One Prominent PM’s Thoughts on the Future of Apple

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

Apple (NASDAQ: AAPL) is the top stock pick among the funds we track; that's no secret. What is up for debate, though, is just how shares of the tech giant will perform in 2013. There are many opinions, and earlier today, we gave the bear's case, so to speak, from the renowned Doug Kass (see his thoughts here).

On the other side of the aisle, there are a number of bullish scenarios that can push Apple higher, but it all starts with the valuation. Recently, Gamco Portfolio Manager Larry Haverty was on Bloomberg TV discussing the stock's relative attractiveness. Here are some of the highlights:

"It trades at 6 times current cash flow [...] that's a 16% return, and sitting on the sidelines is $121 billion of cash, I think probably at the end of this quarter probably over $130 billion of cash. It's earning nothing, and if it decides to go from earning nothing to buying the stock at 16%, you increase the shareholder value."

Regarding Apple's cash flow, we've covered this subject quite a bit recently. In case you haven't read up on just how Apple manages its $121 billion of investable cash, be sure to check out our recent in-depth analysis on the topic (see What is Apple's Secret Hedge Fund Buying?). Getting back to the point, Apple absolutely has the capacity to boost its dividend, which is projected to yield around 2% based on the current payout.

Keeping this in mind, Haverty had this to say about Apple:

"I think last year, at the peak, there was probably over $300 billion of unrealized capital gains in Apple, just from the performance in the last year [...] there was some thought, you're now paying 15%, that might go to 45% [...] that's kind of unprecedented in terms of the tax change and the tax magnitude, and I think that has created distortions in the stock, which create the opportunity."

Haverty also discussed Apple "in a vacuum" to make his case. The portfolio manager broke down his bullish Apple thesis into multiple phases, which include:

"One: it's the world's best retailer. If you had the ability to get at their retail profitability, it would be better than anyone else on the planet. The second thing is: it gets recurring revenue from the iPhone and the Apps on the iPad. The third thing is: it makes these devices [...] it's not really a consumer durable, it's a consumer semi-durable."

Additionally, Haverty mentions the "financial characteristics," which include stellar margins, high ROI, and "not a lot of capital intensity," at "half the multiple of Coca-Cola."

Perhaps most importantly, Haverty discusses the prospects of Apple's decision not to place more of its cash flow into shareholders' pockets, which he describes as "irresponsible" management. Here are his thoughts:

"The reality is right now, Apple could [...] finance in the bond market at 1% and pay the interest and bring the cash over and give it to the shareholders. They could also finance at 1% and buy the stock and get a 16% return [...] They'd flunk a finance class in any business school."

To conclude, Haverty says that "it's time the directors, I think, changed the playbook in terms of the cash management," adding that "if they ever did that, I think the stock could be very close to a trillion dollars in value very, very quickly."

What Can Investors Do at the Moment?

Sitting in the $525 range, there’s no doubt that Apple is an attractive investment from a valuation standpoint. In addition to the cash flow multiples discussed above, it’s worth pointing out that Apple’s earnings growth, measured by the PEG ratio, trades at a massive discount to itself and its peers.

Apple currently sports a PEG in the neighborhood of 0.6; typically any figure below 1.0 signals an undervaluation. Even more importantly, though, this is also below competitors like Google (NASDAQ: GOOG) and Microsoft (NASDAQ: MSFT), which both trade at PEGs near 1.5.

Now, this differential is important, because Wall Street expects Apple to sport earnings growth of 19-20% a year over the next half-decade, which is far above the expectations of Google (15.5%) and Microsoft (9.6%). Moreover, Apple is also cheaper than tech peers like IBM (NYSE: IBM) and Oracle (NYSE: ORCL), which trade at PEGs of 1.3 and 1.4 respectively. The sell-side expects both companies to experience earnings growth in the low double-digits.

Obviously, there are many investors out there that do not subscribe to the value investing philosophy at the moment; after all, someone buying Apple near $675 in early September was still seeing relatively attractive metrics.

Noted tech analyst Gene Munster is one of the best at pointing out that sometimes, Apple investors require a product carrot, so to speak, that can pull expectations higher, and thus, the stock’s price. Last fall, the markets were uncertain about an iPhone 5 that had just been released, and fiscal cliff-related hesitation (and undoubtedly some tax-related selling) certainly didn’t help matters.

Three to four months later, there appear to be a few more growth drivers shaping up to help boost Apple to a fairer valuation. First up on the list is obviously a deal with China Mobile, and we’ve seen reports lately (see Apple: Does China Mobile Need a Bite?) that the telecom may need Apple more than originally though, to stave off the likes of China Unicom and China Telecom.

Secondly, we have the ever-growing rumor mill of what Apple’s next truly groundbreaking new product will be, which includes: an iPhone with multiple colors options, an iPhone with multiple size options, the larger of which can appeal to the growing demand for “phablets,” a smart watch, and a smart TV.

Now, we can also throw in the prospects of a dividend boost, as described above, and it’s likely that at least one of Apple’s product rumors will come to fruition. If, and when this occurs, it may be just what the doctor ordered.


This article is written by Jake Mann and edited by Meena Krishnamsetty. Meena has long positions in Apple, Google, and Microsoft. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, International Business Machines., Microsoft, and Oracle.. 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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