2 Reasons Carl Icahn's $200 Value for Apple Stock Just Doesn't Make Sense

Source: Twitter

Love or hate him, few investors today cast a longer shadow than belligerent and activist investor extraordinaire Carl Icahn.

Perhaps Icahn's recent hot streak has him feeling even more brash than usual. Several weeks ago, Icahn once again set his sights on Apple (AAPL -1.18%), this time arguing the tech giant's shares are worth a cool $200. Particularly in the light of Apple's strong earnings yesterday, I'm here to say he's only partially wrong. Here's why. and activist investor extraordinaire Carl Icahn.

Icahn has enjoyed a very validating year in 2014, most notably finally persuading eBay management to pursue his (and many others') long-standing recommendation to split the online auction house into two separate publicly traded companies.

The complete argument is too long to address line by line (link here), but let's examine a few of the most troubling core assumptions.Icahn's case for Apple at $200
There's a common expression used in financial circles to describe financial models and valuation: "Garbage in, garbage out." Financial estimates are as only as good as the assumptions used to produce them, and the underlying assumptions driving Icahn's $200 Apple share price figure are precarious at best.

The most problematic premise for Apple stock at $200 lies in the underpinning growth forecast. Here's how Icahn projects Apple's sales and earnings-per-share growth over the next three years:

Source: Icahn Enterprises press release. 

Not only do these aggressive top-line expectations assume significant successes from already-announced products Apple such as the iPhone 6, 6 Plus, and still-forthcoming Apple Watch, but they also incorporate significant wins from unannounced future projects such as an Ultra HD TV set. However, both the top and bottom-line assumptions are highly implausible.

Between the heightened general interest surrounding its recently refreshed core products, their recent launches in China and other key markets, and its long-established position as the apex of Apple's annual sales, Apple's current first-quarter fiscal 2015 can give us a sense of the kind of growth the company expects in this budget year. Unfortunately for Uncle Carl, Apple guided for revenue growth closer to 10% for its current quarter. Looking at the bottom line, Icahn argues that a slight expansion of gross margin, an assumed lower tax rate, and ongoing share repurchases will help growth outpace revenue expansions. While I agree with this to an extent, I again find his estimates significantly overoptimistic.

Moving further along his argument, Icahn's assumptions hijack the overall thesis.

In finance, it's generally accepted that, all other things being equal, a higher-growth business deserves a more expensive valuation multiple. It's a broad generalization, but more or less accurate. In reviewing Apple's current multiple, Icahn correctly notes that the company still trades at a meaningful discount to the overall market, even despite its double-digit growth outlook. However, noting that his projections assume significantly stronger growth than the broad market's outlook, Icahn justifies using a higher-growth multiple of 19 times his projected 2015 Apple EPS to produce his "fair value" estimate for the stock price. Again illuminating the dubious growth assumptions he uses, though, hopefully you see the problems in using such a rich premium to arrive at his $200 value for Apple stock.

Like I said, garbage in, garbage out.

Only half wrong
Icahn's overly bold assertion does highlight a key opportunity in Apple. The stock certainly shouldn't be worth $200 a share, but it's hard to argue it isn't at least reasonably undervalued at current levels.

Fiscal 2015 should bring renewed and much-needed growth for the world's largest publicly traded company. Expect Apple to set records in virtually every sales category in the year ahead, something that should deliver earnings growth and slight multiple expansion for the company. I'm certainly bullish on Apple's future. But all good investors should be firmly focused on what is likely to happen versus what we'd like to happen. In Icahn's recent forecast for Apple, he erred heavily to the latter. So while Apple stock appears poised to continue to appreciate in the months ahead, I wouldn't hold my breath for it to touch $200 anytime soon.