AAPL Valuation from a Value Investor

August 13, 2009 | Comments (17)

Here’s some controversy coming your way. A stock price valuation of AAPL by a value investor.

Warning: if you love Apple, I mean really l.o.v.e. AAPL, this may not be what you want to hear.

The Apple Story…

Apple is consistently a Wall Street darling. The company is covered by 35 analysts, it’s products, services and CEO is constantly in the news. Which is why I don’t believe in the “it is misunderstood” theory by so many investors.

Think of 35 analysts as one full classroom of elite students doing the same project and trying to come up with different views and opinions.

I don’t bother with efficient markets but in this case, I would believe that the market as well as the 35 analysts couldn’t all be missing out on revenue generation and where it will be coming from in the future. I’ll leave that to someone who’s good with the magic 8 ball.

Moving on..

Apple Numbers

There is no doubt in my mind that AAPL is a fantastic business. It’s moat is huge, products fantastic, innovation outstanding and execution breathtaking. The same goes for it’s financial statements.

If you take a look at Apple’s financial statements, it is so healthy you would never notice there was a recession in 2008.

  • FCF growth is on steroids
  • Gross, operating, net margins constantly increasing
  • Management is able to make 20c off every $1 of cash invested. Now that is amazing.
  • Every $1 of sales is converted to 15c of FCF
  • Earnings growth is equally impressive

Check out the financial statements of the past 10 years and 20 quarters for AAPL.

(AAPL 10 Year Financial and 20 Quarterly Financial Statements)

So AAPL is a great investment right? Not for a value investor.

AAPL Intrinsic Value

When I previously calculated the intrinsic value of AAPL during the peak of the bull market,  I used two scenarios. One was a realistic growth rate of 14.3% and the other was a euphoric rate that many people wanted me to use which was 22%.  The intrinsic value came out to approximately $130 and $190 respectively.

Now that things have settled down substantially, the 14.3% FCF growth rate was actually the smart one to use. In this fairly valued market, using 15% FCF growth rate is still the most realistic figure.

Also, since 2008 was hard for every company, I’ll readjust the FCF of AAPL to balance out the one year recession. With a discount rate of 9% and growth rate of 15% the intrinsic value comes out to $146.22. Fairly valued as the current price is about 13% above my estimate.

AAPL Price & Value Graph

Is Apple a Buy?

Buffett has said that it is much better to buy a good company at a fair price rather than a fair company at a good price, but my performance to date and results from screens and tests I’ve performed show that maybe Buffett got it backwards.

AAPL may be a great company, but paying fair value for the business will not produce the out-sized returns that you are probably looking for. For a long term passive portfolio, it will probably work out well, but to compound your money at a better rate, there are still better opportunities than its current price.

From it’s lows, AAPL is up 111%. The stocks I mentioned on this blog are up just as much, if not further, and have far for upside potential.

As a company AAPL is definitely awesome. As an investment, the price does not have enough of a margin of safety to preserve capital in the case there is an another unexpected disaster.

Disclosure

Previously held AAPL. No positions at time of writing.

About Jae Jun


Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value investing tools, tutorials and educational material to help empower the individual investor. Keep in touch with Jae via any of the methods linked below.

Get Tips and Strategies to Achieve Higher Returns
Bonus: Get 9 FREE Investing Spreadsheet Calculators
  • Deke

    Your value analysis makes me feel good about my investment. I bought AAPL at $123 a share, and I’ll continue to hold it. I think it will go over $200 a share after the final holiday quarter of 2009.

  • Josef

    How are you valuing the cash on their balance sheet? They have $34 / share in net cash.

  • http://www.oldschoolvalue.com Jae Jun

    @ Deke
    If you bought it at a cheap price and the company is doing fine, there is no reason to sell. I don’t know about whether it will go up that quickly but sure there is potential.

    @ Josef
    When I calculate the intrinsic value with the DCF method, I add tangible shareholders equity to the sum of the future cash flows which will take into account the cash on hand.

