AAPL is NOT Worth $460


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Jae Jun

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Yes I bought AAPL.

Who would have guessed? I don’t like the company. I don’t like their products.

But I do like it as an investment.

The main topic covered everywhere on the internet relates to the lack of innovation which is leading to lower priced products, lower margins, lower profitability and ultimately death.

All are valid points, but none of them concern me.

The common value investing question is whether the company will be around in 10 years and if it is too hard to tell, then it is a pass.

My answer: Yes. It’s as easy as looking at their balance sheet. AAPL could continuously make dumb acquisitions like HP and they will still be around 10 years from now.

Simple Investing Thesis

My reason for investing in AAPL is simple and most likely too simplistic (or dumb) for most. I do not want to write about AAPL’s future and what their product pipeline is like. I want to reiterate that I did not buy AAPL for their product pipeline.

Instead, AAPL at the moment is a classic case of “heads I win, tails I don’t lose much”.

Seth Klarman also referred to this as downside protection investing. All you have to do is protect the downside and the upside will take care of itself.

Here are the reasons I bought AAPL.

  • Downside protection: balance sheet protects the business from going bankrupt. If I can find a net net with a dying business with AAPL’s balance sheet metrics, I would be all over it. So why wouldn’t I buy AAPL?
  • Better than the S&P: A bet that AAPL will perform better than the market over a couple of years.
  • Better than cash: I started the year with about 50% in cash. Cash makes up 1/3 of AAPL’s market cap. In other words, if AAPL was a hedge fund, I transferred my US dollars into AAPL dollars for AAPL to manage. With their management, pricing power and business strength, they are able to invest money in ways I cannot dream of.
  • Priced for doom: Current valuations predict AAPL has zero growth remaining.

What AAPL is Not Worth

Rather than try to figure out what AAPL is worth, the better way is to perform various reverse stock valuation methods to see whether the current price is realistic.

The following methods from the stock analysis spreadsheet will be used:

All four methods are independent of each other. That is, the inputs and outputs from the DCF is not feeding the Graham model or any other model. Getting independent and unique valuations is important in determining the valuation range any stock resides.

Reverse DCF Valuation

(If the image is too small to read, do not worry, a PDF version is available at the end of the article.)

The assumptions made in the calculations is as follows:

  • 9% discount rate
  • $40 billion FCF
  • terminal rate of 2%

This brought the market growth expectation of AAPL to 0.7% at the current price.

The actual FCF is higher that what I used, but to be conservative I lowered the FCF value to $40b.

Will AAPL grow FCF faster than 0.7%? Most likely.

Reverse Graham EPS Valuation

Using Graham’s rendition of the growth formula, let’s see what comes up.

In order to try and kill the investment, I completely low balled the EPS to $33.55. This basically eliminates the 2012 results. Analysts are predicting an EPS of $44.75 this year, but let’s ignore that and continue the low ball valuation.

The expected growth if AAPL earns and EPS of $33.55 is 5.5%.

The image below is a closer look at the valuation and how it can change.

At the current expected growth rate of 5.5%, if AAPL can achieve similar earnings to what it did last year, the value is $600.

If earnings is similar to last year, but growth increased to 8.2%, then AAPL is worth $730 on the high end.

Will AAPL grow earnings faster than 5.5%? Most likely.

Reverse Absolute PE Valuation

Again, remember that all the valuation methods are independent of each other.

According to the PE to earnings growth correlation table, AAPL’s current PE of 10.4 is equivalent to 5% earnings growth.

Starting with 5%, in order to get the valuation anywhere near the current stock price of $460, I had to lower AAPL’s grades significantly.

In it’s current state, AAPL is below average in every category compared to its peers.

Is AAPL below average compared to competitors? No way.

Reverse Earnings Power Value

EPV is based on zero growth by default so this is an easy exercise.

There are only two numbers to be concerned when performing an EPV analysis in reverse.

Find the maintenance capex and what is the normalized income?

