Rewind: Buy Apple in 2008
Phil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you could go back in time to 2008 when Apple stock was $80/share, would you back up the truck and load up? A lot of people mistakenly assume a high share price means the stock is too expensive. Another common mistake is assuming that as the share price increases the risk/reward ratio worsens or the potential for future appreciation declines. Although that may be true in some cases, it is actually the opposite in Apple’s case.
At $560/share today, Apple stock has appreciated 700% from its $80 low in 2008. However, Apple is as good a deal today as it was then. Despite rising from $330/share a year ago, and from $250/share two years ago, Apple is a safer and better value today. Savvy investors with access to a calculator and a little effort can easily see why.
The tale of a cheap stock
Let's take a look at Apple’s valuation and see where it has been since the financial crisis in 2008, and then we’ll compare that to today. In the chart below, I have listed 5 years of Apple’s second quarter earnings per share (EPS), total cash (including short and long-term investments), the amount of cash per share, the price to earnings multiplier (P/E), and the estimated P/E ratio after backing out their cash. All figures are based on the day Apple reported Q2 earnings in the relative year. I’ve used the second quarter (January to March) to eliminate the holiday season effect on the figures.
In March 2008, just before the financial meltdown, Apple’s earnings were $1.82 per share, and the company had $15.4 billion in cash and equivalent. Investors at that time were paying over 30 times trailing 12 month earnings for the shares. If we back out the cash Apple had then, investors were really paying under 26 times earnings for each share of Apple stock.
In March 2009, during the height of the financial crisis, when the S&P 500 was cut in half and investor confidence was at its lowest, investors were paying 13.61 times trailing earnings for Apple shares. In that quarter Apple reported earnings of $2.50 per share and cash reserves had grown to $24.5 billion.
Fast forward to 2012 and the S&P 500 today is at virtually the same value it was 5 years ago before the crash, and double the value from the low of March 2009. By contrast, over the same period Apple’s earnings have risen by 676%, and cash swelled by 510%, yet relative to earnings Apple’s share price today is about the same as it was in March 2009. Minus Apple’s cash shares today trade for less than 11 times trailing earnings.
Apple cash machine
Many investors often look past the P/E ratio to the cash flow. A company’s free cash flow is much harder to manipulate because it is the amount of cash left over after operating expenses, depreciation and amortization and much less prone to accounting variances. Apple shares are priced at less than 12 times the amount of free cash they generated last year, and they generated a lot of cash. Incredibly, Apple’s massive cash reserves grew by an astonishing $50 billion last year, to $110 billion at the end of March, adding about $1 billion a week.
How is Apple able to generate so much cash? Apple maintains industry leading operating margins -- 39% last quarter -- enabling them to keep a large portion of their sales revenue as profit. By comparison, Google -- one of the most efficient Internet companies with very low operating costs -- has a 32% operating margin. Another key observation is Apple’s operating margins are steadily improving over time, as demonstrated in the chart below:
So, not only are Apple sales and revenues accelerating at a terrific pace, but they are actually able to turn more of their revenue into profit. And, since Apple doesn’t have any debts, their $110 billion in cash is sitting in the bank waiting for Apple to spend it or pay it to shareholders. Apple has in fact announced a share buyback program and a dividend coming shortly, but that will only minimally slow Apple’s accumulation of cash.
Ranking the market
Among thousands of publicly traded companies on US markets, there are only 70 companies with market cap over $10 billion, P/E under 15 and price to free cash flow (P/FCF) under 15. Of those 70 companies, Apple is the one and only with sales growth over the past 5 years greater than 30%. To put it simply, that means that despite Apple’s fantastic rise from $80/share, it is effectively one the cheapest stocks on the market currently.
Let’s compare that to some other large popular companies with highly recognizable brands. In the chart below I have listed the company, the current P/E, P/FCF, sales growth over the past 5 years, sales growth last quarter versus sales in the same quarter a year ago, trailing 5 year earnings growth, and earnings growth last quarter versus earnings in the same quarter a year ago. I have highlighted the leader in each of these categories.
