Image source: Apple.
Apple (AAPL +0.10%) is perhaps the most widely followed company in the market. However, investors can often miss the forest for the trees; when you're too busy listening to the latest rumors about a company, you can overlook some major returns drivers. Valuation is one of the most important aspects to consider when making investment decisions, and Apple stock looks remarkably attractive from that point of view.
Apple looks like a bargain
Apple stock is trading at notoriously cheap levels. The company has carried a price-to-earnings ratio of 12.5 times earnings over the last 12 months. When using earnings estimates for the current fiscal year, meaning the 12-month period ending in September 2015, Apple is trading at a P/E ratio near 11.8. By comparison, the average company in the S&P 500 index is trading at a much higher P/E ratio -- in the neighborhood of 18.4.
Importantly, the numbers reported by Apple are particularly clear and transparent. The company 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 tech companies 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.
Apple produced $67.8 billion in operating cash flow during the first three quarters of fiscal 2015, comfortably above the $56.6 billion in operating earnings over the period. Cash doesn't lie, and Apple's cash-flow generation speaks wonders about the quality and transparency of its earnings.
Is Wall Street underestimating Apple?
The main reason Apple stock is so cheap is arguably because Wall Street is expecting growth to slow down substantially as the smartphone market matures. Apple made nearly 63% of total revenue from the iPhone segment last quarter, and the industry seems to be moving beyond the rapid expansion phase. According to estimates by IDC, worldwide smartphone shipments are expected to grow 10.4% in 2015, a considerable deceleration versus a 27.5% increase in 2014.
On the other hand, it's important to keep in mind that Apple still has substantial room for market share gains on a global basis. Based on IDC's calculations, Apple will own just 15.6% of the global smartphone market in 2015, and the company has been stealing market share away from the competition lately.
According to CEO Tim Cook in the latest earnings conference call:
iPhone unit sales grew 35%, which is almost three times the rate of growth of the smartphone market overall and we gained share in all of our geographic segments. iPhone revenue grew even more strongly, up 59%. The strong iPhone results were broad-based in both developed and emerging markets and we experienced the highest switcher rate from Android that we've ever measured.
Apple has recently announced that it sold 13 million new iPhone 6s and iPhone 6s Plus units during the initial sales weekend, which represents a 30% increase from 10 million units for the iPhone 6 and iPhone 6 Plus in the first weekend of sales last year.
A big part of this increase could be the timing of the product availability in China. The iPhone 6 was not available in China during its first weekend of sales, but the iPhone 6s was. Still, even if year-over-year comparisons should be taken with a grain of salt, the numbers look quite healthy at first sight.
Also, Apple is actively betting on innovation with new products and services such as Apple Watch, the new Apple TV, Apple Pay, and Apple Music. According to a recent report from The Wall Street Journal, the company is also firmly committed to building its own electric car, which could be available in the market as soon as 2019.
All of these projects will probably have a discrete financial impact over the coming quarters, but the long-term potential for sales and earnings growth is quite exciting when considering Apple's competitive strengths and the company's track record of success over the years.
Apple stock is trading at bargain valuation levels because Wall Street is anticipating a big deceleration in growth over the middle term. There is a considerable chance the company can do better than expected on the back of sustained iPhone strength and product innovation. If this happens, Apple stock could deliver huge gains for investors.