    Also, I would think that the entire market knows how much cash they have. Isn’t exactly a hidden or overlooked number.
    AAPL also seems to be slowing down. Their FCF is growing at a rate they cannot invest and once AAPL starts looking to distribute dividends it will be a sign that Apple has matured from its growth phase.

  • http://www.oldschoolvalue.com Jae Jun

    Also forgot to add the fair value using Ben Graham’s formula method.

    Ben Graham formula gives a value around $175. Not much higher than where it’s at now. Definitely fairly valued at the moment.

  • http://www.wiftsinvestment.com rupneu1

    How do you get the FCF growth of 14-15%? Is it an average growth rate over numbers of years?
    .-= rupneu1´s last blog ..What now? =-.

  • http://www.oldschoolvalue.com Jae Jun

    @ rupneu1

    It isn’t the FCF average growth rate. The FCF growth is astronomically high so I couldn’t use that. Instead the CROIC is exactly 15.2% when I compare the past years in a staggered fashion, normalize and then taking the mean to remove one time spikes.

    Over the long run CROIC and FCF growth usually converges because as the company grows the numbers in the financial statements should balance. A company that is able to return 15% of its cash will have an additional 15% of cash to invest.

    However, if FCF continues to grow at e.g. 40%, it is likely the company won’t be able to utilize the cash effectively all the time at which point it will slow down and converge to meet CROIC.

    From what I see in the numbers, Apple FCF growth is starting to decline compared to their previous years. Which is my reasoning for using 15%.

  • John A Guentner

    You have not a clue what Apple is about or will be. Go and support the “red hot” computer nerds (i.e. Dell and Microsoft.) Have you checked their stock lately? I have. A few years back Michael Dell suggested “burning Apple to the ground as an irrelevant company…. My, my how things have changed. Apparently you dave not noticed.

  • http://www.oldschoolvalue.com Jae Jun

    @ John A Guentner

    Thanks. Cant do anything but laugh on comments like this. Warned you that you wont like my price target.

  • http://can-turtles-fly.blogspot.com/ Sivaram Velauthapillai

    I don’t even think Apple is going to post, say, 15% return (per year) on its stock (John Guenter is not going to be happy fellow after reading my post ;) ). Here is a simple way to think about mega-caps…

    Apple’s market cap is around $150 billion right now.

    If its stock went up 15% per year for 10 years, guess what its market cap would be?

    It would be worth $606 billion! That is a staggering number. Barring, high inflation (in which case the dollar is worth less) or some massive bubble, it is highly improbable Apple can get that big in such a short period of time.

    To put that into context, ExxonMobil’s market cap is right now around $330 billion. One can’t compare a cyclical to a growth stock but ExxonMobil has the hightest market cap right now I believe (outside those Chinese companies, who we can’t rely on because China has capital controls on their stock exchanges.) ExxonMobil’s profit is around $31 billion versus $5 billion for Apple. ExxonMobil’s earnings will collapse (it’s a cyclial) while Apple’s won’t but even then, will the market place a 30x P/E multiple on Apple (the current P/E)? I doubt it.

    Any company that gets above a market cap of $500 billion will have a hard time staying there. The free market slays anyone that dares to go above $500 billion! The field is litterred with corpses of Microsoft, Cisco, GE, and ExxonMobil…

    Having said all that… Can you make 15% per year on Apple? In certain special cases you can, but those are not representative of typical investing. For instance, if Apple keeps issuing a large dividend, either by increasing its profits signficantly or increasing its debt, the investor may come close to 15% per year. I think it’ll still be tough but financial engineering can create wealth… or if the stock goes up and down a lot, and if investor buys at a trough, sells at a peak, then buy at a trough again, then sell at a peak, and so on, they can make 15%. This return isn’t because the company created that wealth; rather, you are profitting off clueless investors who buy at a peak and sell at a trough…
    .-= Sivaram Velauthapillai´s last blog ..Newbie Thoughts: Characteristics of my newbie (concentrated) portfolio [VERY LONG] =-.

  • http://www.personalfinanceplaybook.com Todd @ Personal Finance Playbook

    Excellent post. I hope you make a lot off the advertising on this site. You add a tremendous amount of value to your readers. Clear, simple analysis. Love it. Keep it up.

