Will Apple Break Through $1 Trillion Market Cap?

Apple has continued its amazing run, and as of this writing is trading at a market cap of $751 billion (stock price of $128.95). AAPL has left the next largest market caps in the dust -- Microsoft ($399 B), Google ($375 B) and Exxon Mobil ($372 B).

Many people are increasingly concerned that Apple’s stock price is not sustainable, and even more seem skeptical it can ever break through the $1 Trillion Barrier.  The closest any other company has come to Apple’s current market cap was Microsoft which peaked at $619 B on December 28, 1999; adjusted for inflation, that would be $872 B in today’s dollars.

I know more than a bit about that comparison, having bought AAPL in 1985 and MSFT in 1986 shortly after their IPO. I sold my first MSFT shares in January 1998, and the largest block several days before that all-time high in late December 1999 – this translated to a 46,367% realized return (464 times).  AAPL is now priced at an 18,390% (184 times) return, yet I’m holding my Apple shares. Why?

In 1999, Microsoft was the second most admired company on the planet (after GE) per Fortune. Microsoft totally dominated desktop operating systems with an 89% market share for Windows and Microsoft also dominated the world of application software with Excel (spreadsheets), Word (word processing) and Powerpoint (presentations). They dominated browsers with Internet Explorer’s 75% market share and also dominated mail/calendaring/contacts applications with Outlook. Their Hotmail was #1 among free mail services with a 41% market share. But I saw cracks forming. The combination of extremely high market share with maturing markets made growth difficult. This was exacerbated by Bill Gates handing over the reins to Steve Ballmer, whom I felt was not up to the challenge.  Windows was far inferior to Apple’s Macintosh operating system, and Apple was beginning to climb out of its hole under the second coming of Steve Jobs. As importantly, the valuation of MSFT had gotten way ahead in terms of multiple relative to the stock market. MSFT’s PE was 78 and the S&P 500 was 29 – so it was 2.7 times the market multiple. But Microsoft was nearly fully penetrated in their core markets of PC operating systems and applications, and underlying growth in PCs was slowing. So the growth outlook was bleak and clearly did not warrant a 2.7 times premium on the market. Hence it was obvious to me that the multiple and stock price were not sustainable, even though Microsoft would continue to generate huge amounts of earnings and cash for many years to come. Selling MSFT at that time was a good call, since even 15 years later the stock has never recovered fully.

Apple today is in a very different situation:

• Apple is still growing, with EPS up 40% in the most recent quarter and 48% in the previous quarter.
• Apple is showing with Apple Watch that it can continue to innovate not just through evolutionary products such as the iPhone 6+ which keep it at the front of the pack, but also through expansion into new categories such as wearables. A new Apple TV set-top box and media service is just around the corner. There will be more growth to come and more categories.
• Most of Apple’s underlying markets are still growing -- such as smartphones and wearables. Tablets look like they are maturing with the recent 23% year-on-year decline in iPads, but this is distorted by cannibalization from the larger iPhone 6+ and thinner/lighter laptops; as the IBM partnership hits its stride and tablets get ingrained in enterprise, and older iPads ripen to be worthy of replacement, this category will grow again.  In computers, Apple continues to grow in a declining market, with sales up 10% while the market declined 7%; this pattern is a long-term trend with Apple growing market share in 35 of the last 36 quarters, yet there is still upside since Apple is only 7% of the market worldwide. That’s very different from Microsoft’s 89% at their peak.
• From a valuation perspective, Apple is trading at 13.1 forward PE ratio and 15.9 TTM (Trailing Twelve Months) PE, compared to the S&P 500 market TTM multiple of 20.6. Backing out Apple’s $194 billion in cash, the PE TTM multiple drops to 11.8. So even if one were concerned that Apple’s growth will slow just because of the laws of large numbers, trading at 57% of the market multiple seems irrational. 

So compared to MSFT in 1999, Apple’s valuation is 57% of the market multiple not 2.6 times the market multiple as MSFT was in 1999. 

Apple’s valuation multiple has consistently lagged the market for years, under the belief that it is too big to grow faster than the market. But AAPL’s EPS growth above 40% in recent quarters challenges those skeptics:

Apple’s PE has not changed much since 2009, despite a tenfold increase in stock price.  Thus the stock price appreciation has been driven by earnings growth not speculation:

Apple has been trading below the market since 2010, and remains significantly undervalued relative to the market – especially when adjusted for Apple’s large cash position:

So what would Apple be worth if it were trading at the market multiple (assuming no further stock buybacks and no further growth in profit)? $960 B at a stock price of $165 per share. Adjusting for cash, Apple would be worth $1,154 B and a stock price of $198 per share. 

So a $1 Trillion valuation is quite possible indeed. The road will be bumpy, with some dramatic pullbacks as investors express nervousness from time-to-time, concerned that Apple cannot sustain growth. But as the numbers above show, even without growth, a $1 Trillion valuation would only be catching up to the market valuation multiple.

Disclosure: I have owned Apple shares since 1985.