At some point in the
not-too-distant future, the stock market will realize that Apple’s valuation is
overly discounted. Yes, Apple's earnings are not likely to grow at the percentages seen a few years ago
(although Apple’s growth remains strong in some areas of software and services
where gross margins exceed 80%). However, expectations for lower growth are much
more than appropriately discounted into the current stock price. Here’s why.
Basic Investing 101 says that a
company’s Price/Earnings (PE) ratio should be a reflection of its anticipated
future growth rate. The forward PE of the S&P 500 is 15.9. So companies expected to grow earnings at a
rate faster than the market should have higher PEs and those that have lower
expectations should trade at lower multiples.
Apple is currently trading at a
forward PE of 11.4, but adjusting for its cash hoard, the forward PE is
7.5. Does Apple deserve to trade at a PE
less
than half of the market PE? Well, only if the market truly believed
that Apple's growth rate in earnings would be less than half of the market growth
rate.
Let’s take a look at the 33 largest market cap stocks in the US. Unfortunately for efficient
market enthusiasts out there, analyst expectations for growth of Apple earnings
at 19.6% are at the top of this peer group (#4 of 33). So the explanation of
“low growth” for Apple’s low PE is irrational, at least relative to the general
market. Here are the specifics:
Apple bashers would say that the
largest cap companies are not the right comparison because size makes these
companies a lower growth peer group -- it's hard to grow faster from a large base of revenue. Again, this is not true – projected growth
for these largest cap stocks averages 11.3% vs. 9.6% for the S&P 500.
The PEG ratio factors together these
two measures of 1) valuation multiple and 2) growth expectations, with lower PEG
numbers representing better value.
Again, Apple with a PEG ratio of
0.63 is the best value among the 33 largest cap companies:
So if the market is correct in
expecting Apple will grow at 19.6% vs the S&P 500 at 9.6%, then Apple’s PE
should be more than twice the S&P 500, not half the S&P
500 PE.
Go figure. Seems irrational to
me.
Note: All stock prices and analyst projections were as of March 1,
2014, and based on information from Yahoo Finance.
Disclosure: I've owned Apple
shares since 1985