    Apple is an excellent company. I have a Macbook myself. It’s a great machine. I don’t know if it was a “value” investment, because it was more expensive than most of the PCs I could have gotten, but it’s an impressive piece of equipment to have at my disposal. I like Apple, and I like Jobs, but I have wondered for some time about Apple’s sustainability. That’s always the problem with technology. Your time in the sun is limited. Can Apple always have such a dominant market share in premium computers and phones? So far they’ve stayed ahead of the pack while innovating – smoothly going from the iPod to the iPhone. The question always becomes, how long can that last? There next big thing surely will flop at some point, right?

    One thing that they do have that’s incredibly valuable is a great brand, though. The Apple brand means a lot right now. People associate it with excellent. I think you threw that in with your “great company” analysis, but it’s worth considering somewhere in the numbers as well. Anyway, just my two cents. Great post.

  • http://www.oldschoolvalue.com Jae Jun

    @ Sivaram,
    Great comment Sivaram

    If 99% of aapl investors take a step back from their emotions they would realise that the law of large numbers is against them. They’ve grown at a gangbusters rate but they are getting closer and closer to a huge obstacle that is far beyond the control of a company.

  • http://www.oldschoolvalue.com Jae Jun

    @ Todd,

    Thanks for your thoughts. Wish I made a lot from ads but unfortunately I don’t.

    If Macs could support everything I do, I would buy one in a heartbeat because you’re right, they have a superb brand and following. Definitely a moat in terms of brand awareness and emotional factors.

    However, I’m not so sure that it is an equally excellent investment at its current price. The company has to do too many things right for it to meet everyones expectation.

  • http://www.oldschoolvalue.com Jae Jun

    FYI

    Good discussion going on Seeking Alpha on this post. Lots of comments on GAAP numbers and Non-GAAP numbers as well.

    http://seekingalpha.com/article/156150-apple-is-still-a-great-investment-right-not-for-value-investors

  • assman

    I don’t consider Apple a great company from a Buffet point of view. Here are the things I don’t like about Apple

    1. No moats. I don’t think itunes or the app store are moats. I have an ipod but I have never used itunes. The app store is reproducible and I think google’s app store will probably be comparable.
    2. Apple products are a bad value proposition: expensive and very shoddily constructed.
    3. Its not clear Apple cares about investors as much as it cares about innovation. It has no dividend or share buybacks
    4. Apple relies on innovation not monopoly. This is very dangerous since other companies may out innovate you and innovation does not occur forever.
    5. The devotion to Apple is highly irrational much like SUV buyers. Most apple buyers are stupid.
    6. The markets apple operates in are highly competitive and very prone to fads and status seeking. Things can change on a dime

    I see very significant downside risk for Apple. I don’t consider it a great company from a Buffet point of view.

  • http://www.oldschoolvalue.com Jae Jun

    assman,

    Appreciate your insight. All valid points but we’ll let the market handle that and move on investing something that will actually make us money.

  • allan levy

    Looks like you owe Mr. Gunther. The trouble with value investing is that investment is trusting your money to other people. You are betting on their integrity and competence. To judge that you have to watch their actions. Financial analysis is vital because if you don’t look at numbers you can’t tell whether people are lying. Once you know that you make your bet on whom you are giving stewardship of your money. If you follow Apple, you see relentless focus, take no prisoners execution (ask Adobe or HTC), long term vision (creating a new platform of mobile devices and a relationship building platform for customers with Apple store, and almost flawless execution. Value investing doesn’t reveal these qualities.

  • amit

    Jobs left a decade ago, where was the innovation then? Did they not almost go bkrupt? Do you want to bet on that again, now that he’s leaving once more? Allan, the numbers cant tell the whole picture but i’m amazed how ppl ignore the odds of failing to innovate, never before did they have the answer right in their faces!! They may still continue to growfor a couple of years but a L-T investment based on aapl’s capacity to innovate is foolish. Just look at RIM, probably the best example…

x
Receive Email Tips and Strategies on Achieving Higher Stock Returns

Bonus: FREE Set of 9 Investing Spreadsheets