AAPL has been increasing its capex each year and maintenance capex is certainly going up with it. I’ve set the maintenance capex level to $6b. Here are the details of how to calculate maintenance capex.

For the normalized income, I low balled it again. The adjustment normalized income is $44b according to my calculations, but I have reduced that down to $40b.

Even when using a higher maintenance capex and lower normalized income, the final EPV comes out to $442.94 which is within 3% of the current price.

This was a long way of saying that AAPL is priced for zero growth.

Summing Up

AAPL is cheap and there is no need to complicate it. Fundamentally, it is extremely cheap by being priced for zero growth.

Zero growth expectations with a bullet proof balance sheet protects the downside and AAPL will have to experience some severe negative growth for it to be a value trap.

Download the Apple Reverse Stock Valuation Report

Download the FULL 14 page reverse stock valuation report on Apple.

Disclosure

Long AAPL at the time of writing.

  • guester

    What about negative growth?
    Samsung Note 2 could eat into Iphone and Ipad sales.

  • kumud

    Funny how you said in your article that you hate Apple products and not a fan of its product pipelines yet the home page of yours show Macbook Pro :) Not that there is anything wrong with it, I just wanted to highlight it.

  • dgoyal

    Even though you presented good financial analysis, I disagree with its conclusion. As another reader has already pointed out, Apple is getting challenged with prospects of negative growth.

    A look at quarterly reports for Q4 2012 and prior 2 years is really revealing. These reports share Apple’s revenue by product for 5 primary product lines (Mac, iPod, iPhone, iPad and iTunes/Software services) plus accessories. Data provided in these reports also let you estimate revenue per unit for first 4 product lines.

    Analysis of that data reveals that (I am not able to paste my tabular analysis in this text box but you can visit my blog at http://economics-and-business.blogspot.com/2013/02/aapl-is-not-worth-460.html for details.)

    1. iPod market is a declining market, even though revenue per unit is steady. It contributes only 4% towards total revenue.

    2. Mac market remains steady, revenue per unit is steady. It contributes only 7% towards total revenue

    3. iPad total revenue has remained stable; however revenue per unit has declined drastically. It shows that Apple is facing strong competitors and is really fighting on price per unit. This segment contributes 20% towards Apple’s total revenue

    4. iPhone segment’s Qtr over Qtr revenue growth was 129% in Q4 2011. In Q4 2012 this growth is down to 28%. Price per unit remains steady. This segment contributes 56% towards Apple’s total revenue.

    It is easy to conclude that Apple’s growth engine for last three years have been its iPhone (primary) and iPad (secondary) products. It is also very clear that significantly strong challengers in these segments have appeared during last two years. Samsung has in fact overtaken Apple in smart phone market.

    Author’s comment, “With their management, pricing power and business strength, they are able to invest money in ways I cannot dream of”, is not really validated by any management decision that Apple has shown in last 2 years. Apple’s growth was due to its ability to create innovative products and define new markets. Current management has not demonstrated that. It is risky to assume even zero growth year over year.

    A cash pile or large market cap is no guaranty of continued market dominance. Hewlett Packard is a good example. For last 10 years this once great innovative company is trying to find its way. Once valued at more than $110 billion, its today’s valuation is $33 billion. Another good example is RIM. Stock price of this company, once darling of corporate users, has tumbled from a peak of $225 to $14.58.

    Apple perhaps has another magic trick up its sleeve and may come up with another great product. However that is only a speculation, and unless Apple management provides some proof, I will not be betting my money on Apple at today’s price.

  • Guest

    Jae Jun

    Looks like my earlier post somehow got deleted due to some technical issues. Posting again.
    ————-
    I tend to disagree with this analysis. You will actually reach a totally different conclusion if you take a look at quarterly reports for Q4 2012 and prior 2 years. These reports share Apple’s revenue by product for 5 primary product lines (Mac, iPod, iPhone, iPad and iTunes/Software services) plus accessories. Data provided in these reports also let you estimate revenue per unit for first 4 product lines.

