Why Apple shares remain grossly undervalued and have nowhere to go but up

Tue, Jan 3, 2012

Analysis, Finance

Though Apple’s earnings continue to grow at an astronomical pace, the company’s share price hasn’t been able to keep up. Sure, shares of Apple have recently been trading in the upper $300/lower $400 range, but its P/E ratio is absurdly low measured against some of the other industry players who haven’t enjoyed, nor are poised to enjoy, the massive earnings that Apple has achieved. At the end of 2011 it was at 14.85.

Commenting on the matter, Andy Zaky a few weeks ago penned a thoughtful article highlighting the many reasons why Apple is the most “undervalued and underappreciated large-cap growth company in America.”

When it comes to the stock market, it’s not so much a game of “how much money are you making now” as it is a question of “how much money will you be making in the future?” This dynamic explains why shares of Microsoft have been languishing over the past 5 years; even though revenues have recently set all-time records, investors remain wary of Microsoft’s ability to grow at an appreciable rate.

But Apple is a different story entirely. Save for the last quarter, Apple has continuously smashed Wall St. expectations every single quarter over the past few years. And what makes Apple’s earnings rise all the more impressive is that it’s revenue is already substantial. Put simply, increasing earnings by 45% when you make $28 billion a quarter is profoundly more challenging compared to a company with quarterly revenue of $350,000. Nonetheless, Apple’s revenue growth the past few years has surpassed the expectations of even the most bullish of analysts.

And yet, Apple’s amazing growth seems to be wholly ignored by business pundits who seemingly place more faith in mysteriously sourced rumors in Digitimes than they do in cold hard numbers. In Apple’s most recent quarter, the company reported a growth rate of 121.94%, its highest growth rate in over 6 years.

“Yet, one would never know this by listening to CNBC, Bloomberg or reading the average article from The Street.com or Business Insider”, Zaky points out. “Instead, the only stories you will see are ones that don’t really matter in the grand scheme of things.”

For example, CNBC likes to trout out Apple’s declining iPod sales, even though that segment of Apple’s business only contributes 4% to Apple’s bottom line. Yet that somehow supersedes the news that Apple’s iPhone sales are growing much faster than the overall smartphone market. Indeed, business pundits have a decidedly pessimistic outlook on all things Apple, so much so that even when Apple products are absolutely destroying a market, these bozos are quick to point out that Apple’s products are bound to tumble eventually.

There’s an unfortunate and constant kernel of hypocrisy that anyone who closely follows shares of Apple is undoubtedly familiar with. For years, investors were quick to put a damper on Apple’s prospects citing the company’s need to find new revenue streams outside of the iPod. But Apple was able to do just this with the iPhone and subsequently the iPad. Yet for some ungodly reason, the pundits at CNBC now decide to harp on iPod sales that, as Zaky points out, don’t play a significant role in Apple’s quarterly earnings anymore. At the very least, you’d think that they’d be smart enough to focus on more pressing issues that make them seem at least marginally aware of the topics they’re covering. And sadly, these are the very same talking heads America listens to these days for financial advice.

We’ve also seen a similar dynamic in the way analysts and business pundits view and interpret the pricing of Apple products. If Apple’s pricepoints are high, analysts are quick to claim that Apple needs to lower its pricing as to gain a foothold in a particular market. If Apple’s pricepoints are low, analysts are quick to question if Apple’s margins will be large enough to really have a significant impact on their bottom line.

Unfortunately, many of the financial gurus tasked with covering Apple look at the company through a lens that obfuscates what really matters – that Apple makes a shit ton of money every quarter and is poised to grow its earnings at a rate that is unprecedented for a company as large as it.

In late 2007, Apple traded at $200 a share after reporting $3.93 in EPS on $24.5 billion in revenue. Turn the pages to 2011 and it’s an entirely different company. In just four years, Apple’s earnings have grown 600% to $27.68, and its revenue skyrocketed 341% to $108.2 billion. That’s the most explosive 4-year growth rate of any large-cap company on the entire S&P 500.

Yet, one wouldn’t know this given the stock’s very sluggish performance, extremely depressed valuation and the media’s permanently negative sentiment on the stock over the past few years. The stock is now trading at an extremely low 13.1 trailing P/E ratio. We’re talking about a valuation level that Apple hasn’t seen in nearly a decade – this despite the fact that the company grew its earnings 82% this year which is the highest in over 7 years. We’re talking about a valuation that is more than 10% lower than the lowest point during the financial crisis.

Zaky next points out that while Apple has increased its earnings by 600% in just 4 years, Apple shares have only increased by 81%.

So maybe all of Wall Street is asleep at the wheel and every company is undervalued.

Not exactly.

The P/E ratios of companies like eBay and Amazon are all higher than Apple’s. And this in spite of the fact that Apple’s recent growth is the highest in company history. Earnings are on the rise, and with a huge ceiling for growth, one can only scratch their head at the buffoonery that drapes the less than nimble minds of Wall Street who can’t see the true value of Apple.

Apple is now trading at the S&P 500 average valuation of 13x despite growing its earnings at a pace that is higher than the top 100 S&P 500 stocks and higher than 90% of the stock listed on the index. By pricing Apple at $363, the market is saying that Apple is worth no more than the average stock. 66% revenue growth and 82% earnings growth isn’t valued at all. Neither is Apple’s $100 billion cash (including fiscal Q1 2012) nor its entire balance sheet for that matter. In fact, Apple is now valued below the average stock trading on the NASDAQ-100 which suggests that the market believes that it is better to hold the NASDAQ-100 (QQQ) than it is to hold Apple from a valuation perspective.

The point of all this, Zaky says, is to illustrate the extent to which share of Apple are undervalued. Consequently, Zaky asserts that the market’s blindness to the reality of Apple’s financials can’t go on indefinitely and that Apple’s inexplicable period of P/E compression will come to an “abrupt end.” After all, Zaky points out, if we assume an even mild growth rate for Apple of 50%, the stock will have to rise substantially just to maintain its shockingly low P/E ratio – to around $577. And if Apple’s P/E ratio should actually rise to appropriate levels, well, then Apple investors might be dancing in the streets.

Put simply, Apple has nowhere to go but up.



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