On Thursday, ExxonMobil handed over the title to Apple (AAPL +0.63%) once again as the world's most valuable company. Riding a solid third quarter and intensifying rumors for an iPhone and iPad refresh, Apple stock is up about 17% since it reported earnings. But even as the world's most valuable company, the stock still looks like an absolute bargain.
I'll show you why.
Valuing Apple
Every business is ultimately worth its projected future cash flows discounted by the time value of money -- it's that simple.
So, what can we expect for Apple's future earnings potential?
Though Apple's revenue and EPS growth rates are certainly slowing, rosy guidance from management and likely next-generation iPhones and iPads signal that year-over-year comparisons could begin to move upward once again. Analysts seem to agree. Apple analysts, on average, expect Apple to grow EPS by 18.3% per annum for the next five years.
But let's be a bit more conservative, estimating that Apple will grow EPS in line with the historical rate of inflation (about 3%) for the next decade and beyond.
Given these assumptions and using a 10% discount rate, a discounted cash flow valuation yields a fair value for Apple shares of $619.
Investors, of course, don't want to buy a business at fair value. They want to leave room for error. In other words, investors want a margin of safety. Fortunately, today Apple trades at about a 25% discount to $619, giving investors a decent margin of safety.
Not bad.
Too conservative?
Apple has been stirring the pot and cookin' up some surprises.
"[W]e are laser-focused and working hard on some amazing new products that we will introduce in the fall and across 2013," said Apple CEO Tim Cook when the company reported third-quarter results.
If Apple's history of cranking out new products that deliver for shareholders is any indication of what the future might look for, this estimate could be way too conservative.
It's not every day investors can identify a market leader with products customers still love trading at a discount to a conservative estimate of the company's worth.
For investors with time horizons longer than five years, Apple stock is a strong buy.
