Even if Apple Hits $1 Trillion by 2016, Oracle and Adobe More Undervalued
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With over 13.9 million shares on average traded each day, Apple (NASDAQ: AAPL) may very well be the hottest stock on the Street. But it isn't necessarily the most undervalued, as its bulls tout. My own view of the rising electronics producer is that it is undervalued, but that there are more attractive value plays right now. It is more than double the market capitalization of Microsoft (NASDAQ: MSFT), which has a virtual monopoly on the PC market and computer software. The company is also worth 4x Oracle (NASDAQ: ORCL) and 37.5x Adobe Systems (NASDAQ: ADBE). These multiples speak not to Apple's expensiveness, but rather to Oracle and Adobe's substantial undervaluation.
Take a look at software producer at Oracle. The $144.4 billion company generated $13.1 billion in free cash flow last year as opposed to just $8.5 billion two years ago. At that growth, the company would generate $25 billion in free cash flow in three years and would be worth $275 billion at the current 11x multiple. A 10% discount rate would peg intrinsic value at north of $200 billion for around 45% upside. This price target would mean the company should be trading more at around 21.5x earnings, which is just about where the Shiller PE multiple currently stands.
Oracle is currently trading at a respective 15.1x and 10.1x past and forward earnings. Earnings over the past five years going through the recession were 19.3% annually, but only 12.2% is expected for the next five. Based on expectations, the company should realize 2016 EPS of $4.13 and be worth $38.47 in present terms at a 15x multiple and 10% discount rate.
Like Apple, Oracle is also liquid. It has $30.7 billion in cash and $14.2 billion in net cash. It is concerning that the firm trades at 3.2x book value, but ROE is still above 20% and the company has multiple opportunities to explore and grow.
Adobe comes across as the more expensive investment, but it is a much better investment than what many commentators recognize. It trades at a respective 19.7x and 11.6x past and forward earnings with a high current ratio of 3 and a low debt-to-equity ratio. As a software producer with $3 billion in cash, the company can easily create value through synergistic acquisitions. The stock has more than doubled from the early-2009 low of $16.70, and it currently is closer to the 52-week high than the 52-week low.
Investors are, specifically, failing to appreciate Adobe's free cash flow generation. In 2011, the $15.1 billion producer generated $1.3 billion in free cash flow, which has grown appreciably from the preceding year's levels. In fact, if the company continues to grow free cash flow at 16% (less than half of last year's 37% annual growth), the company will have $2.7 billion in free cash flow by 2016. At a 15x multiple with years of excellent growth ahead, the company will be worth north of $40 billion. A discount rate of 10% would place the intrinsic value of Adobe at $25 billion, which provides more than a 65% margin of safety. Adobe is thus easily worth a "buy."
Apple's free cash flow has been an even greater success story. Free cash flow was $30.1 billion in 2011, which dwarfs 2008's $8.4 billion. That is a CAGR of 54% but is not sustainable in the future given market saturation, intense competition in technology, and few barriers to entry. The idea that the company had to press patent charges against Samsung for "copying" its tablet shows how dependent the company is on image. iPods, iPads, iTouchs, and iPhones may have become hot consumer goods, but consumers are fickle and have shown a particular lack of attachment to certain tech brands. These brands include Microsoft, Dell, Adobe, and Oracle (the latter two are more on a corporate buying level).
The problem is thus that the world's most valuable company can't sustain growth rates anywhere near where it has in the past. Accordingly, it is reasonable to look at what the company can produce. Over the past five years, annual EPS growth was 65%; over the next five, analysts expect 20.7%. That means earnings will go up 2.6x to $66.6 billion by 2016. If the company achieved that growth (which looks high), it would be worth $1 trillion in five years.
A $1 trillion valuation discounted backwards by 10% yields a present valuation of $620.92 billion, which provides a 10% margin of safety. Put differently, if Apple - already the world's most valuable company - becomes the first trillion dollar company by 2016, it still is far less undervalued in present terms than Adobe and Oracle.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Microsoft, and Oracle. Motley Fool newsletter services recommend Adobe Systems and 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.