Apple Is Still Cheaper Than You Think

When my Foolish colleague Anders Bylund named Apple (Nasdaq: AAPL  ) the worst stock for 2010, he cited valuation.

"The fact that Apple's stock appreciated by nearly 150% last year and is cruising at all-time record altitudes could be a classic setup for a fall back to Earth, Icarus-style," Anders said.

You call this expensive?
Fair point. Stocks like Apple tend to churn like butter, rising and falling in roller-coaster style. But if Apple does take a hit, it won't be because the stock is expensive, as Anders asserts.

I don't question his math. Anders is right that Apple trades for more than 20 times earnings, and it's never fair to call a stock with a 20 or better P/E ratio cheap. The problem, as I see it, is that price-to-earnings, or even price-to-free cash flow, are poor measures for valuing Apple.

What makes more sense, you ask? And I answer: EV-to-EBIT, a lengthy acronym for comparing enterprise value to earnings before interest and taxes. EV-to-EBIT is best because it accounts for Apple's massive cash hoard, $23.5 billion if you don't include the company's $10.5 billion worth of long-term investments.

On this basis, Apple still has room to run. Here's why:

Calendar Year

Closing EV-to-EBIT

Average EV-to-EBIT

2009

21.85

15.42

2008

19.02

8.19

2007

26.62

35.85

2006

23.66

25.60

2005

29.29

31.71

2004

58.53

43.69

2003

139.39

100.17

2002

23.45

26.81

2001

Not material

Not material

2000

2.54

27.55

1999

35.66

17.41

1998

16.21

29.65

AVERAGES

33.02

30.17

Source: Capital IQ, a division of Standard & Poor's.

As of Friday's close, Apple was trading for 20.34 times EV-to-EBIT, a 33% discount to the average multiple for the Mac maker under CEO Steve Jobs since his return to the company in 1997.

Only the truly unconscious don't know that Apple has returned 5,090.39% in the 12 full years since, or 38.97% per annum.

Be a cash counter
To be fair, some of you might argue that Apple's $178 billion market cap already accounts for cash because investors are buying with full knowledge of Apple's Big Wallet.

Even if that's true, it's still difficult to discern what investors are willing to pay for Apple's cash cushion. This is also true of Google (Nasdaq: GOOG  ) , Microsoft (Nasdaq: MSFT  ) , Cisco (Nasdaq: CSCO  ) , and every other cash-rich, debt-light company trading on the index. EV-to-EBIT solves this problem by stripping out cash and related interest and tax benefits to value the growth potential of the underlying business.

Interestingly, this measurement could even be considered conservative since recent years would include additional amounts of deferred revenue due to the iPhone's introduction. This adds even more "oomph" to the logic that Apple's trading to a historical discount.

Leveraged companies face a similar issue. That's why you'll see Sirius XM Radio (Nasdaq: SIRI  ) sometimes refer to EBITDA, which adds back depreciation and amortization to earnings in recognition of how debt is used to pay for essential capital equipment. 

Think of it this way: If the P/E is snacks, dessert, and dinner, EV-to-EBIT is dinner and EV-to-EBITDA is dinner with a side.

Valuing the fruit
Apple's discount to its historical average EV-to-EBIT suggests a couple of important things for would-be investors:

  1. The company is valued for slower growth than it has experienced in years past.
  2. Catalysts, while historically important to Apple's investors, may not be necessary in order to generate returns from here.

Yet there are catalysts. It's a big week for Apple. Later today, the Mac maker will report fiscal-first-quarter earnings, and then on Wednesday is expected to announce a tablet computer that speculators believe will be called the "iSlate." At the same time, Jobs could unveil a business model for selling Web content from newspaper and magazine publishers such as New York Times Co. (NYSE: NYT  ) and Meredith (NYSE: MDP  ) .

If we're expecting something big, it's because we've seen big ideas from Apple before, and the iSlate offers another chance for Jobs and team to remake an industry to Apple's advantage.

And if The Big Idea isn't big enough? So be it. Apple can't hit it out of the park every time, and going by the numbers, it doesn't need to.

Now it's your turn to weigh in. Would you buy Apple at these levels? Make your voice heard using the comments box below.

Apple is a Motley Fool Stock Advisor selection. Google is a Motley Fool Rule Breakers recommendation. Microsoft is a Motley Fool Inside Value pick. Motley Fool Options has recommended a diagonal call strategy on Microsoft. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers had stock and options positions in Apple and a stock position in Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy is suffering from a snack attack. Time to pull out the Hamiltons.


Read/Post Comments (12) | Recommend This Article (24)

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 January 25, 2010, at 4:24 PM, geoslv wrote:

    I'm thinking that the tablet might incorporate television. Any reason not? With new deals with the TV networks, I suspect Apple TV may find a way to break out. Could the table be a portable TV?

    Apple shares rise because of new products.

  • Report this Comment On January 25, 2010, at 5:35 PM, ellipsoid wrote:

    I'm keeping the outperform rating in CAPS.

  • Report this Comment On January 25, 2010, at 5:36 PM, memoandstitch wrote:

    “If you annualize our quarterly revenue, it’s surprising that Apple is now a $50+ billion company,” Steve Jobs.

    $50B? I think Jobs forgot to look at AAPL's latest market cap before saying that or he's just being honest.

  • Report this Comment On January 25, 2010, at 5:36 PM, memoandstitch wrote:

    “If you annualize our quarterly revenue, it’s surprising that Apple is now a $50+ billion company,” Steve Jobs.

    $50B? I think Jobs forgot to look at AAPL's latest market cap before saying that or he's just being honest.

