Apple: On the Difference Between Uncertainty and Risk
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Uncertainty and risk are not necessarily the same thing, and looking at Apple (NASDAQ: AAPL) under different possible scenarios shows that the investment may be uncertain, but the risk looks quite contained from a valuation point of view.
The future is uncertain, nobody knows for sure how Apple will do in the following years, and forecasting earnings and cash flows is no easy task at all for high growth companies operating in such a dynamic and competitive environment. Risk, on the other hand, could be described by the probability of making a bad investment decision: buying the wrong stock or paying too much for it.
The main thesis of this post is as follows: even considering different possible scenarios (uncertainty) the probability of making a bad investment decision (risk) in Apple at current prices is quite low. I have compiled in the following table different earnings estimates for Apple in the fiscal year ended in September 2013, and calculated P/E ratios based on those estimates.
There are currently 50 analysts who have published earnings estimates for Apple next year, the average estimate is nearly $54 per share, the lowest one is $48 and the highest estimate published is around $64. There is a significant degree of variability in these estimates, which reflects the uncertainty surrounding these kinds of forecasts.
On the other hand, calculating the different valuation scenarios under particular earnings assumptions, Apple looks attractively valued even when using the most pessimistic earnings forecast. If the company reported something close to the average earnings estimate it would be trading at a P/E ratio of 11, the valuation goes down to 9 if we use the most optimistic forecast and Apple would be trading at a P/E around 12 if earnings per share were $48, the lowest forecast available.
We should keep in mind that Apple has a very solid track record at reporting earnings above the average estimate for a long time, but it´s still convenient to analyze its valuation under a pessimistic scenario. Let´s assume that uncertainty plays against Apple investors next year, and the company reports earnings of $48 per share.
Trading at a P/E of 12 Apple would be quite cheaper than the average stock in the Nasdaq 100 index. The PowerShares QQQ Trust (NASDAQ: QQQ) ETF which tracks the Nasdaq 100 and has Apple as its main holding is trading at an average P/E of 16. There are many interesting names in this ETF, but Apple has a quality level and growth prospects which are better than those of the average stock in the index, deserving a higher valuation than the average.
Analyzing Apple´s historical valuation, the company would still be trading at very low ratios based on next year earnings estimates. We can see the historical P/E for Apple in the following chart by Ycharts: the average P/E for Apple in the last five years is 20.8, the maximum was above 43.5 in 2007 and the lowest P/E ratio for Apple was 11.35 in December 2008.
In conclusion, even under the most pessimistic earnings assumption for 2013 Apple would still be trading at valuation ratios similar to those it had during the toughest moments of the financial crisis. Earnings may be uncertain, but the investment doesn’t look too risky from this perspective.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.