Apple: On Valuation and Expectations
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When making investment decisions, we could differentiate two sides of the equation: the company per se, and the valuation of the stock. Companies with the highest quality and the most exciting growth prospects often trade at higher valuations, and investors need to be careful about the perils of excessive valuation ratios.
But valuation is an art as much as a science, although mathematical ratios and calculations are employed in the task, there is not such a thing as a completely objective valuation assessment. After all, the fair price to pay for shares of a company will always depend on the earnings and cash flows that the company will deliver in the future, and the future is always uncertain to a greater or lesser degree.
Instead of thinking about the valuation problem in terms of trying to figure out if the stock is cheap or expensive, one interesting approach is to analyze what kind of expectations are currently incorporated in the price, if you believe the company can perform as expected or better, then you have found a convenient buying opportunity.
Apple (NASDAQ: AAPL) represents a very interesting example to analyze, the bear case for the stock goes something like this: the company has achieved fabulous growth rates via successful innovation over the last years, but now it has become the biggest company in the world, with a market cap above $500 billion. Past rates of growth are unsustainable, so this is not a good entry point considering that Apple will face slower growth in the future.
However, market capitalization is a measure of size, not valuation. Of course it’s usually harder for companies to keep expanding at extraordinary rates as they get bigger in size, but that doesn´t mean Apple is overvalued. Quite on the contrary, the current valuation is more than reasonable for Apple, even if we assume much lower growth rates for the future.
Apple has expanded earnings per share at almost 65% annually over the last five years, but the company is still trading at a P/E ratio below 14. Those kinds of valuation levels don´t require sky high growth rates to be justified. In fact, there are many companies with growth rates in the 10% zone which are trading at higher valuations.
In Apple´s case, analysts are expecting on average a growth rate in the area of 19% annually for the next five years. This is certainly much lower than what the company has delivered in the past, and if Apple were to keep launching new successful products like the much anticipated Apple TV there is clearly a lot of potential for higher growth rates than what analysts are expecting.
But even if that is not the case, a P/E ratio of 14 is quite cheap for a company that grows at a 19% annually. In the following table we compare valuation statistics and growth expectations for Apple and four other big tech companies: Google (NASDAQ: GOOG), Amazon (NASDAQ: AMZN), eBay (NASDAQ: EBAY) and Facebook (NASDAQ: FB)
Amazon and Facebook are trading at much higher P/E ratios, although they have higher expected growth rates, the difference in valuation looks too excessive even considering those growth expectations. These are two very particular companies; Amazon is reducing profit margins in order to increase sales, so we could argue that earnings are underestimated at current levels in relationship to future possibilities. About Facebook, enough has been written on the fact that the social network has gone public at bubbly valuation levels due to excessive optimism and unrealistic expectations.
Even when compared to companies like Google and eBay which are much cheaper, Apple comes out as a winner: it has a similar expected growth as Google, but a lower P/E than Google. In comparison to eBay Apple has both higher growth expectations and a lower P/E.
Apple is attractively valued in relationship to its growth possibilities, even when assuming a moderate growth rate below 20% for the next five years. Regardless of its size, Apple is a cheap company which is offering nice prospects for outperforming the indexes in the middle term.
acardenal owns shares of Apple and Google. The Motley Fool owns shares of Apple, Amazon.com, Facebook, and Google. Motley Fool newsletter services recommend Amazon.com, Apple, eBay, and Google. 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.