998, not so long ago for anyone who remembers life at the beginning of the Internet Revolution, but a lifetime ago in the technology industry.

We look back to that time period because we want to see if we may glean any information to make our view of today and beyond simpler. We like constructs or frameworks based upon the past because they can act as short-cuts to make dealing with today's complex decisions more straightforward.

In the late 1990s Microsoft (NASDAQ:MSFT) and Cisco (NASDAQ:CSCO) were on growth trajectories to take over the planet. The media loved them. Investors loved them. Even by mid 2000 when the bloom began to come off the technology bubble, these companies had still given their long-term investors an extraordinarily profitable ride. If you happen to be on the youngish side (say under 35 years of age) you may wonder why we are talking about such archaic companies as these in 2012.

The tables below show that these companies may serve as an example of what is in store for the operations not the stock price our very dear Apple (NASDAQ:AAPL) in the future. Media, investors, and consumers love AAPL just like they did MSFT and CSCO a little over a decade ago. But before you "wig out" (we don't really know if the kids are still saying this phrase that is particularly wonderful in our minds) about what this means for AAPL's stock price going forward, please let us explain.

The point of this exercise is to see what happens to revenue growth rates and net income margins of highly successful companies. It is a universal truth in capitalism that fantastic success brings competition, some good and some great. Within the technology space in particular, that competition is usually quite disruptive and may even make the initial successful company irrelevant. While irrelevance may occur or be occurring to both MSFT and CSCO, it has not happened yet as evidenced by their continued growth.

That growth, however, has been much slower following the boom days. For example, CSCO posted annual revenue growth of 53.3% for the five years ending July 2000. Since then it has averaged about 12%. The growth rates have slowed due to competition and industry maturation. Microsoft, due to its software products' ubiquitous nature, has fared better with regards to growth since 2000.

So which of these companies, MSFT or CSCO - if either, will AAPL's revenue growth rates be like going forward? About 90% of Apple's revenues come from hardware such as iPod, iPad, iPhone, and Macs. And since the history of all technology companies demonstrates that hardware companies have the most difficult time maintaining an edge, we believe that we should expect sales growth and margins to move more in line with CSCO than MSFT. Remember, competition, especially in technology is a powerful, unavoidable force.

Before we run forward projections for AAPL it is important to note the returns CSCO investors received since 2000. Following those heady days of the late 1990s, CSCO investors would have suffered a -5% annual return over the last twelve years (yes that is a negative average return each year). But it is important to distinguish operational similarities such as revenue growth or income margins with stock prices - more on this in just a moment.

With that in mind here are our high level forecasts for AAPL (note that 2012 numbers are estimates as AAPL has yet to announce their FY 2012 full year results as of this writing).

We show revenue growth averaging 12% for the coming decade which is just like CSCO's following 2000. Net income growth slows to 8%, a calculated result as the company posts lower margins.

The upshot of our analysis is that even with a drastic slowing of growth rates and margins, down to the level CSCO achieved, AAPL seems very inexpensive today - cheap even, with an intrinsic value of $773 per share.

This short exercise proves the very reason we run our shop the way we do. Growth rates are fun. Growth rates are sexy. But, growth rates are trumped - every time - by the price you pay. Cisco Systems was not a bad investment in 2000 because its growth was about to slow. It was a terrible investment because it was priced for shoot-the-lights-out performance for eternity. We don't have that problem with AAPL at these prices. We can acknowledge its likely slowdown in growth rates and margins, without automatically claiming the stock is not a bargain.

At around 20% undervalued, AAPL will serve investors looking for a company to own for five or more years quite well if purchased at today's prices. So if you're like Stephen Tyler from Aerosmith and you too, "Don't want to miss a thing," consider adding AAPL to your portfolio of diversified holdings.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.