Apple (NASDAQ:AAPL) has been a darling of the market all year long. Shares of the technology giant are up roughly 40% in 2014, compared to the market's 12% gain. Recently, Apple's stock price has taken a dip due to the sell-off in the broader market. With such impressive gains in the book and Apple's stock price looking shaky, it may be tempting to take profits and sell out. But that would be a huge mistake.
Apple isn't cheap, but it's far from expensive
It's true that Apple isn't cheap, and it certainly isn't the screaming bargain that it was last year, when it traded as low as $55 per share (split-adjusted). Right now, Apple trades for 16 times trailing earnings, which is below the market's average valuation. This is striking because Apple's earnings are likely to grow strongly next year. Consider that Apple registered 6% revenue growth and 13% earnings growth this year, without the benefit of new products for most of fiscal 2014.
Apple's recently released iPhone 6 is only starting to show up in its financial statements, but its impact could be enormous. Apple sold 10 million of the iPhone 6 and iPhone 6 plus models just in its first weekend. And, it's worth noting that this figure didn't even include sales in China, where the iPhone 6 wasn't available until October.
Apple sold 39 million iPhones last quarter. This represented 12% growth in units sold just from the previous quarter. As a result, Apple's fiscal fourth quarter was its strongest revenue growth in seven quarters. Apple saw huge success for the iPhone across its geographic markets last quarter, with 26% sell-through growth, which indicates strong underlying demand for the iPhone.
Analyst estimates currently peg a wide range of potential iPhone sales next year. JP Morgan analyst Rod Hall offered an aggressive prediction of 235 million iPhones sold next year. If this proves to be accurate, Apple could generate $141 billion in iPhone revenue next year, even if average revenue per unit sold holds steady at last year's $602. This would provide Apple with 38% revenue growth just from the iPhone next year.
Other product releases, including the Apple Watch, will fuel even more growth next year. Sales estimates vary, but analysts with RBC Capital project the Apple Watch will generate $10 billion in revenue next year, which would contribute 5% revenue growth next year on its own.
Overall, analysts expect Apple to earn $7.76 per share in fiscal 2015. This would represent 19% earnings growth year over year, which seems achievable thanks to rising estimates for the iPhone 6 and the Apple Watch, plus contributions from Apple's other products. Since Apple is still modestly valued, there's plenty of room for Apple's valuation and earnings multiple to expand. The median analyst target price for Apple is $122 per share, which would represent a valuation of 15 times next year's average EPS estimate. This may be too conservative, since a 15 multiple for 2015 earnings is just on par with the market multiple. Investors would likely be willing to pay a higher multiple than this for above-average earnings growth. The highest current price target for Apple is $150 per share, which means Apple would trade for 19 times earnings next year. That represents a 31% return from here, not including dividends.
Continue to hold Apple through the product refresh cycle
Based on the product releases that will boost Apple's profits in 2015, I'm betting the company will out-perform its rather modest expectations. Analyst estimates still look too low considering the many catalysts Apple has working in its favor, and if Apple can manage to top these projects, its valuation multiple is likely to expand. And, there's always Apple's dividend, which is surely set to grow as its earnings grow, too. Apple pays a 1.7% dividend yield, which is slightly below the market average, but Apple increased its dividend by 7% in 2014 and by 15% the year before. The $11 billion in dividends paid to shareholders in fiscal 2014 accounted for just 22% of Apple's free cash flow. That leaves plenty of room for future dividends to grow at double-digit rates.