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:

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.