Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Worries about Apple's (AAPL +3.26%) strategy of introducing a incrementally improved iPhone 8 alongside a revolutionary iPhone X (at a price high enough to spark a revolution) are looking well-founded. Earlier this year, an analyst even argued they could force Apple to kill the iPhone X.
So you may be surprised to learn that, despite all the negativity surrounding Apple these days, one analyst is stepping up and recommending that you buy it -- and naming a really optimistic target price to boot.
Here's what you need to know.
One stock is the apple of DA Davidson's eye. Care to guess which? Image source: Getty Images.
Upgrading Apple stock
Ace analyst DA Davidson -- which ranks in the top 10% of analysts we track on Motley Fool CAPS -- is the one singing Apple's praises this morning, in a note covered on StreetInsider.com (subscription required). And while Davidson doesn't dispute that Apple shares are under pressure -- down 5% year to date -- this analyst has every confidence that Apple can turn things around.
Running down the list, Davidson names three key areas that it believes could serve as "[p]otential catalysts for shares":
- Growing iPhone sales, which already constitute nearly 62% of Apple's revenue.
- Posting better-than-expected results from its newer products, including the Apple Watch and HomePod.
- And/or by returning more money to shareholders through "an accelerated repurchase effort and increase in dividends following the changes to the U.S. tax code."
Cash is king
DA Davison reminds investors that Apple has "the most valuable global brand" and is arguably "one of the most significant technology companies in the world," both arguments in favor of why its sales strength should continue after the bump in the road that we call iPhone X, and why consumers might warm to Apple's Watch and HomePod offerings (despite the seemingly commanding lead that Amazon has established with Echo).
More important than sales per se, though, Davidson highlights Apple's "strong share in the premium (high-margin) markets for smartphones and a growing (but select) number other devices," to bolster the argument that the company's profits could be quite strong even with just modest sales growth.
Speaking of margins...
As for the "returning money to shareholders" part of Davidson's buy thesis, the analyst points out that "high margin and large sales figures enable the company to generate significant free cash flow, which it increasingly returns to shareholders via buybacks and dividends." Indeed, over the past 12 months Apple generated $52.7 billion in free cash flow, which not only fully backs up its $50.5 billion in reported GAAP net income, but actually outpaces it.
With a dividend payout ratio of just 25%, Apple can more than afford to maintain its modest 1.4% dividend yield, and indeed, has plenty of cash firepower with which to increase that dividend, accelerate share repurchases -- or both -- if it has a mind to.
Valuing Apple stock
But is Apple stock a buy, as DA Davidson argues it is? Is the stock worth the $220 a share that Davidson says it should sell for? After all, Apple stock only costs about $167 a share today. If Davidson's right, then investors at today's prices are buying the stock for nearly 25% off its true value, which seems a pretty sizable discount on a stock with such high visibility. Could savvy Wall Street investors really have failed to have noticed a valuation mismatch of this size in a company of such high profile?
Well, let's see here. At a market capitalization of $838.5 billion, Apple stock sells for about 15.9 times trailing free cash flow, and about 16.6 times trailing earnings. Analysts quoted on Yahoo! Finance peg the stock for 13.2% long-term annual earnings growth. Add 1.4% of dividend yield to that number, and you can expect to get about a 14.6% return on Apple stock -- not enough to make the shares a screaming bargain at 16.6 times earnings (or 15.9 times FCF, either) -- but probably not a terrible price to pay for "the most valuable global brand" in the world.
A word about debt
One final thought before I close. Some investors may point out that with cash of $77.2 billion and debt of $122.4 billion, Apple's net debt load is about $45.2 billion. That makes Apple stock about 5% more expensive than meets the eye, which could be enough to push the stock out of "buy" territory.
That's a valid point, and worth bearing in mind. What you should also bear in mind, though, is that buried on Apple's balance sheet and not obvious to the casual eye (or perhaps to Wall Street), are nearly $208 billion in investments in long-term marketable securities -- accumulated as a direct result of Apple's massive free cash flow machine. Factor that near-cash-equivalent into your valuations, and Apple is actually not in a "net- debt" position at all, but arguably cash-positive on its balance sheet -- and about $163 billion cheaper than its market cap makes it appear.
With what I'd argue is an enterprise value closer to $675 billion, or 20% cheaper than its market cap, I believe Apple is still cheap enough to buy -- and I agree with DA Davidson that the stock is a buy.
