Source: Apple.
Jack Hough from Barron's has published a compelling article explaining why Apple (AAPL 2.07%) stock could easily return 25% in the coming year. These kinds of forecasts are nothing more than estimates, and they're always subject to errors and revisions. However, the numbers look quite solid, and there are valid reasons to believe Apple stock could return 25%, or perhaps even more, in the year ahead.
By the numbers
Apple stock would need to rise to $160 from a current price in the neighborhood of $128 to gain 25% in a year. The dividend yield is currently 1.5%, and the company will most probably raise dividends again in April, so even a slightly smaller price increase could bring the total return for investors to 25%.
With a market capitalization of nearly $748 billion, Apple is the most valuable publicly traded corporation in the world, and a 25% rise for such a gigantic company is clearly no small potatoes. On the other hand, such a rise would not be too demanding in terms of valuation.
Wall Street analysts are on average forecasting that Apple will earn $8.59 per share in the current fiscal year. Under such a scenario, a stock price of $160 per share would mean that Apple would be trading at a P/E ratio around 18.6, roughly in line with the current P/E ratio for the average company in the S&P 500 Index.
The quality of earnings
Even after rising 25% in the coming year, Apple would be still be reasonably valued, especially considering that the company's reported earnings are of higher quality and more transparent than the numbers many other tech companies have reported. Apple reports earnings on a GAAP basis, meaning that earnings figures account for variables such as expenses related to issuing stock to employees, which many other industry players typically exclude from their adjusted earnings figures.
Cash flows can be a more transparent metric than earnings, since they aren't as prone to accounting manipulations and adjustments. Apple runs its business in a remarkably efficient way, and it collects money from sales before it pays suppliers, allowing the company to generate massive amounts of cash flows on a consistent basis.
Source: Apple.
Apple produced $33.7 billion in operating cash flows during the last quarter, comfortably above the $24.2 billion in operating earnings during the period. Free cash flows were $30.5 billion in the quarter, materially higher than the net income of $18 billion. Cash doesn't lie, and Apple's cash-flow generation speaks wonders about the quality and transparency of its earnings.
In addition, Apple owns $178 billion in cash and liquid investments on its balance sheet, versus only $36 billion in debt, for a net cash position of $142 billion. This means that more than $24 per share, or nearly 19% of the current stock price, is backed by net cash.
On growth and innovation
Apple crushed Wall Street forecasts in the last quarter, as the company delivered a massive 30% sales increase. On the back of expanding profit margins and share buybacks reducing the amount of shares outstanding, earnings per share jumped by a mind-blowing 48% year over year.
iPhone unit sales grew 97% in BRIC countries during the quarter, with revenues more than doubling in China, which has become Apple's second largest country for smartphones. As the mobile revolution expands to emerging markets over the middle term, Apple is remarkably well positioned to continue capitalizing on its leading brand power and quality differentiation.
Source: Apple.
The company is entering new product categories in 2015, with Apple Pay and Apple Watch, which will be go on sale in April. On a longer-term basis, although the company hasn't confirmed the rumors, there are strong reasons to believe management is working on an electric-car project, too.
Even if these products won't have a big financial impact on sales and earnings over the short term, they still show that the company is actively focused on innovation, and that it has exciting new products in the pipeline. It's hard to forecast sales growth with any precision, but considering the company's current performance and future growth opportunities, it wouldn't be a big surprise to see Apple delivering above-average growth rates in the coming years.
In a nutshell, considering valuation levels, earnings quality, and future growth prospects, a 25% return in Apple stock over the coming year sounds like a reasonable scenario. In fact, the figure could even be too conservative if Apple's new products outperform expectations.