  • Report this Comment On January 25, 2010, at 5:51 PM, Turfscape wrote:

    memoandstitch wrote:

    "I think Jobs forgot to look at AAPL's latest market cap before saying that or he's just being honest."

    I'll assume you realize the difference between revenue and market cap...

  • Report this Comment On January 25, 2010, at 6:59 PM, PSU69 wrote:

    I own AAPL and I sell it on peaks from time to time to keep the mix balanced. I also buy it when the mob drives the proce down. Their Mac sales success is stellar. The Apple stores are doing alot to support the brand. Personally, I am anxious to understand the tablet. My BlackBerry is only with me due to AT&T poor serevice where I live. So if Verizon hooks up with the iPhone I predict more folks will move to iPhone.

  • Report this Comment On January 26, 2010, at 4:50 AM, baldheadeddork wrote:

    My problem with this kind of analysis is that it tells you where a company has been. Apple has had an a-m-a-zing run over the last fifteen years, and that's reflected in its cash horde and the average performance since Jobs returned.

    But, where is the company going? That's the question I can't shake, because the answers don't look good.

    iPhone: There isn't one Android phone that can knock off the iPhone, but a couple dozen Androids is another matter. Google is running the same playbook against Apple on smartphones that Microsoft used in OS's, and I don't see how the outcome can be any different. Android phones will soon offer 99% of the function and features of an iPhone, they'll be available on every network, and they'll cost 50-75% less.

    iTunes/Apps Store: This will remain viable as long as Apple sells portable media devices, but they're soon going to be competing against Google and the Android devices.

    MacBook: After making some good inroads in the laptop market earlier in the decade, Apple lost market share to Windows-based devices in the last year. They had a brief advantage with the ultra-slim MacBook Air in late 2008, but the Atom-based netbooks have turned it into roadkill. They've also had a big increase in hardware quality problems across their product line, Windows 7 is being warmly embraced by consumers, and having a substantial price premium isn't a good place to be in a severe recession.

    The (in)famous iTablet: I'll go on record as predicting this is going to be the biggest commercial dud since Newton. If its color it will not have good battery life, and if it doesn't it's just another e-reader. Apple is very late to the eBook game. However they sell eBooks they'll be competing against the established dominant players in the online and brick and mortar book retailing. This will be news to the MacHeads, but tablet computers have been around for a decade and they've only worked in niche applications because they're just a lot less comfortable to work on than a laptop.

  • Report this Comment On January 26, 2010, at 9:35 AM, frigginusername wrote:

    I would have to agree with the previous poster that Windows 7 is a huge leap for MS. However, I'm not so sure I agree with his gloomy predictions.

    While I'm sure the Android platform will mature and be competitive, we've already seen major cracks in an open platform's ability to control style, support, and reliability. Apple invented the "App Store" and has a QA process that makes the Android App store dev approval process look pretty pathetic. The previous iterations of MS Windows vs OS X have also shown how being all things to all people isn't always easy.

    Apple dominates on superior beauty, reliability and simplicity, and I dont' think anyone else is even close to challenging them in any of those areas in the mobile phone, laptop, desktop, and I imagine, the new burgeoning tablet market.

  • Report this Comment On January 26, 2010, at 10:39 AM, BillGatezzz wrote:
  • Report this Comment On January 29, 2010, at 3:53 PM, Beagle2Mars wrote:

    I went into an Apple store in London two weeks before Christmas. I could see backlit iphones and customers. Packed out with 20-something guys all being ignored as there were too few sales people. Why does Apple continue to sell huge numbers of Iphones? Good product but it does have competition. Is that the only product? Ipad is innovative, maybe, a gadget, definitely.

    Why is Apple in Hong Kong? Is it a distribution centre or are they trying to stop the copycats? If they don't know, they should get out and quick.

    I'm holding but I'm not buying.

  • Report this Comment On January 29, 2010, at 5:40 PM, 1022ThirdAvenue wrote:

    Thank you for this article. I have read a lot of Internet conversation originating from those who are knocking iPad because it does not have this or that feature and, therefore, there is no future for either it or Apple. Consider the following: "ObamaCare." The iPad is a perfect general-use mobile device for doctors. With the 3G networking capability, a doctor can be virtually anywhere and access the complete medical records of a patient. Show me one device or one company that could build such a device within the next 6 months to 2 years and I will buy that company. Perhaps Steve Jobs is a genius after all by creating a device in anticipation of a ready made market.

    Also, I read a lot on Motley Fool about price/earnings, enterprise value, cash to debt ratio, and a lot of other measures of the current and long-term prospects to derive decisions of whether to buy, hold, or sell shares in a particular company. For more than a decade, I have thought that such measures fall short of proper strategies for deciding whether a company is worth buying. This is because any measure that you can derive is intrinsically ignorant of the future of the enterprise. The future prospects of a company rests only in its human capital and intellectual property. Apple Computer, and other similarly situated companies, is vastly undervalued because both of these resources are largely ignored by the participants in the stock market. Apple has on board, and recruits, people who are both intelligent and incredibly creative. It also has a large portfolio of intellectual property. Apple has a very good CEO who is able to employ both of these assets to turn existing concepts into futuristic devices.

    Thus, to those naysayers, think again about Apple.

  • Report this Comment On February 03, 2010, at 6:29 PM, SlickRick491 wrote:

    Apple is still in the beginning stages of their growth. Expect their international sales to push over 70% of their total in the next few years. The IPAD will sell better than most expect as we continue to adapt to cloud computing and if the iphone comes to Verizon this year look out. There's only 2 kinds of investors here, those that own AAPL and those that whish they did!

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