Apple leads in all the growth categories by a significant margin, trouncing both Amazon and Google, its nearest growth rivals in this group. Microsoft nudged out Intel for the lowest P/E in the group, and both of them have a slightly lower P/E than Apple, but both Microsoft and Intel’s earnings growth shrank last quarter versus the same quarter last year, as did Amazon’s and GE’s. Ironically, General Electric, which has been delivering negative sales and earnings growth for five years, has a higher P/E than IBM , Intel, Microsoft, Wal-Mart, and Apple. In the all important free cash flow category, Microsoft is barely a nose ahead of Apple, but Apple’s 5-year sales and earnings growth are more than 400% greater than Microsoft’s. The elephant in the room is obviously Amazon, with a whopping P/E of 174.5 and P/FCF of 83.26. Is that really justifiable, or sustainable?
I won’t make the mistake of predicting what the market is likely to do, but to put things in proper perspective I’d like to draw some parallels to some of the companies we’ve looked at so far, starting with Google. Last quarter Apple reported $11.6 billion in profit, more than Google’s total revenue at $10.7 billion. If Apple shares were to trade at Google’s P/E ratio of 17.93, they would be priced at $735.49. Priced at GE’s P/E of 15.74, Apple shares would be $645.65. Priced at Qualcomm’s P/E ratio of 20.04 they would be $822.04. Priced at a P/E ratio of 21.38, which Apple itself was valued at two years ago, the shares would be $877.01.
In the 2010 January to March quarter (Q2), when Apple shares were 21.38 times earnings, Apple sold 8.7 million iPhones, and had yet to ship its first iPad. In Q2 this year, Apple sold 35.1 million iPhones and 11.8 million iPads, yet its share price dipped to 13.6 times trailing earnings, defying common logic.
Fuel for growth
We’ve looked at where Apple came from and where it is today. But the markets are forward looking, so let’s explore where Apple is going next.
Apple sold 37 million iPhones in Q1 and another 35 million in Q2. Can it sustain these numbers? iPhone 5 is reportedly coming this year, that should give Apple a nice pop, although anticipation of iPhone 5 may slow sales leading up to its release. But the big iPhone numbers are contingent on China Mobile. Apple already supplies China Telecom and China Unicom, but a deal with China Mobile would open up a subscriber base of 665 million. For reference; AT&T’s subscriber base is approximately 77 million. If Apple closes the deal with China Mobile, the Apple share price will soar along with iPhone sales.
The iPad is hot with consumers, and so far competitors haven’t been able to effectively counter Apple’s juggernaut. Nearly 12 million iPads were sold last quarter and Apple discounted the iPad 2 during its release of the new iPad, so cost should be less of a barrier. There is speculation Apple may be releasing a smaller, lower-priced iPad in the near future, but until more concrete evidence is available I’m not counting on it. Without the little iPad, Apple should still sustain moderate growth.
A key factor in Apple’s iPad growth strategy is the enterprise market. During the Q2 earnings conference call Tim Cook stated 94 percent of Fortune 500 companies have either deployed or are currently testing the iPad, and further added, "We're shifting our focus here to penetration in the enterprise." Penetrating the enterprise market could significantly alter Apple’s earnings trajectory, and if the CEO is focused on it then it is a strategic objective for Apple, so I expect they will execute successfully.
Finally, the media is buzzing with rumors of an Apple branded TV or iTV. While there may be something in the works, trying to predict new Apple products, or worse, trying to time them, is futile. If Apple does bring a TV to market it could be disruptive and may deliver another big stream of revenue, but for now investors shouldn’t count on this while evaluating Apple’s potential worth.
What to expect
Despite Apple’s spectacular growth, the shares continue to get cheaper relative to their earnings and cash flow. If the past 5 years are any indication, this is not a temporary phenomenon and I would expect the pattern to continue. However, as long as Apple keeps growing at these rates the share price will follow, all the while improving shareholder value. That is the elixir that sent the shares from $80/share to $560/share over the past 5 years. So if you missed it 5 years ago you can get an even tastier bite of Apple today.
Invest wisely, my friends.
FoolSolo owns shares of Apple and Intel. The Motley Fool owns shares of Apple, Amazon.com, Google, Intel, and Microsoft. Motley Fool newsletter services recommend Amazon.com, Apple, Google, Intel, and Microsoft. 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.