Apple (AAPL) Valuation


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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?

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