How Cheap Is Apple, Really?

Apple (Nasdaq: AAPL  ) is trading for 30 times trailing earnings. Some would argue that this makes the gadget guru an entirely unsuitable investment vehicle. Others like to point out the flaws of the P/E valuation metric, and blithely buy the stock anyway. Fellow Fool Tim Beyers argues that the company is cheaper than you think. Tim is a genius, but this time, I think he's wrong.

Let's have a closer look at Apple, and compare and contrast it to the competition:

Company

EV/FCF

LTM P/E

Forward P/E

PEG

Apple

12.4

29.6

25.1

1.7

International Business Machines (NYSE: IBM  )

10.8

12.7

11.2

1.2

Microsoft (Nasdaq: MSFT  )

12.3

15.2

12.9

1.5

Google (Nasdaq: GOOG  )

18.6

32.5

19.1

1.2

Dell (Nasdaq: DELL  )

10.1

14.6

12.1

1.6

Hewlett-Packard (NYSE: HPQ  )

11.7

15.1

10.6

1.2

Garmin (Nasdaq: GRMN  )

4.7

11.2

13.4

1.0

Data from Capital IQ (a division of Standard & Poor's) and Yahoo! Finance. Data current as of Aug. 26.

Price to earnings
All sorts of P/E ratios will make Apple look bad here. On a trailing basis, only Google looks more expensive -- but then again, who wants to base investment decisions on an accounting metric that is prone to manipulation and paints an incomplete picture? When you use forward estimates instead, in order to iron out some of the inconsistencies, Apple becomes the priciest stock of the whole bunch.

Of course, analysts have a tendency to underestimate Apple's growth -- the company has never missed an analyst consensus target since Thomson started tracking estimates for Apple. For that reason, I tend to knock a couple of points off whenever I'm thinking about Apple's forward P/E figures. But it'd take at least six bonus points to dive below Google's supposedly pricey valuation, and much more to reach the industry average. Yep, Apple looks expensive on a price-to-earnings basis, any way you wrangle the numbers. Let's move on.

The Fool Ratio
The same dynamics play into the price-to-earnings-to-growth ratio as well. Apple comes out looking expensive thanks to stingy forecasts and tricky earnings accounting. Google and IBM start to smell like roses, and Garmin might even be on sale at a discount.

As beloved as the PEG ratio has been in Fooldom -- heck we sometimes call it the Fool Ratio -- this metric has shortcomings of its own. Like the P/E, it's useful as a starting point before diving deeper, but it's not a silver bullet to cure valuation lunacy. Also, Apple's accounting for iPhone sales means that its revenue isn't fully realized in the quarter the phones are sold. Instead, the company recognizes revenue and cost of goods sold across each phone's estimated 24-month lifespan. So earnings simply don't tell the whole story here. Fair enough. Let's try a measure that backs out these accounting effects.

Break out the cash flows!
OK, now we're talking. If the proper value of a given company equals discounted future cash flows, it follows that any quick-and-dirty metric worth its salt should depend on the company's powers of cash generation. Also, we account for Apple's large cash hoard by using its enterprise value instead of its market cap.

From this angle, Apple is a superstar. Apple pulled in $10.3 billion of free cash flow over the last 12 months. That's about five times Dell's respectable cash bonanza, and nearly twice the cash mighty Google created. Heck, Apple even beats tech giant HP.

But Apple is also considerably more expensive than most of these high-tech peers. Looking over the cash flow metrics in the table above, Apple comes out looking fairly valued at best, and a bargain only if you put it next to Google. That's sort of like bringing an ugly friend along on a date, just to make yourself look better. In fact, if you're looking for an affordable gadget designer, Garmin might be your best bet. The company's lowly cash flow multiple likely results from poor growth projections as smartphones encroach upon its GPS-navigation turf.

It all boils down to growth
We've examined Apple from four different angles, and found its valuation relative to its peers lacking every time. Clearly, the market expects Apple's growth engine to remain far more revved-up than competitors'. So if you own this stock, you'd better have a firm conviction that the company will grow fast enough to leave analyst expectations eating dust for years to come.

Will the iPhone still be a hit in 2013? Can the Mac steal any more market share from Microsoft's PC hegemony? Is the iTunes-iPod symbiosis immune to new upstarts and counterattacks from a resurgent old-line music industry? For today's share price to make any sense, the answer to all of these questions must be a resounding "Heck yes!" I don't think it'd be good enough if one or two of those dream scenarios play out, and not even Babe Ruth expected a home run on every swing.

Could Apple succeed on every front? Sure. Will it? Highly doubtful. For one thing, Apple's absolutely crushing the high-end market for computers. NPD reports that it has more than a 90% market share on computers costing more than $1,000. To Apple's credit, this is an amazing statistic, but it also limits the growth of its computing business. 

In addition, we're starting to see the iPod sales slowing down as iPhones and other convergence devices with built-in MP3 players take their place. The rise of the iPhone has been impressive by all measures, but its ascent will most likely be paired with continued declines in iPod sales. Finally, Apple's forthcoming rumored tablet will probably be the hardest sell of its recent "game-changing" products. I wish Apple all the best in its efforts, but persuading consumers to buy what will probably amount to an eReader/oversized iPhone will be a much tougher job than storming the MP3 player market ever was.

If I owned any Apple stock, I'd sell today and lock in some profits -- because these prices can't last.

Please excuse me while I don this asbestos suit. The comments box below should be visible from space when the flames start flowing.

