In the Apple (AAPL, Financial) event yesterday, there were no major announcements, but I view the overall update as positive. After looking at valuation and cash flows, it appears the stock is worth holding for the next three to five years. While I don’t expect Apple to provide stellar upside, the stock will deliver value creation through higher dividends and accelerated buybacks.
Considering Apple’s current price and September 2016 consensus EPS estimate of $9.01, the stock is currently trading at FY 2016 PE of 11.9.
The S&P 500 IT index currently trades at 726 and with 10% earnings growth for 2016, the index EPS comes to $37. I must mention that 10% earnings growth assumption is optimistic as the IT index earnings witnessed a decline in 2015 compared to the prior year. Therefore, the S&P 500 IT index trades at FY 2016 PE of 19.6, which is significantly higher than Apple’s PE.
Further, the S&P 500 index currently trades at a forward PE of 17.3 and even the broader index forward PE is significantly higher compared to Apple. While Apple is unlikely to see strong earnings growth even in the next three to five years, the valuations are still attractive on a relative basis.
Importantly, Apple has a cash glut of $216 billion, and this cash will be increasingly used in the next three to five years for accelerated buybacks. I also expect the company’s dividend payout to increase in the coming years and my point is backed by the company’s operating cash flow analysis.
For the first quarter 2016, Apple reported operating cash flow of $27.5 billion and the cash utilization for dividend and share buyback was $9.8 billion. In addition, Apple incurred capital expenditure of $3.6 billion for the period. This implies total cash outflow of $14.4 billion and on a quarterly basis, Apple still has a cash buffer of $13 billion. In my view, this cash will be utilized for buybacks and dividends with no major investments (as compared to cash flows). I expect Apple will pursue inorganic growth opportunities with focus on disruptive technology.
While my discussion has entirely been focused on the company’s valuation and cash, Apple will also continue to progress in terms of product development and innovation. In 2016 itself, it is entirely likely that iPhone 7 will be launched and new product releases will continue to provide earnings increases on an ongoing basis.
I don’t expect Apple to provide stellar returns in terms of stock upside, but the stock will deliver strong returns to shareholders through dividends and share repurchase. However, I am bullish in the next 12 to 18 months even from a stock upside perspective considering the discussion on valuations in the article. This makes Apple an interesting bet for the medium to long term.
Disclosure: No positions in the stock.
