Getting Real About Apple Inc. (AAPL)

The adjusted P/FCF, obtained by subtracting the net cash from the market capitalization, is about 6.4. The most profitable company to have ever existed is trading at 6.4 times its free cash flow.

Valuation

I’ll use a discounted cash flow calculation to value Apple in each of my three scenarios. For my discount rate I’ll use both 12% and 15% to define a fair value range.

1). Slow-Growth Scenario – Apple grows its free cash flow at a rate of 6% annually over the next 10 years and 3% annually after that.

2). No-Growth Scenario – Apple maintains its current free cash flow indefinitely.

3). Death Spiral – Apple’s free cash flow declines by 3% annually for the rest of time.

The fair value range for all three scenarios are shown below.

The same market that only a few months ago was predicting Apple stock would continue to $1,000 and beyond is now pricing Apple at a level that assumes that the company will whittle away into nothingness. Apple’s valuation is now similar to that of Microsoft, which I’ve written about here. Both companies have huge amounts of cash and are valued in the mid-single-digits times free cash flow. Apparently the expectation is that both companies have unsustainable profits. This seems unlikely.

The Bottom Line

Apple, much like Microsoft, is currently priced at a completely irrational level. The pace at which overwhelming optimism has turned to overwhelming pessimism is astounding. In the short term I have no idea what Apple stock will do. But the stock is almost certainly worth far more than the current market price.

The article Getting Real About Apple originally appeared on Fool.com and is written by Timothy Green.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.