Why You Shouldn’t Sell AAPL Just Yet


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Jae Jun

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Well…

What can I say about Apple that hasn’t been said?

Everyday there are between 3-5 “new” and lengthy articles of the company. Not to mention all the news articles that flood the internet.

For me, Apple is an investment where I do very little to follow it.

Of all the companies I own, Apple is last on my list of stocks to review.

And when I do, it’s mostly just the numbers.

A giant the size of Apple can’t change in a quarter or even a year. Although the company is a fast and dynamic, it takes well over a year before a decision made by Tim Cook makes it out to the market.

When I first bought Apple in late 2012, the only thing I was concerned about was valuation.

My initial reasons for investing in Apple were simple and can still be summed up in the same 4 points.

  • 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. (This has improved today)

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For the most part, Apple still fits the same mold. The expectations have increased but continue reading and you’ll see that it’s still undervalued.

Before the split, I said that it wasn’t worth $460 ($65 post split).

And it certainly wasn’t worth $530 ($75 post split).

It’s taken at least 2 years for the market to get over its pessimism.

The only area that I have an advantage with Apple is knowing when to buy and sell.

i.e. valuation.

So using the Fundamental OSV Analyzer, I’ll take you through how I go about determining whether Apple is cheap or not using the various valuation models in the analyzer.

The checks will be done using reverse valuation methods which is one of my favorite ways to gauge the value level of a stock.

Reverse DCF of AAPL

To do a reverse DCF, enter the latest numbers into the equation to figure out the growth rate.

Normally, you do a DCF by entering the growth rate to get the intrinsic value.

But do the opposite by fiddling around with the growth to make the intrinsic value and current price match. That’s when you know you’ve hit the market expected growth rate.

With the current share price at $108, using 9% discount rate and the latest FCF figure of $49.9b, the expected growth rate comes out to 5%.

From the looks of it, the market still hasn’t caught on to the value because 5% growth is much to low.

Reverse DCF of AAPL Shows 5% Growth Expectations

Reverse DCF of AAPL Shows 5% Growth Expectations | Enlarge

Reverse EPS Model Using Graham’s Formula

Let’s take another look from an earnings angle instead of cash flow.

Here’s the reverse EPS Ben Graham Model.

AAPL Reverse EPS Model Using Graham’s Formula | Enlarge

The beauty with any valuation model is that you can use it for reverse valuations.

It’s not just the DCF that has a reverse method.

Any model can be applied in reverse to get the market expectations.

They even do this with accounting, so it’s still surprising reverse valuations are not widely used for investing.

A few things to note regarding the numbers in the image above.

  • I’ve update the 20 year AA corporate bond rate to 3.91. If you use the OSV analyzer, you should update it occasionally.
  • I’m using the analysts EPS estimate as I’m looking for the market expectations and the analysts are the market consensus.

After fiddling around with the growth rate to get the intrinsic value to match the current price, the growth rate again comes out to 5.5%.

Mighty similar to the 5% from the reverse DCF.

Reverse EBIT Multiple Valuation Check

Now let’s move even further up the income statement by inverting the EBIT multiples to see what the market expectations are.

This one is messier so hang in there instead of just glossing it over.

AAPL Reverse EBIT Valuation Model

AAPL Reverse EBIT Valuation Model | Enlarge

To see what multiple the current stock is trading at, enter the latest revenue, cash and equivalents, and off balance sheet numbers.

For Apple, since they have most of their cash listed under other long term assets, you’ll need to break open the SEC filing to get the real number. And while you’re at it, do a CTRL+F for “off balance sheet” and it will take you to additional debt that is on the books but not on the balance sheet.

Then simply check various multiples to see which one causes the current price and the valuation price to match.

In this case, the conservative multiple of 10x EBIT gives a number very close to the current price.

When I use the current real EBIT multiple of 12 (rounded up from 11.6), the value comes out to be $124.

If you look at the past 5 years at the EBIT multiple Apple has been trading at, it’s insanely low when you consider the products and the potential expansion of its ecosystem.

Apple Pay alone could increase the value of Apple by a couple of multiples so it’s surprisingly that the current EBIT multiple of 12.5 is the highest its been in 5 years.

AAPL EBIT 5 Year Trend

AAPL EBIT 5 Year Trend | Enlarge

Reverse Absolute PE Model

This model was created by Vitaliy Katsenelson, author of Active Value Investing.

The attractiveness of this model is that it focuses on an absolute method of using multiples.

What I mean by that is that when you use PE multiples, it’s used to compare industry competitors. But what if the market is hot and everything is trading at 25x or 30x. Relative comparisons make it seem like it’s fairly valued because everything else is trading around the same levels.

But with this method, since you can look at the stock independently, it makes it possible to focus on a single stock for valuation purposes without messing it up with competitors numbers.

Katsenelson Reverse Absolute PE | Enlarge

Katsenelson Reverse Absolute PE | Enlarge

The Katsenelson Absolute PE model shows that the current price is equivalent to a PE of 12 with a 7% expected EPS growth rate.

The current PE is 17 by the way.

So again, this model is also signalling that the current price is still cheap compared to the value.

Reverse Earnings Power Value

The only real improvement seen with any of the models is the earnings power value method.

The main point to note here is that an EPV model ignores all growth.

Nada.

And back in March, the EPS and the current price clearly showed that the market was expecting nothing out of Apple.

This was then.

reverse Earnings Power Value

Reverse Earnings Power Value (March 13, 2014) | Click to Enlarge

This is now.

AAPL Reverse EPV

AAPL Reverse EPV (Nov 3, 2014) | Enlarge

After adjusting for the cash on hand and off balance sheet liabilities, the EPV has finally dropped below the current price.

What does that mean?

The market is expecting growth out of the company.

What the EPV model doesn’t do is tell you how much growth. So to keep it simple, use it as an indicator of cheapness.

So What’s It All Worth Then?

Even at $108 and hitting all time highs, it’s still cheap. My main assumption is that Apple will be able to grow at 10%.

Here’s my graphical view of Apple at this point.

AAPL Investment Visualization

AAPL Investment Visualization

The intrinsic value range comes out to be $125 to $150.

I’m ignoring the NCAV, total net reproduction cost and EPV values as the first two are balance sheet related numbers and EPV doesn’t factor in any growth.

The average valuation target is then $138, but just round up to $140.

That’s still an upside of 30% with very realistic numbers. I’m not projecting to the moon and my numbers are based on low growth numbers to begin with.

Here’s a better look at the valuation targets. Click any of the buttons below to view the image. If you don’t have any social media accounts, make sure you sign up with your email as the full content is always unlocked via email and you’ll also get valuation templates as a bonus.

AAPL Valuation as of Nov 2, 2014

Don’t be fooled into thinking that Apple is going to rise 80% like it did during its glory days.

But Apple still offers a great place to park your money with very little risk.

Further Reading

To know more about each of the models used in this article, check out the post on 8 of the best stock valuation methods to value any stock.

Want to get value stocks on your own without all the hassle of manual inputs or trying to build your own models? Then check out our service with the OSV analyzer.

Disclosure

Long AAPL

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