Why I'm Betting on Apple Stock in 2014

Going into 2014, I'm betting big on Apple (NASDAQ: AAPL  ) stock. In fact, it's my largest holding. My bet on the stock has nothing to do with the catalyst of a new product category (although this is certainly possible, and maybe even probable). It doesn't even have to do with big expectations from the China Mobile deal. The basis for my reasoning is simple: The stock continues to trade below a conservative fair value estimate.

Zooming out
One of the most Foolish tools in an investor's toolkit is the simple action of zooming out. A 10,000-foot view of Apple reveals a solid business with an irrational price tag.

At just 14 times earnings, and 11.5 times forward earnings estimates, the market doesn't expect much out of Apple. In fact, all Apple needs to do is continue to grow earnings each year at a rate in the low single digits to live up to its valuation.

A discounted cash flow valuation, assuming Apple continues to grow EPS by 3% annually over the long haul, suggests that the fair value of Apple shares is $729 (using a 10% discount rate on future cash flows).

As it turns out, however, this projection for 3% annualized growth to Apple's bottom line is very conservative. The average analyst estimate at Yahoo! Finance for Apple's annualized EPS growth over the next five years is 14.3%. At this rate of growth, Apple's total annualized EPS would nearly double in just five years. For Apple's annualized EPS to reach those same levels while growing at just 3%, it would take 22 years. Case in point, my estimate for 3% annualized EPS growth over the long haul is extremely conservative.

Too much cash
But it gets better. While analyst estimates for double-digit growth in EPS undoubtedly take into consideration Apple's massive $60 billion share repurchase program, these projections don't consider the implications this could have on Apple's dividend.

Today, Apple pays out $12.20 per share in annualized dividends. Trading at $567 per share, this gives investors a 2.2% dividend yield. Assuming Apple continues to boost its dividend by 15% annually (as it did in April this year), Apple would double its dividend in five years. This would give investors about a 4.2% yield five years from now on the cost of shares bought today -- not bad.

But could Apple continue to boost its dividend by 15% annually over the next five years? Easily. Today, Apple is only paying out about 29% of its annual earnings in dividends. And we shouldn't forget about the $149 billion on Apple's balance sheet either. 

The other factors
A conservative discounted cash flow estimate suggests Apple is trading at about a 22% discount to fair value today. This is a meaningful discount for a market leader, enough to convince me to keep holding onto the stock.

But, chances are, the scenario may be far too conservative. The China Mobile deal alone could add meaningful incremental value to Apple's bottom line. And the rumor mill is abuzz with potential new product categories Apple may enter in 2014; if these new categories turn out to be the disruptors like Apple's iPhone and iPad were, they could be big catalysts.

Here's a peek at my second-largest holding.

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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 December 24, 2013, at 11:15 AM, nickgs wrote:

    peek not peak

  • Report this Comment On December 24, 2013, at 11:31 AM, DanManners wrote:

    Baird analyst Zun Zhang says China Smartphone sales slowing greatly and people hate the 5c and 5c and 5s sales are dying. He feels China Mobile deal is meaningless to Apple sales and that the stock will tank. I think his price target is 385.

    Apple down big today because of that and should be back below 500 soon.

  • Report this Comment On December 24, 2013, at 11:45 AM, gametv wrote:

    daniel - i agree completely. wall street seems to be looking at 2013, where apple profits fell, and assuming that apple is a zero growth company. that is a very poor assumption. apple clearly has a wonderful brand, creates products that customers love and is expanding its presence in international markets. the iphone 5S is a minor upgrade in comparison to the new models that will come out in 2014. looks like more than 1 new iphone 6 in 2014. wall street is also misunderstanding the "iwatch". this opens up a whole new category of wearables, which is probably the form factor for phones in the near future. in the battle for smartphone market share, apple owns the high end and can move down,android owns the low end and it is tougher to move up-market. the ipad pro will help to drive the enterprise and small businesses to apple. and the biggest untold story is the ibeacon and electronic wallet. apple's software adoption rates mean a majority of apple iphones will be wallets within just months of launch. the stickiness of the ios system is very strong and the valuation is simply too low.

  • Report this Comment On December 24, 2013, at 12:01 PM, TheRealRacc wrote:

    Gametv, popular form factor for phones has increased, not decreased. Wearable devices (as the primary cell phone) is several years out. People want an easy to use and easy to read device, which requires a bigger screen (see Samsung's rapid rise to dominance).

    Customers who bought the original iPhone, love their products. People who bought into the iPhone 4 and don't have as strong an affinity to the company, are open to other brands/models (particularly those with larger screens).

    AAPL still has no catalyst to go back to $700, other than the hype machine and its dependence on hype investors.

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