How to invest

AAPL Valuation from a Value Investor

August 13th, 2009 by Jae Jun

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.

Tags: aapl, intrinsic value, Stock Analysis
Posted in Featured, Stock Analysis | 17 Comments »

Apple (AAPL) Valuation – Part 2

January 28th, 2008 by Jae Jun

So a lot of people have been complaining that I was too conservative with my first valuation of AAPL. I assumed that AAPL would grow at 14.3% for the first 3 years, slowed down 10% in yrs 4-7 and further slowed down 10% in yrs 8-10 until the company slowed down to a steady 5% from yrs 10-20.

Why Do it This Way?

Because;
1) I am valuing a business, not a 4 letter ticker symbol
2) I’m not optimistic enough to believe that a company can grow at 20-30% for the next 10-20 years
3) I am valuing based on assets and previous performance
4) I want a solid, reliable investment. Not an emotional roller coaster.

More Realistic Growth

So you still think I need a realistic growth rate considering how Apple will take over the world… Well what is a realistic growth? I don’t believe there is such a thing since all growth predictions are just that… predictions. That is why I don’t care what growth rate the ‘pros’ give it.

And unless you are God, I won’t believe anyone trying to predict the future.

A More Aggressive Growth Situation

If I had used the growth rate based on AAPL’s FCF growth over the past 10 years, the growth rate would be 44%! That’s staggering! Apple was able to generate on average 44% free cash flow each year for the past 10 years. Can AAPL generate FCF at 44% for the next 10 years? Maybe, maybe not. I like to keep things safe and stick with the ‘maybe not’ option. After all, it’s my money I’m putting down, and I don’t want to lose it.

So just this once, I will use the 5 yr projected growth rate from Yahoo which is 22%.
So in years 1-5, growth rate will be 22%, slowed down 10% in yr 6-8, slowed down another 10% in yr 9-10, until it grows at 5% from yr 10-20.

Based on these assumptions, the present value of the future cash and its networth today comes out to be $172 billion. Which translates to an intrinsic value of $193.20.

In my first post I got an intrinsic value of $130 with a very conservative rate of 14.3%
Using a more ‘aggressive’ rate of 22% gives me an intrinsic value of $193.20

See the images below to see some ratios and calculations. (The first image got cut off but it should be from 1998-2007)

Price Follows Value

Now look at the following 2 graphs which represent actual stock price and calculated intrinsic value. The first one is the conservative scenario. The second one, aggressive.

Notice how price follows value?

In the conservative case, we see a situation where the market pushes the price up way above its intrinsic value. In the aggressive case, we see that if people had SOLD AAPL at $193, they would be sitting on some big fat profits before the market dived.

In either case, one has now reached its intrinsic value and the other is getting close to a buy price target. You be the judge.

It’s Just a Numbers Game

I could have made the intrinsic value come out to be $400 or $1000 just as easily. That’s what the speculators want to hear and they just want the affirmation of other people to agree with them. Don’t just fiddle the numbers to match the feeling you have about this stock.

Problems with the darlings on Wall Street is that people start buying just because someone else did. They find safety in numbers and in the deluded fact that if it goes down, at least they wont be the only fool.

Don’t be that fool. Buy companies based on objective analysis and reason.

Disclaimer
I hold no shares of AAPL

Tags: aapl, apple, intrinsic value, Stock Analysis
Posted in Stock Analysis | 4 Comments »

Apple (AAPL) Valuation

January 27th, 2008 by Jae Jun

As you probably know Apple is a leader in consumer electronics. If you’ve never heard of the iPod, it’s time to crawl out of the cave you’ve been living in.

Now the tech industry is a fast paced, constantly changing environment where companies have to be the first one to release an innovative product in order to get ahead. Just following the crowd won’t cut it in this sector. This is a reason why Warren Buffet and Charlie Munger do not invest in tech companies. They prefer stable, boring companies with steady growth rather than the wham-bam-thank you-maam nature of tech.

Apple as a Market Leader and Innovator

Apple are doing a lot of things right and it oohs and ahhs the crowd each time Steve Jobs releases a new gizmo at Macworld. The new Macbook Air is pure porn for the techies and nerds. However, Apple was only able to get back to being the darling on Wall Street with its iPod phenomenon. As it can be seen, nothing can currently penetrate the hold Apple has on the mp3 player market. Competitors like Creative, Samsung, Sandisk have all been trying but nothing seems to be working. Consumers just crave the small, sleek, clean design of the ipod. Who can’t resist?

