Monday, September 17, 2012

Apple iPhone 5 and Future Valuation

Apple Inc. (AAPL) is one of the most high profile stocks in the world. Regarding its valuation, people are often confused by its high price. However, even though the price is high, Apple’s valuation is significantly lower than its historical earnings growth rate, and more importantly, its forecast growth. Consequently, we believe that this high profile growth stock that has recently began paying a dividend, is undervalued at these levels.

About Apple Inc: Directly from their website:

“Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App Store, and is defining the future of mobile media and computing devices with iPad.”

Earnings Determine Market Price: The following earnings and price correlated FAST Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Earnings & Price Correlated Fundamentals-at-a-Glance

A quick glance at the historical earnings and price correlated FAST Graphs™ on Apple Inc shows a slight picture of undervaluation based upon the historical earnings growth rate of 35.9% and a current PE of 15.8. Analysts are forecasting the earnings growth to continue at about 22%, and when you look at the forecasting graph below, the stock appears undervalued (it’s outside of the value corridor of the five orange lines, based on future growth).

Apple Inc: Historical Earnings, Price, Dividends and Normal PE Since 1998

Click the images below for larger view.

Performance Table Apple Inc.

The associated performance results with the earnings and price correlated graph, validates the principles regarding the two components of total return; capital appreciation and dividend income. However, since Apple Inc has just begun paying a dividend, we are not yet including any dividends in our performance calculation.

The following graph plots the historical PE ratio (the dark blue line) in conjunction with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 1998.

A further indication of valuation can be seen by examining a company’s current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Apple Inc. is 4.30 which is historically normal.

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1. The rate of change (growth rate) of the company’s earnings

2. The price or valuation you pay to buy those earnings

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 46 leading analysts reporting to Capital IQ forecast Apple Inc.’s long-term earnings growth at 22% (orange circle). Apple Inc. has no long-term debt (red circle). Apple Inc. is currently trading at a P/E of 15.8, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 26.4. If the earnings materialize as forecast, Apple Inc.’s True Worth™ valuation would be $2563.34 at the end of 2017 (brown circle on EYE Chart), which would be a 30.9% annual rate of return from the current price (yellow highlighting).

Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in Apple Inc. to an equal investment in 10-year Treasury bonds, illustrates that Apple Inc.’s expected earnings would be 10 (purple circle) times that of the 10-year T-Bond interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

Summary & Conclusions

This report presented essential “fundamentals at a glance” illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it’s imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

Disclosure: Long AAPL at the time of writing.

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