Why Apple Stock Could Be Worth $120

As Apple stock nears its all-time high, is the stock really worth more than $100? Even more, is it undervalued?

Aug 9, 2014 at 11:00AM

With Apple's (NASDAQ:AAPL) second-quarter behind it, it's a good time to return to valuation. Also, with the stock nearing its all-time high, it's worth returning to some important questions:

  • What is the company actually worth?
  • Are investors who buy shares today getting a good deal?
  • Can investors who own the stock today expect to get a decent return on their investment over the long haul?
  • What exactly is the intrinsic value of Apple stock?

Let's find out.

Apple Store China

Apple store in China. Source: Apple.

Searching for a moat
Before attempting to value any company, it's important to first decide if its business looks sustainable in the first place. Without durability, buy-and-hold investing is rendered useless. So, does Apple have a sustainable competitive advantage?

Warren Buffett refers to sustainable competitive advantages as economic moats.

"In business, I look for economic castles protected by unbreachable moats," Buffett has said. 

The harder it is for competitors to grab a piece of a company's profits, the wider and deeper a company's moat. Common sources of moats include switching costs, network effects, intangible assets, cost advantages, and scale.

Itunes Radio Tmf

iTunes works seamlessly across Apple's products. Source: Apple.

In an environment of rapid change, economic moats are even more important when looking at technology stocks. But tech stocks with predictable staying power are few and far between. Fortunately, Apple is one of them, with a number of powerful sources for its moat. Here are some of the most prominent sources for Apple's moat:

  • Intangible assets: Apple's brand is incredibly powerful, evidenced by the premium prices consumers have paid for its products for decades.
  • Switching costs: With an incredibly robust ecosystem of competent products that work together seamlessly, the purchase of one Apple product often leads to another. This makes Apple's ecosystem of products "sticky," which makes it difficult to move away to another platform.
  • Scale: It's difficult for manufacturers to match the quality of Apple products. With basically more money than it needs for research and development and for locking in third-party supplier contracts, Apple can use its scale as an operational competitive advantage.

With a powerful brand, a "sticky" ecosystem of products and services, and operational scale, Apple looks poised to sustain high levels of profitability for years. This makes the stock a prime candidate for valuation.

Apple stock valuation
With top- and bottom-line growth rates having slowed in recent years, a discounted cash flow valuation model is a good fit for Apple stock. After all, the value of every asset is ultimately equal to the present value of discounted cash flows -- and Apple's free cash flow has enough history for us to make reasonable assumptions about the future.

It's fairly easy to create a bullish case for the stock using a discounted cash flow model. If Apple's free cash flow increased by only 3% per year in perpetuity, or at the historical annual rate of inflation, and future cash flow was discounted at a rate of 10%, the fair value of Apple stock is $120.

If you doubt that Apple can grow its future cash flow at 3% annually over the long haul, keep in mind that a discounted cash flow valuation puts for more weight on the free cash flow in the years in the near-term than it does in the years further out. So, if Apple is able to grow its free cash flow in the next five years at more meaningful rates than 3%, yet rates fall below 3% over the longer term -- a similar case could be made.

Iwatch Concept

iWatch concept design by SET Solution. If Apple's rumored iWatch proves to be both a meaningful driver to earnings and wholly accretive to Apple's business, these inputs for Apple's free cash flow growth may prove to be too conservative. Image used with permission. Watch a video of this concept here.

Further, not all cash flow is created equal. Fortunately, Apple investors know that its free cash flow is prone to create value. Management and the board of directors have historically proven their fiduciary responsibility to shareholders. In recent years, for instance, Apple initiated a dividend and, more importantly, ramped up its repurchases when shares were trading at post-split levels around $60 to $80 -- far below today's levels close to $100.

The company has also been very conservative in the prices it pays to acquire companies, with its acquisition of Beats Electronics for $3 billion as its largest ever. This figure pales in comparison to some of the billion dollar deals made by Apple's smaller peers. And, looking further back, there's no doubt Apple's investments in new products have panned out nicely. So, compared to many other companies, Apple is likely to outperform its peers when it comes to the use of free cash flow.

In a discounted cash flow analysis, conservatism is key. Counting on just 3% annualized growth of free cash flow per year over the long haul, this scenario purposefully underplays the continued potential of Apple's iPhone line and other new products we could see in the coming years. Yet these conservative inputs still yield a fair value estimate of $120 per share for the stock -- or a margin of safety of about 21%.

With such a meaningful margin of safety to a conservative estimate of Apple's fair value, this market leader looks like it will be a rewarding investment for those willing to hold over the long haul. Perhaps Apple's 15.4 price-to-earnings multiple and its 11.9 price-to-free cash flow ratio really are as cheap as they look.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

[Editor's note -- Added additional commentary to Apple's Beats acquisition]

Daniel Sparks owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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