The iPhone was launched in mid 2007 with huge success, selling over 1 million iPhones in its first 3 months. The iPhone catapulted Apple into the handset arena with its innovative and breathtaking features and usability. They also have many other products which I won’t go into here.

Making Sense of Historical Data

First off, Buffett tells us that we should be looking at at least 4-5 year histories. Makes sense, since figures from a single year does not say much. I tend to look at 10 year histories in order to get a sense of the company and how it has fared.

So What Do The Numbers Say?

Looking at the cash flow statement for the past 10 years we see that from 1998-2004 there was no real growth in Free Cash Flow (Buffett calls it Owner Earnings). The company burnt through $47 mil and $85 mil in 2001 & 2002 before turning a profit in 2003. This was probably due to the aggressive iPod campaign finally paying off. From 2003 on, FCF growth has been huge. Realistically, can this keep up?

Apple’s Future Growth

Since Apple has had a turnaround from the time Steve Jobs made a comeback, I will consider 5 years worth of historical data. Free Cash Flow grew at an average of 44.3% over the 5 years and CROIC at 14.3%. (For a full detailed explanation on CROIC go to http://www.fwallstreet.com/blog/23.htm). Now a company grows at the rate its cash grows since cash is what drives business and earnings. However, I prefer to think that the business will only grow as fast as its Cash Return On Invested Capital (CROIC). Here we see that for every $1 Apple invested from its FCF, it was able to generate an additional $0.143 in cash.

Apple’s Future Cash Value

At the end of fiscal year 2007, Apple had $4,735 mil in FCF. If the future cash of the business is to grow at a rate of 14.3% for the first 3 years, slowed down 10% for the next 4 years, and slowed down by a further 10% for the next 3 years, till it slowly grows at a rate of 5% for the next 10 years, the sum of the future cash for 20 years comes out to be $262,041 mil.

Apple’s Current Value

We’ve just calculated the sum of cash over 20 years. Apple will have $262,041 mil in cash. But we are not just buying the future $262,041 mil cash. We are buying the networth of the company as well. At the end of 2007, Apple’s shareholder equity was $14,532 mil.

But there is a problem, I don’t have $262,041 mil to buy the company’s networth of $14,532 mil + future cash of $262,041 mil today. And why would I want to pay $262,041 mil today just to receive $262,041 mil over 20 years resulting in a 0% return?

Discount it Back

By definition, the current value of the company is the sum of its future cash value discounted back to today. This means that you should discount $262,041 mil by a certain percentage in order to find how much $262,041 mil is worth today. Remember the time value of money concept? You want to receive something like yearly interest each year for the money you are investing today so that you can get a piece of the networth and $262,041 mil.

What Discount Rate Do I Use?

We use a discount rate of 9% since Apple is 1) a well known brand 2) I expect it to still be around in 20 years and 3) it has a moat.

The Intrinsic Value is…

Thanks to Microsoft Excel, discounting $262,041 mil by 9% and adding the 2007 networth results in a present value of $115,301 mil. This means I should pay only $115,301 mil today for the $262,041 mil + $14,532 mil.

Divide $115,301 mil by the current number of shares outstanding gives a per share intrinsic value of $129.70

But Wait, There’s More

Up until now, we have been projecting the future cash based on assumptions of CROIC growth rate. I have no ability in predicting the future and I know 100% that my calculations are not spot on. So what do I do? The core principle Benjamin Graham told us is to use a LARGE Margin of Safety (MOS). A 50% MOS shows that my calculations has the potential to be off by 50%. Therefore, I would have to purchase Apple at 50% of $129.70, i.e. $64.85. Closing price of AAPL on Jan 25th was $130.01. Pretty close to the calculated intrinsic value.

Click the image below to see the cash projection.

Here we see the historical price of AAPL over 5 years compared to the intrinsic value and target price. Note how price follows value. Pretty scary huh?

Tags: aapl, apple, intrinsic value, Stock Analysis, valuation
Posted in Stock Analysis | 11 Comments »