Google is a Motley Fool Rule Breakers selection. Apple is a Motley Fool Stock Advisor recommendation. Dell and Microsoft are Motley Fool Inside Value picks. Garmin is a Motley Fool Global Gains selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Anders Bylund owns shares in Google, but he holds no other position in any of the companies discussed here. You can check out Anders' holdings or a concise bio if you like. The Motley Fool is investors writing for investors.


Read/Post Comments (9) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2009, at 3:29 PM, bioexpert wrote:

    Why people keep on using market cap instead of EV for most measures of stock value is beyond me. You are smart enough to say EV is a better indicator than MC due to Apple's large cash hoard and no debt, but you only use EV in your EV/FCF number and continue to use MC for everything else, e.g. P/E, P/E/G. This is just plain bad logic, made worse by being internally inconsistent.

    Not surprisingly, EV/FCF looks fine for Apple. In fact EV/FCF is the same for Apple and Microsoft basically! With Apple you get a growing company that has huge room to expand (10% market share in PCs means a huge upside potential), while with Microsoft you get a mismanaged company with an increasingly outdated business model. I'll take Apple over MSFT for the same EV/FCF anyday.

    This article shouldn't even have been posted until you recalculated all the other ratios with EV instead of MC.

  • Report this Comment On August 28, 2009, at 4:21 PM, daniel940 wrote:

    How can you list these companies as Apple's competitors? There are more differences between these companies (and therefore how you measure growth, valuation, potential for quick moves to the upside or downside, what have you) than there are between typical companies in other industries. AAPL has typically (going 4 years back) traded at a multiple in the 20s, 30s and even 40s. During the same period, MSFT enjoyed mutiples in the high teens, low 20s. IBM in the mid-teens. DELL in the mid/upper teens, low 20s. HP in the low teens for the most part. To be fair, it looks like GOOG has almost never had a P/E below 20 in that same period. If GOOG is properly valued, it sounds like AAPL is overvalued. If GOOG is being disproportionately hammered by the very fluid expectations of "jump in-jump out" online advertising campaigns, while AAPL is being rewarded for the theory that nothing stops teens from buying a new iPod every 6 months, then there does seem be a disparity here. I think I just talked myself into buying Google.

  • Report this Comment On August 28, 2009, at 4:39 PM, MaBellIsDead wrote:

    Regarding: "f I owned any Apple stock, I'd sell today and lock in some profits -- because these prices can't last."

    Not a bad idea if you are satisfied with the current price. After all, what is use of retaining a stock that has no dividend? Capital gains is what it's all about.

    But I've been reading comments similar to yours for many years - I believe since the time I bought in at around $9, because Jobs was coming back.

    A couple days ago i did sell some aapl ( I love the opportunity to pay huge capital gains), but I'm sure Appl will grow my remaining shares much higher.

  • Report this Comment On August 28, 2009, at 4:52 PM, misternl wrote:

    No company has the velocity of technological innovation of apple.

    No company is creating as much impact in as many different large markets as apple.

    Despite the contraction, apple will post strong growth across its segments in both this quarter and next. This by itself is worth a substantial amount.

    I say aapl over $200 by Christmas.

    N

  • Report this Comment On August 28, 2009, at 5:14 PM, stan8331 wrote:

    Apple does have a fairly scary P/E. If they fail to continue innovating at some point, shares could easily tank. But there just aren't many companies that produce products customers are willing to pay extra for and jump through hoops to own. Most iPhone users wouldn't take a Blackberry if you gave it to them - I don't believe the reverse is true. Apple now has a lengthy track record of surpassing analyst estimates by producing lust-inducing products that carry a significant premium.

    All that said, I'm not suggesting jumping in with both feet at $170. The wiser strategy would be to tiptoe in at current levels and look for a major market correction to accumulate more shares. If a crash is imminent, as we are being assured by the ultra-bears, there might yet be another great opportunity to load up on Apple.

  • Report this Comment On August 28, 2009, at 6:28 PM, plange01 wrote:

    apple is as cheap as google goldman and baidu...subtract about 70% from their prices and you get their real value...

  • Report this Comment On August 30, 2009, at 9:04 PM, beetlebug62 wrote:

    Well, if you get flamed, perhaps, it's because readers remember that you, Anders, were the source for dozens of articles that stated that TMo had pre-sold 1.5M G1s, back in the late Fall of last year. Of course, you were wrong, very wrong, based upon false assumptions, but never acknowledged your mistake. Your math and analysis is inconsistent and suspect.

  • Report this Comment On August 31, 2009, at 9:56 AM, Barney229 wrote:

    I'm a little nervous about Apple. Stand back from the math and look at the business track record of the company over the last 20 years. Apple has been in a position of heady growth based on cool product innovarion on a number of occasions. But each time it climbed high and had excellent share values, it crashed afterwards. Then after years in the share-price dungeon fresh innovation brought it back to the great heights only to be followed by share price collapse again. Thiis rollercaoster curve happened when Jobs was in charge originally, when he was gone for 10 years and even in his current tenure.

    I think Apple is a great company and has well earned its fantastic share price ratios. But I'd be nervous holding shares at today's prices unless you are *convinced* that Apple will remain at these dizzy heights of product innovation for many years to come. I contend that history does not support that view.

    In the spirit of full disclosure: I don't own Apple stock as I wasn't smart enough to buy it when it was on the rise. But I'm considering shorting now.

  • Report this Comment On March 04, 2010, at 5:45 PM, XMFSmashy wrote:

    Well, you nailed that one, misternl.

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