Apple Stock (NASDAQ:AAPL)
The fact that the value of Apple stock is getting closer and closer to $3 trillion is a significant contributor to the fact that the S&P 500 (SPX) has gained 15% so far in 2018. That justifies taking a closer look at the valuation, which is consistently high in comparison to the overall market.
The current price of Apple stock (NASDAQ:AAPL) is approximately 29 times the earnings per share that analysts tracked by FactSet anticipate the company to deliver over the course of the next year. This is approximately fifty percent higher than the comparable figure for the S&P 500. It is not unheard of for the shares to sell for such a premium, particularly during times when the market is favoring technology stocks.
According to the conventional wisdom on Wall Street, the sum in question is justifiable given the numerous years of earnings growth that Apple is expected to deliver, the high quality of the business, and the cash that is currently on hand. However, the growth rate isn’t exactly skyrocketing, and the valuation appears to be absurdly high at first glance.
According to Brian Macauley, portfolio manager at Broad Run Investment Management, who was asked about the valuation, “a pedestrian rate of earnings growth,” “I would think it’s likely to go down,” It is not the stock that belongs to Broad Run.
Nevertheless, when everything is taken into account, the valuation does make some sense.
Earnings growth on its own is not sufficient to make the case for Apple, despite the fact that there is much to like about the possibility that Apple’s profits will increase. The general opinion on Wall Street is that the company that makes the iPhone will see an increase in its earnings per share of approximately 9.8% on an annualized basis during the three years beginning in 2024. Because the company is able to raise prices on the newest iPhones and continue to expand in areas such as streaming and payments, it is anticipated that sales will increase to $489 billion by the year 2026, representing an annualized rate of increase of just over 7%.
Even if the rate of expansion in those businesses slows down generally, Apple can still make progress in certain areas. According to the observations of Dan Dolev, a payments analyst at Mizuho, PayPal (NASDAQ:PYPL) appears to have lost market share to Apple Pay.
Dan Ives, an analyst at Wedbush Securities, predicts that the company’s market cap will reach $4 trillion by the year 2025. This growth potential can be traced back to “the power of the Apple ecosystem,” he said. The fact that Apple products are used by billions of people immediately establishes a ready market for any new services the company may introduce.
Buybacks of stock, which reduce the share count and therefore increase per-share profits, are expected to boost EPS growth from what can be expected from a 7% increase in sales to the 9.8% that Wall Street has penciled in. Buybacks of stock reduce the number of outstanding shares of a company’s stock.
However, earnings per share (EPS) growth of less than 10% is probably not enough on its own to justify the current multiple of the stock. The current valuation of the S&P 500 is 19 times earnings, which is approximately 2.3 times the 8% compound growth in aggregate EPS its component companies are expected to achieve over the next two years. In contrast, the comparable figure for Apple is approximately 2.93 times.
If Apple’s so-called PEG ratio, as that metric is known, were to match the number for the S&P 500, the tech company’s price/earnings ratio would be down to approximately 22 times, which would imply a significant loss for the stock. Apple’s PEG ratio is known as the price-to-earnings ratio.
The fact that Apple has a cash reserve of $166 billion is also an important consideration. Apple, in contrast to most other companies, has more cash on hand than it owes, which means that the market value of its stocks is higher than it would otherwise be. The cash hoard totals 57 billion dollars after deducting all of the debt.
If Apple did not have any net cash, its market cap would fall to $2.833 trillion, which is lower than the current value of $2.93 trillion. That would bring the current share price down to $180 from its current level of $186, bringing the P/E ratio down to 28 and the PEG ratio down to 2.85, both of which are still higher than the figure for the market as a whole.
The difference of 0.5 can be attributed to investors’ expectations that Apple will be able to maintain moderate growth for longer periods of time than the typical technology company. The stock market is giving Apple credit for its ability to leverage its brand and scale to continue expanding, which makes perfect sense given that rising profits mean that dividends and buybacks can grow, thereby supporting the share price.
Ives stated that the company has “the best install base of any consumer products company in the world,” which is the basis for these expectations of consistent profits over the long term.
The fact of the matter is that there are good reasons to think that Apple should be trading at such a significant premium to the S&P 500. However, this does not necessarily imply that investors should rush to purchase the stock. The best times to purchase it are when it is being dragged down by a decline in the market as a whole.
Featured Image: Unsplash @ Masaaki Komori
