It appears the market is afraid of a possible slowdown in Apple’s (AAPL) growth in its next earnings and has dropped the stock from the $130s in 2015 to below $94 in February, a drop of 20%. This is shortsighted speculating rather than investing. It is time for value investors to be greedy.
Forward estimates are not a science as we see by Morgan Stanley’s (MS, Financial) note in March that said that, per its iPhone tracker, demand for the iPhone for the March quarter is tracking well ahead of the Street consensus. This is after it had lowered its price expectation by 12% in December 2015. This is why a value investor looks at the past actuals rather than forward estimates, which are a form of speculation.
It is time to follow Warren Buffett (Trades, Portfolio)'s advice and be greedy while investors in the market are fearful of a slowdown at Apple. What I see is a franchise company with large-scale profits selling at a wonderful price.
Using some of Buffett's investing philosophies and other factors here is why I think the market is missing something on Apple, and it is time for value investors to take advantage of the valuation speculators have given us.
Business: understandable, consistent growth, huge earnings and the most valuable brand
Although Apple is not something Buffett sees in his circle of confidence, I am comfortable with the business I see. They have two major products, the iPhone and iPad, that are the top and seventh best-selling products of all time. The products sync with one another along with other Apple products and all connect on the iCloud. I also look around and see many iPhone and iPad users who are incredibly loyal to the products and new models that come out.
These products have produced a long-running history of earnings growth to be the No. 1 company in profits even three times as much as Google and more than Exxon (XOM, Financial). And while it is making this much money it has continued to grow like a growth stock. Fears that the growth is going to slow ignore the value of the existing earnings and also are speculative on the future.
The company's revenue and earnings growth in 2015 were 23.6% and 27% (from GuruFocus). The fourth quarter of 2015 actually had earnings growth accelerate to 38% from the previous year. Even though Apple may be facing competition the company has continued to put up the big numbers. Many speculators use the trend as your friend with stock prices but not with earnings.
Charts from GuruFocus are for revenue growth and earnings growth.
Apple has an economic moat. For competitors to catch them, Microsoft (MSFT) would have to increase earnings by 80%, Alphabet (GOOGL) by 200% and Samsung (XKRX:000830, Financial) by 45% (from Fortune 500).
This is a powerful moat as it will take some hard work to get to Apple’s castle. The accelerating growth at the end of 2015 does not make it look like it will be overtaken soon. Along with this Forbes has Apple as the world's most valuable brand.
Management: continue to grow the company earnings, and such a strong company management does not have to be spectacular
Steve Jobs' passing left big shoes to fill, and Tim Cook, who took over in August of 2011, has grown the company and faced challenges with a candid transparency. The main concern most people have is where is the next big product.
The iPhone came six years after the iPod and the iPad came three years after the iPhone (cheatsheet.com). It is understandable that we are coming to six years from the iPad and people are getting restless, and it is not perceived that the Apple watch has been successful so far.
Still Apple has not always been open about what it is working on, they like the dramatic rollout, so things could be on the way. Even so there is time for development with the current scale of earnings it has.
Finally both Buffett and Peter Lynch have said that it is good to own a business that any idiot could run. If you are from the camp that Cook is not a good CEO the stellar earnings growth shows this is a company that any idiot could run.
Cook is doing a good job and knows that products like the iPhone do not pop out all the time. In fact in history there are none who have matched the iPhone so for now it is one of a kind. Still Apple product development is outstanding so I have confidence that a good product will be coming.
Another supporter of Cook’s is Carl Icahn (Trades, Portfolio) who is an activist investor with one of the best investing records around. He often gets involved in companies that are not performing up to their potential. Often his solution is to replace the management, but in Apple’s case he says on Wall Street Week, “I feel so secure with Apple that, if it goes down, I just buy more, I don’t worry,” explaining that “you’re not going to find a better guy to run Apple than Tim Cook.”
Financial: high profit margins, high return on equity, stellar growth
We covered much of this earlier, but Apple’s profit margins are over 30%. The company’s ROE was 59% in the last quarter of 2015 and over 40% for 2015. All this with the highest corporate profits of any company in the U.S. and accelerating growth.
Value: low price earnings, low price earnings to growth, growing dividend and a 34% discounted cash flow calculation, earnings based
Apple’s PE of at this time is around 10, and the historical earnings PEG is .35 with forward earnings being a PEG of .97. These are all good values, and the discounted cash flow earnings based shows Apple at a 34% discount or margin of safety. Apple is a wonderful company selling at a wonderful price, and these are the type of situations a value investor looks for.
DCF Calculator from GuruFocus (click to enlarge)
Further examples of Apple's great value and operating profits is in my due diligence article.
Conclusion
The market is worrying about the next quarter, and that is a short-sighted view. With the large earnings and cash flow Apple should sell at a higher price even if there is not growth. If there is modest growth you have a discount of over 30% on the intrinsic value of the company. If the company does grow faster than expected, which it has been doing, or has a new hit product then this discount is even greater.
On all counts I see the fat pitch we should be looking at. Time to place our orders. What do you think?
Disclosure: I am long Apple.
