NerdWallet ScoreBoard: Take a Bite Out of Apple Stock Right Now

Investing, Investments
  • Thesis: Apple (AAPL) is an attractive long term investment at current prices below $550 per share. In this price range Apple trades at earnings multiples which are below the market average with better estimates for earnings growth over the next five years.
  • Risks: It is conceivable that Apple would be forced to compete solely on the price of its devices and its profit margin would drop.
  • Catalysts: Any news that allows a reset in market sentiment. This could include positive numbers from the holiday season, the announcement of a new product, or CEO Tim Cook growing a beard to look more like Apple’s late former-CEO Steve Jobs.
  • Recommendation:Buy Apple shares at earnings multiples below the S&P 500 index for your diversified portfolio if you have not already done so. If you invest through mutual funds, you may have a sizable position of Apple as components of your large cap or growth funds, making you are sufficiently invested.
    • Price Target: Shares are a clear growth-at-reasonable-price play below $618 per share.
    • Downside: Margin compression could drop Apple shares to $329 per share.
  • Disclaimer: I am looking over 3+ year timeframes. For shorter investment horizons you should look to other articles for advice. I also own shares of Apple.

For the past few years investor sentiment has been very positive for Apple. However, in the last three months, media coverage started to turn against the company. Most of the reasons cited against Apple are not meaningful challenges to its long-term future earnings growth. A diverse set of reasons for Apple’s drop have included increased competition, Mapplegate, and its legal battles with some of its competitors.

To be fair, some of these could be legitimate short-term concerns. Mapplegate, for example, has been said to have measurably dented iPhone sales. However, it will not impact the long-term future earnings of the firm. Three years from now, you will not find yourself talking to your coworkers about how Mapplegate made Apple go bankrupt. Even the apparent finality of court decisions may be an illusion as they are overturned and delayed through the appeals process.

This Apple discontent is a blessing in disguise. The revolt against Apple coincided with a drop in stock price from $705 to $505 between September and November, making Apple a compelling buy between 11 and 12 times earnings. This makes Apple cheaper than its profitable competitors on an earnings basis and cheaper than the S&P 500 index:

Ticker

Investment

P/E

Earnings Growth Est.

AAPL

Apple

11.95

22.0%

MSFT

Microsoft

14.34

9.0%

GOOG

Google

20.28

13.5%

SPY

S&P 500 ETF

14.01

9.5%

SSNLF

Samsung

15.61

NA

Apple’s analyst growth estimates are arguably the most credible estimates in the history of investing because Apple attracts unparalleled media and analyst attention. Even in light Mapplegate, legal battles, and other current issues, the average analyst estimate for earnings growth is 16.5% for the fiscal year ending September 2013. Analysts expect a forward earnings growth of 22.0% for the next five years, on average. Apple has demonstrated that such estimates are possible since it posted an average 70.8% earnings growth rate in the past five years.

At this point it is painfully obvious that Apple is a buy based on earnings. Investors can buy more earnings per dollar from an Apple investment and also enjoy higher projected earnings growth. For the sake of thoroughness, forward price-to-earnings ratios based on today’s stock prices and future projected earnings were calculated three years into the future:

Investment

P/E (TTM)

P/E(2013)

P/E(2014)

P/E(2014)

Apple

11.95

9.79

8.02

6.58

Microsoft

14.34

13.16

12.08

11.09

Google

20.28

17.88

15.76

13.89

S&P 500 ETF

14.01

12.79

11.68

10.66

Apple clearly dominates.

How would an investment in Apple turn out in three years using current valuations and analyst estimates? We can determine this by projecting earnings growth according using average analyst estimates and then assuming that the investment will have a market multiple that is in line with the current 14.01 earnings multiple of the S&P 500:

Investment

TTM

2013

2014

2014

Apple P/E

11.95

9.79

8.02

6.58

AAPL Price at 14.01 P/E

$618.64

$754.93

$921.24

$1124.19

All-in-all, Apple is a compelling growth-at-reasonable-price opportunity presented by the market today.

The Risk of Price Competition

What’s the catch? There is a fear that Apple will suffer margin compression, and that its profit will drop as it is forced to lower its prices.

This is possible, though Apple is largely protected from price competition. Many Apple customers are so brand loyal that they would be happy to pay hundreds of dollars for a turd with an Apple logo. Better yet, many Apple customers don’t pay for their iPhones directly, but pay through amortization from their phone carriers. Special financing makes consumers less sensitive to higher prices.

To play devil’s advocate, we could construct a worst-case scenario by reducing Apple’s profit by lowering its profit margin to those of its competitors:

Company

Operating Margin

Profit Margin

Apple

35.3%

26.7%

Microsoft

36.0%

21.7%

Google

28.1%

22.2%

Samsung Telecom

18.8%

NA

Since Samsung’s Telecom segment has the lowest operating margin of Apple’s competitors, we could estimate that Apple’s earnings operating margins are 1.88 times (35.3%/18.8%) what Apple could face if it had to compete with Samsung on price. If this had already taken place Apple would trade at a 22.44 price-to-earnings ratio today. Moreover, if we valued Apple with compressed earnings at the market’s current earnings multiple, shares would trade at $329.48 ($527.68×14.01/22.44).

I should also point out that Apple’s margins are not astronomically better than its peers Microsoft and Google, so a margin compression scenario would not change its relative appeal over Microsoft or Google at current market prices since they would also have to fall.

Conclusion

Apple is a clear buy candidate. At today’s prices, investors get value and growth in Apple shares.