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Apple Doesn't Need Growth to Reward Investors

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With Apple (NASDAQ: AAPL) shares now floating around $500, the stock's story has shifted dramatically. Just four months ago shares brushed an all-time high of $702, 40% higher than today's price. At $700 Apple investors were depending on double-digit growth in earnings for the valuation to make sense. Now, however, growth is simply a bonus.

The Widening Gap

In early September the sentiment around Apple shares was all but positive. In the wake of an iPhone launch and amidst the buzzing rumors of a possible iPad Mini, investors were bracing for Apple's monstrous holiday quarter. Analysts continued to hike up their price targets, resulting in a consensus estimate around $780.

This bullishness, however, didn't last long. Beginning with Apple's Maps fiasco, shares began to slide ... and slide, falling by more than 28%. Now, with FQ1 earnings just around the corner (Jan. 23), some investors are worried that Apple will not live up to expectations.

But here is the most interesting part of this development. In the same period that shares slid 28%, analysts' price targets fell by only 6%. According to Bloomberg, Apple trades at a much greater discount to analyst price targets than any other company in the S&P 100. The table below highlights the five companies in the S&P 100 with the largest differences between price and price target:

<table> <tbody> <tr> <td>Company</td> <td>Spread</td> </tr> <tr> <td>Apple</td> <td> -33%</td> </tr> <tr> <td><strong>Devon</strong> <span class="ticker" data-id="203351">(NYSE: <a href="http://caps.fool.com/Ticker/DVN.aspx">DVN</a>)</span></td> <td>-25% </td> </tr> <tr> <td><strong>Apache</strong> <span class="ticker" data-id="202829">(NYSE: <a href="http://caps.fool.com/Ticker/APA.aspx">APA</a>)</span></td> <td>-23% </td> </tr> <tr> <td><strong>National-Oilwell Varco</strong> <span class="ticker" data-id="202676">(NYSE: <a href="http://caps.fool.com/Ticker/NOV.aspx">NOV</a>)</span></td> <td>-23% </td> </tr> <tr> <td><strong>Anadarko Petroleum</strong> <span class="ticker" data-id="202830">(NYSE: <a href="http://caps.fool.com/Ticker/APC.aspx">APC</a>)</span></td> <td>-23% </td> </tr> </tbody> </table>

Interestingly, all four of these other "cheap" stocks are members of an energy sector that has been battered and bruised for the first half of 2012 and finished the year underperforming the S&P 500 by about 1,400 basis points. With oil prices up 4% already in 2013, the sector is on the rise again––but still undervalued and littered with an overwhelming proportion of buy recommendations from analysts.

But among the top five bargains in the S&P 100, Apple is the cheapest of the bunch by more measures than price and price target spread. Take a look at how Apple compares with these companies based on several other valuation metrics:

<table> <tbody> <tr> <td>Company</td> <td>P/E</td> <td>Dividend Yield</td> <td>Forward P/E</td> </tr> <tr> <td>Apple</td> <td>11.5</td> <td>2.1%</td> <td>8.5</td> </tr> <tr> <td>Devon</td> <td>31.1</td> <td>1.5%</td> <td>10.5</td> </tr> <tr> <td>Apache</td> <td>13.0</td> <td>0.8%</td> <td>7.6</td> </tr> <tr> <td>National-Oilwell Varco</td> <td>12.5</td> <td>0.7%</td> <td>9.6</td> </tr> <tr> <td>Anadarko Petroleum</td> <td>21.2</td> <td>0.5%</td> <td>17.6</td> </tr> </tbody> </table>

Measured by P/E, dividend yield, and forward P/E, Apple remains the cheapest of the group (with the exception of Apache's forward P/E ratio of 7.6 compared to Apple's 8.5).

A Reverse Valuation

Sometimes it seems like analysts and the market seem to be looking at two different companies entirely. Not only is the spread between price and price target enormous, but the growth rate assumed by the market is ... zero (after inflation).

To calculate what growth rate Apple would need to be fairly valued at yesterday's closing price of $506 per share, I used a reverse valuation. Using a 12% discount rate in my reverse valuation, I found that the market is assuming an annual growth rate in earnings of just 3% annually – no higher than the historical rate of inflation.

The Bottom Line

At today's share price of $506, Apple investors can earn a 12% annualized return on Apple's stock as long as the company simply manages to grow earnings alongside the rate of inflation: 3% annually. But as evident by the massive spread between the consensus price target and Apple's stock price, such paltry growth expectations are simply unrealistic. Now's the time to buy. There is a blatantly obvious discrepancy: growth is expected, but it is not priced into the stock.

DanielSparks has no position in any stocks mentioned. The Motley Fool recommends Apple and National Oilwell Varco. The Motley Fool owns shares of Apache, Apple, and Devon Energy. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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