Is Apple the World's Best Value Stock?
The biggest story on Wall Street in recent months has been the plunge in Apple's (NASDAQ: AAPL) share price. The stock, which for a long time only went up, has fallen around 35 percent from all-time high levels above $700 which were hit in September.
The reasons for this have been debated endlessly, but one of the major concerns that investors have pointed to is falling margins for iPhone, which according to Trefis research, accounts for around 55 percent of Apple's valuation. Other reasons for the decline that have been bandied about include weak PC demand hurting Mac sales and dissatisfaction with the iPad Mini price point relative to competitors such as Google's (NASDAQ: GOOG) Nexus 7 and Amazon's Kindle Fire tablets.
The most recent leg down in the stock came in the wake of the company's first-quarter earnings results. While net income was above consensus estimates, both sales and margins were a cause for concern. Net sales rose 18 percent to $54.51 billion, which missed estimates of $54.73 billion.
Gross margin was down sharply from 44.7 percent a year ago to 38.6 percent in the company's fiscal first-quarter. Operating margin went from 37.4 percent to 31.6 percent. Apple also guided for second-quarter sales which were below Wall Street expectations.
The revenue shortfall was largely due to iPhone sales that did not meet some analysts' expectations. Nevertheless, iPhone sales rose 29 percent year over year to 47.8 million units. Margins are under pressure due to increased competition and could continue to fall as Apple's markets mature. Trefis also points out that margin compression was exacerbated in the most recent quarter due to new product launches.
The latest quarterly results from Apple are the third time in a row that the company has missed estimates. The fiscal Q4 report, which was released on October 25, 2012, showed that declining iPad sales had weighed on earnings. Apple missed consensus earnings per share estimates in the fourth-quarter, reporting EPS of $8.67 versus consensus of $8.75. Revenues, however, unlike in Q1, were above the Street -- but not by much. Apple reported sales of $35.97 billion compared to consensus of $35.80 billion.
In the first quarter, both gross margin and operating margin were only down slightly year over year. Apple's string of disappointing earnings reports have certainly contributed to the decline in the stock, but there are other more important factors at play. In fact, the real reason that Apple is down so much makes the stock extremely compelling at current rock bottom valuations. Simply put, Apple's share price is being pushed well below its intrinsic value because of supply/demand dynamics in the market and momentum.
It is always important to remember that over the short-term stock prices are determined by supply and demand and not fundamentals and valuation. Currently, Apple's fundamentals and valuation has taken a back seat to a shift in the supply/demand dynamic in the stock. Apple is the largest holding of hedge funds and other fast money traders. Due to its size, it is also one of the very largest holdings of all institutional investors.
Furthermore, most of these investors were sitting on very large gains in the stock. Once hedge funds and other investors began dumping the shares after Apple reported a few quarters of mildly disappointing results, downside momentum picked up and overall sentiment changed rather dramatically. Instead of speculating when AAPL will hit $1,000, the question on Wall Street is when the stock will hit $300.
Since everyone already owned AAPL over the last couple of years, there is huge supply. Now that the downtrend has been established, buyers have been scarce and unable to meet supply. Sooner or later, however, supply and demand will find an equilibrium point and valuation and fundamentals will matter again. At this point, today's dirt cheap valuation will look like a steal.
Apple is basically the cheapest large tech stock on Earth. Other technology leaders such as Amazon (NASDAQ: AMZN), Facebook (NASDAQ: FB), Google (NASDAQ: GOOG) and even Microsoft (NASDAQ: MSFT) are much more expensive on a valuation basis. In fact, Apple is trading at a valuation that is more in-line with capital intensive industrial and manufacturing businesses.
At current levels, the stock is trading at a trailing P/E of 10.38, a forward P/E of 9, and a PEG ratio of 0.52. Its price/book ratio is 3.35 and its Enterprise Value/EBITDA multiple is 6.58. Investors will be hard pressed to find a cheaper stock in the high-flying technology sector.
If you back out the cash on the company's balance sheet, around $137 billion, then Apple is trading at roughly 7x 2012's net earnings. Essentially, investors have the opportunity to buy the best business on the planet at a 7 multiple.
Another interesting way to calculate Apple's current valuation is to figure out the stock's P/E using the last 4 years of earnings. This helps to mitigate the effect of Apple's stunning results over the last couple of years. The company's average net income between 2009, when it reported income of $8.2 billion, and 2012 when net income was $41.7 billion, was $22.47 billion.
Therefore, Apple shares are currently trading at around 19x the last four years' earnings. If we applied that same multiple to Wall Street earnings estimates for fiscal 2014, Apple's stock would be trading at $967.
The current value proposition in the name is extremely compelling. Investors are able to purchase Apple's tremendous business and brand, including iPhone, iPad, and the entire iOS ecosystem, for just 7x last year's earnings. The brand itself was estimated to be worth $87.1 billion in 2012 by Forbes, a year over year gain of 52 percent.
Furthermore, at today's prices, there is no innovation premium whatsoever in the stock. This is pretty incredible considering the innovation that Apple has consistently brought to the market with iPod, iPhone and now iPad. The market is essentially pricing the stock like it will never release another new product again. This is primarily due to the shift in supply/demand for the shares which has little to do with fundamentals and more to do with sentiment and momentum.
Another factor that underscores Apple's value properties is its recent institution of a dividend and share buybacks. At current levels, the stock is yielding around 2.30 percent and that yield rises which each leg down in the share price. Given the company's cash horde, Apple will likely become more and more shareholder friendly over time by raising the dividend and implementing larger buybacks. Very, very few companies are in as favorable of a position to reward shareholders.
When you add it all up -- the business, the brand, the valuation -- Apple may be the world's most attractive value stock right now. The bottom line is that when the planet's most innovative company has one of the cheapest stock prices in the market, it is time to buy with both hands.
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