    Analysis of that data reveals that

    1. iPod market is a declining market, even though revenue per unit is steady. It contributes only 4% towards total revenue.

    2. Mac market remains steady, revenue per unit is steady. It contributes only 7% towards total revenue

    3. iPad total revenue has remained stable; however revenue per unit has declined drastically. It shows that Apple is facing strong competitors and is really fighting on price per unit. This segment contributes 20% towards Apple’s total revenue

    4. iPhone segment’s Qtr over Qtr revenue growth was 129% in Q4 2011. In Q4 2012 this growth is down to 28%. Price per unit remains steady. This segment contributes 56% towards Apple’s total revenue.

    It is easy to conclude that Apple’s growth engine for last three years have been its iPhone (primary) and iPad (secondary) products. It is also very clear that significantly strong challengers in these segments have appeared during last two years. Samsung has in fact overtaken Apple in smart phone market.

    Author’s comment, “With their management, pricing power and business strength, they are able to invest money in ways I cannot dream of”, is not really validated by any management decision that Apple has shown in last 2 years. Apple’s growth was due to its ability to create innovative products and define new markets. Current management has not demonstrated that. It is risky to assume even zero growth year over year.

    A cash pile or large market cap is no guaranty of continued market dominance. Hewlett Packard is a good example. For last 10 years this once great innovative company is trying to find its way. Once valued at more than $110 billion, its today’s valuation is $33 billion. Another good example is RIM. Stock price of this company, once darling of corporate users, has tumbled from a peak of $225 to $14.58.

    Apple perhaps has another magic trick up its sleeve and may come up with another great product. However that is only a speculation, and unless Apple management provides some proof, I will not be betting my money on Apple at today’s price.

  • http://www.oldschoolvalue.com/ Old School Value

    That’s why I lowballed the FCF and eps. If I were to use flat numbers the expected growth is negative already. But I don’t believe it will be negative.

  • http://www.oldschoolvalue.com/ Old School Value

    :) dislike and hate are very different though.

  • http://www.oldschoolvalue.com/ Old School Value

    I completely understand what view you are presenting, but like I am saying, it isn’t anything new. In fact, if I changed my numbers to be flat or slightly declining from the previous year, instead of flat out low balling it, negative growth is already priced in.

    If I adjust the margins down, I don’t see the doom and gloom that started to escalate since the price drop.

    Negative growth is a possibility, but the difference between a company like HP, RIMM and AAPL is the intangible brand name.

    Even during the heydey of RIMM, people weren’t rushing out to buy the blackberry. The same thing could happen to AAPL, but I don’t see it happening anytime soon.

    Am I going to hold this for 10 years? Nope. But 2-3 years is very likely.

    At the moment, I’m letting price be a tool, and not an indicator.

  • dgoyal

    Jae –
    My take on Apple situation is that even short term future, i.e. next 2 years, are unpredictable. (if I am allowed to speculate, higher probability is that Apple will slowly decline to $300 range over next 2 years. however it is only my gut feel)

    Steady per unit revenues of Mac and iPod indicate that Apple appears to have maintain its differentation in these segments, by creating a niche market and a loyal customer base. However both of these segments are not really growing.

    Falling per unit revenue of iPads indicate that this segment is facing tough competition from its Android rivals. Newly arriving Windows tablets are likely to dent it further.

    iPhone per unit prices are still holding firm. However, market research indicates that new users are finding more fun in large screen Android phones.

    I would argue that balance sheet and financials should be analyzed in conjunction with overall market situation.

    So far Apple was always able to surprise its competitors and create new markets. Apple needs to find this mojo again. (disclosure: I got rid of my Apple stock in last week of December. Now I don’t hold any positions in Apple)

  • http://www.oldschoolvalue.com/ Old School Value

    Thanks for your thoughts and differing opinion. I do respect that and appreciate you taking the time to comment.

    Time will tell of course. We are still 2 years out to know what will happen :)

  • http://www.daniel-sparks.com/ Daniel

    Excellent, objective, fundamental analysis — the stuff that makes great investors. Keep em’ comin’