With Apple Inc. (NASDAQ:AAPL) trading below $500, value investors are starting to come out of the woodwork. Buying one of the world’s most powerful tech companies at bargain prices sounds like a sure win. Still, it is not a done deal. Academic research shows that using price to earnings (P/E) ratios from multiple years is a much better predictor than earnings from the trailing 12 months. Apple Inc. (NASDAQ:AAPL)’s ten year P/E is far above its 12 month P/E ratio and this should cause some hesitation.
Apple Inc. (NASDAQ:AAPL) sells high-end computing devices. iPhones have grown to become its greatest revenue driver at more than half of all Q2, 2013 revenue. iPads and Mac computers are second and third, respectively. The company has come a long way from the nineties when it was struggling to compete with Microsoft Corporation (NASDAQ:MSFT) in the PC market. With the iPod and the iPhone, Apple Inc. (NASDAQ:AAPL) completely leapfrogged Microsoft and took computers to where the modern consumer is; mobile and on the move.
Where is the future heading?
Apple Inc. (NASDAQ:AAPL)’s competitors continue to catch up and Apple Inc. (NASDAQ:AAPL) must be ready for a fight. The Asia Pacific region provides precious growth. In Q2 2013 Greater China grew 8% year-over-year (y-o-y), Japan grew 19% y-o-y and the rest of Asia Pacific grew 26% y-o-y. Still, competition is heating up and many Android phones are cheaper than iPhones. Companies that track internet traffic show that the trend-setting cities of Hong Kong and Singapore have seen substantial falls in the iPhone’s market share relative to Android.
Google Inc. (NASDAQ:GOOG) offers Android as an open-source operating system (OS) in the mobile computing space. It is a healthy and free alternative to the costly prospect of developing a proprietary OS. Hardware without software is worthless and Google Inc. (NASDAQ:GOOG) is working hard to bring its app store up to the level of Apple’s iTunes store. Still, Apple’s tight control over its OS helps to create an easier environment for app developers. This is one area where the company has an advantage over Google.
Google makes the majority of its money from its search engine, but it continues to move into related markets. With Google Fiber, the company is becoming a direct provider of internet services. Overall, Google’s growth has slowed from a five-year EPS growth rate of 20.5% to a three year growth rate of 12.1%, but it continues to maintain its market share in its core search engine business.
Microsoft Corporation (NASDAQ:MSFT) is profitable, but it is fighting for its life. In Q1, 2013 PC sellers had their worst sales drop in 20 years. Microsoft’s Surface tablet has not performed as well as was hoped. For simple consumer needs like checking email, looking at the news and updating social networks, smartphones are a simpler and easier solution than a traditional PC. Microsoft’s five year earnings per share (EPS) growth rate of 3.8% is nowhere near Apple’s five year EPS growth rate of 59.6% or Google’s five year EPS growth rate of 20.5%.
AAPL PE 10 data by YCharts
What about the broad market?
To gain some perspective it is helpful to take a look outside of the tech industry. Robert Shiller’s cyclically adjusted 10-year P/E ratio is a useful and long-term look at the market. By taking a 40,000′ view it provides a better idea of just how reasonably priced stocks are. Current valuations around 22.6 are rather expensive and five-year total real returns are expected to be around 2.5% to 5%.
S&P 500 Cyclically Adjusted Price-Earnings Ratio data by YCharts
Where does this place Apple?
Apple’s 10-year P/E ratio of 30.7 is far above Shiller’s cyclically adjusted 10-year P/E ratio of 22.6. Both ratios take a roughly comparable long-term view. Relative to tech giants like Microsoft or experienced oil and gas firms like Exxon Mobil Corporation (NYSE:XOM), Apple is still a young company. Its high P/E 10 ratio and low one-year P/E ratio imply that a degree of caution is necessary.
Conclusion
Apple has not yet proved that it can maintain its current earnings. This does not mean that Apple is a bad investment, but that long-term investors are making a bet that management will be able to maintain its price premium. A one-year P/E ratio has some predictive power and paints Apple as a good deal. For value investors looking to add a little flare to their portfolio, Apple is a good fit. Very risk-adverse investors would find a better fit sticking with broad-market ETFs.
Google’s one-year price-to-earnings ratio of 24 is significantly higher than Apple’s, but Google has a very stable position in its core search engine market. Google is not a deep value play, but it is a good investment given expected internet adspend growth. Microsoft is more of a gamble. Even though its search engine is improving, its one-year P/E ratio of 16 is rather expensive considering its challenges in mobile.
The article Is Apple Really a Value Play? originally appeared on Fool.com and is written by Joshua Bondy.
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