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Undervalued Apple Has 22.5% Upside Potential

The shares of the world’s biggest technology company Apple Inc. (AAPL) are down 6% this year due to the disappointing guidance for the current quarter. Nonetheless, Apple is still confident about its future, and so is Carl Icahn (Trades, Portfolio) who now owns 1% of the company.

Its previous earnings alone caused a 7.25% drop in share prices on Jan. 27 as the shareholders were disappointed by the company’s lackluster guidance for the current quarter. Subsequently, Apple purchased around $14 billion of its stock which gave some confidence to investors. Apple’s shares however, have still not fully recovered and are still down 3.35% post-earnings.

With the recent buyback, Apple has now purchased a record $40 billion shares in just around 12 months amid pressure from Carl Icahn (Trades, Portfolio). The new buyback was one of the main reasons why Icahn dropped his $50 billion buyback proposal. The activist investor has purchased additional shares of the smartphone maker. According to data provided by GuruFocus, Icahn now owns $4.73 billion worth of shares, or 1% of the company.

Biggest Tech Company

As mentioned earlier, Apple is the biggest technology company on the planet in terms of market capitalization. On the other hand, in terms of enterprise value, Google (GOOG) is ahead of Apple.

Apple’s current market cap is $470.76 billion, whereas Google has a market cap of $404 billion. Considering that Apple has around $141 billion in net cash while Google has $58 billion net cash, Apple has an enterprise value of $330 billion which is short of Google’s enterprise value of $346 billion. In short, according to Mr. Market, Google is more valuable ($16 billion more!) than Apple.

This was being expected as Google’s shares have been rallying while Apple has underperformed. In the last six months, Google’s stock has risen by a massive 40%, easily outperforming the broader S&P-500 ETF (SPY) which is up 12.5%. On the other hand, Apple has lagged behind, rising by only 8% in the corresponding period.

On the other hand, in terms of cash, no other tech company can compete with Apple. The iPhone and iPad maker generates considerably more cash flows than some of the biggest names in the technology space, such as Google, Microsoft (MSFT) or IBM (IBM). This is shown in the picture below.

Source: YCharts.com

In the last 12 months, Apple has generated more than $40 billion in free cash flows. That not only puts Apple ahead of other technology companies but also ahead of most of the other listed companies anywhere in the world.

Enormous Pile of Cash

As mentioned earlier, Apple sits atop a massive pile of cash which, by December, could cross $150 billion if it keeps growing at the current rate. The company’s cash reserves are bigger than the market cap of some of the biggest names in the technology industry such as Intel (INTC), Cisco (CSCO), Hewlett-Packard (HPQ) or Yahoo! (YHOO).

However, most of this cash is located outside of the U.S. Therefore Apple can't use this cash for dividends or buybacks, otherwise it could end up paying a large tax bill. And since the company only uses domestic funds to return cash to shareholders, its foreign cash pile has been growing at a tremendous pace.

According to its previous quarterly filings, Apple’s subsidiaries have around $124.4 billion of its cash, which is about $30 billion more than last year.

The company will eventually have to justify keeping this cash as reserves. It could, in the coming years, use the foreign cash to make a big acquisition, just like Microsoft which used its foreign cash to purchase Nokia (NOK)'s devices and services unit.

Bottom Line

Apple is not the best technology company in terms of enterprise value, but its ability to generate cash flows remains unparalleled. The shareholders have been concerned about the company’s cash reserves lying outside of the U.S., but an announcement of an acquisition could turn into a significant upside for shareholders.

The company’s shares are currently trading at $527.76. According to Peter Lynch’s approach (based P/E of 15), Apple’s shares are currently undervalued. A P/E of 15 would suggest a potential upside of 14.6%. Moreover, a P/E of 16, which is the sector’s average, could suggest a potential upside of 22.5% from the current levels.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


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