Why Apple is a bargain-busting buy

The stock's valuation makes it look too cheap not to take a bite.

By InvestorPlace Jun 21, 2012 9:35AM

By Dan Burrows

InvestorPlace's special report about Apple (AAPL) on the occasion of the iPhone's fifth birthday would surely be incomplete if we didn't weigh in on the prospects for its stock. Let's start by looking at how it's fared recently.

Turns out the shares have seriously stumbled since hitting a record closing high of $636 in early April. The stock is off more than 8% since then to about $580 and change, shedding $50 billion in market cap -- more than the entire value of Hewlett-Packard (HPQ) -- along the way.

That's a sharp sell-off. By comparison, the S&P 500 is off just 2% over the same period.

But on the upside, the decline has made Apple a very cheap, high-quality stock. Just have a look at the valuation -- ultimately the most important single factor for long-term investors -- and what you've got is a bargain-busting buy.

First up, let's talk about quality. Value investors use return on equity (ROE) as a proxy for quality because it demonstrates how much profit a company generates with the equity shareholders have plowed into it.

Apple's ROE stands above 47. How stratospheric is that? Only three companies with market caps above $100 billion have ROEs higher than Apple -- GlaxoSmithKline (GSK), Philip Morris International (PMI) and IBM (IBM). Considering that Apple has a market value of more than half-a-trillion dollars, well, it's clearly in a class by itself.

At the same time, Apple's price-earnings ratios (P/E) don't reflect anything close to its profit growth, both past and projected. In other words, what the premium shareholders are willing to pay for each dollar of earnings is far below the stock's own long-term averages -- something known as multiple compression. That premium is much lower than the broader market as well.

We'll talk about why that's going to be good news for the stock in a moment. But first, here's a rundown on the valuation:

  • Apple's forward P/E of 10.8 (yes, based on analysts' estimates) currently stands 49% below its own five-year average of 21.1, according to data from Thomson Reuters Stock Reports.
  • Apple's trailing P/E of 14.2 (actual income already earned) currently sits 44% below its five-year average of 25.4.
  • Versus the broader market, Apple's forward P/E offers a 15% discount to the S&P 500's forward P/E of 12.8.
  • By trailing P/E, Apple sits 6.6% below the S&P 500's 15.2.

Now here's the kicker: Apple is cheaper than the broader market despite having far stronger growth prospects. Apple is forecast to post annualized earnings growth of 22% over the next five years against just 11% for the S&P 500.

That's why Apple's price/earnings-to-growth ratio (PEG) is so laughably low. PEG measures how fast a stock is rising relative to its growth prospects, where 1 is considered fairly valued. Apple's PEG is 0.6 -- or 40% below its own five-year average and about 65% below that of the broader market.

These measures say Apple is a screaming buy on valuation alone. If nothing else, reversion to the mean suggests that multiple expansion -- that is, rising P/Es -- will boost the stock. If Apple's forward P/E were to expand to 16, or the halfway point between its current P/E and five-year average P/E, the stock would trade at $864.

Lastly, forget JPMorgan Chase's (JPM) claim to fame; Apple has the true Fortress Balance Sheet.

Including long-term investments, Apple has more than $100 billion in cash -- more than any non-financial firm. The company is absolutely soaked in cash. And even after excluding those long-term investments (which aren't really the same thing as cold, hard cash), Apple boasts a whopping $28 billion in cash, cash equivalents and short-term investments.

All that cash comes to $30 a share. If you subtract that from the share price (since stockholders "pay" for earnings, not their own cash), the multiples fall even farther. The forward P/E dips to a bit over 10, and the trailing P/E drops to 13.5.

That's right: Apple is even cheaper than it first appears.

True, it may take the market a good long while to pony up for what Apple's really worth. But at current valuations, it looks like too much of a bargain not to take a bite.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

More from InvestorPlace

Jun 21, 2012 1:16PM
Jun 22, 2012 7:12PM

It's funny, I search InvestorPlace articles, and there were non about facebook pre-IPO. But plenty saying "duhhhhhh" after the IPO.


Suspicious? My guess is this guy touted facebook, made a cut in a few hours, then deleted his old articles.

Jun 21, 2012 2:14PM
Apple's a buy because WS analysts are hyping and projecting it's future without considering Microsoft's and Samsung's new products impact on Apple's future. Just wait until Apple has a big miss.
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