Apple (NASDAQ:AAPL) stock is having an amazing year, rising by more than 60% over the last 12 months on the back of booming iPhone 6 sales and exciting new product launches. But investment decisions need to be based on future potential, not past performance.
Fortunately for investors in Apple stock, the company still offers considerable room for gains from current levels. In fact, there are strong reasons to believe Apple could be on its way to becoming the first listed company with a market value above $1 trillion.
Apple is still cheap
With a market capitalization in the neighborhood of $725 billion, Apple is the biggest listed corporation in the world. Apple stock would need to appreciate by nearly 38% to reach $1 trillion in market value, and this is a considerable challenge for such a big business.
On the other hand, valuation is not about the size of a company's market cap; its stock price needs to be compared against its fundamentals, and Apple is still attractively valued from that point of view. Wall Street analysts are on average forecasting $8.64 in earnings per share during the fiscal year ending in September. Apple is trading at a P/E ratio of 14.5 if those estimates are correct. By comparison, the average company in the S&P 500 is trading at a forward P/E ratio in the area of 17.6.
A 38% gain from current levels would put Apple's stock price at $173. This would mean a P/E ratio of nearly 20 times earnings forecasts for the current fiscal year. Under such scenario, Apple would be trading at a small premium versus the general market, but nothing too demanding for such a top-quality business.
Explosive financial performance
Apple is truly firing on all cylinders thanks to booming demand for the new iPhone models. Total sales grew nearly 30% year over year during the December quarter. Apple's profit margin is on the rise, and Apple is reducing its share count via buybacks, so earnings per share increased at a mind-blowing 48% versus the same quarter in the prior year.
The December quarter is particularly strong because of the seasonal weight of the holidays. Besides, the period was the first full quarter in which the massively successful iPhone 6 and iPhone 6 Plus models were available in most markets. This means the company should not be expected to sustain this level of performance over the coming quarter. However, everything seems to be indicating that Apple will continue growing at above-average rates over the middle term.
iPhone unit sales grew 97% in BRIC countries during the last quarter, with revenue more than doubling in China, which is now Apple's second largest country market for smartphones. As the mobile computing revolution continues gaining steam in emerging markets, Apple is in a position of strength to continue benefiting from its brand power and product differentiation.
Also, the company owns a gargantuan cash hoard, with more than $178 billion in cash and liquid assets on its balance sheet. The business produced nearly $30.5 billion in free cash flow during the last quarter, so Apple has enormous financial firepower to continue repurchasing stock and increasing dividends in 2015 and beyond.
Why new products are important
The iPhone is the main growth contributor by a wide margin, and that is unlikely to change any time soon. However, Apple is actively innovating and entering new product categories, and this could be a big plus for investors.
Apple Watch will reach the market on April 24, marking Apple's formal entry into wearable computing. It's far too soon to make a clear assessment about the product, but given that Apple is all about design and creating an enjoyable customer experience, a smartwatch sounds like a good way to capitalize on the company's strengths.
Apple Pay is reportedly off to a strong start, and if it continues doing well, it could allow Apple to produce recurring revenue from its gigantic customer base, as opposed to selling new devices to generate revenue.
The company has recently reduced the price of Apple TV from $99 to $69, and rumor has it that Apple will launch a revamped version of the product in June. On a longer term basis, Apple seems to be exploring the possibility of building its own electric vehicle, so the pipeline appears to be full of promising projects with big disruptive potential.
Considering the size of the business, these new ventures will hardly move the needle by much in the beginning. However, if Apple can prove it has the ability and drive to continue bringing successful new products to the market, this could do wonders for Apple stock in terms of valuation and upside potential.
Stock prices cannot be predicted with precision, especially in the short term. On the other hand, when considering Apple's valuation, financial performance, and growth potential, a market capitalization of $1 trillion sounds quite plausible over the middle term.
Andrés Cardenal owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.