September 2012: For Apple Inc. (NASDAQ:AAPL) it was a prosperous time. New products excited investors and consumers alike. Every quarterly report crushed even the most optimistic expectations. There were even talks that Apple could become the first trillion dollar corporation. Two months later Apple Inc. (NASDAQ:AAPL) came crashing down, along with its share price. Concerns about lost market share, recycled products and shrinking margins became the new story. Ten months after reaching its all-time high Apple is now trading 40% lower.
Apple’s share price continued to drop despite record-setting numbers each quarter. We are at a point where it is hard to explain the rationale behind Apple Inc. (NASDAQ:AAPL)’s current valuation. It is trading at a level more in line with a failing company than a company in its prime.
Valuation metrics
The most basic valuation technique is to use a company’s P/E ratio to see how expensive a company’s earnings are. The ratio takes into account everything from the strength of the company’s balance sheet to expectations of future earnings. The higher the ratio the stronger we believe the company is. I selected five companies that share, if not identical, similar traits to Apple Inc. (NASDAQ:AAPL). As you can see Apple’s forward P/E ratio is significantly lower than these peers.
Growth was the main driving force when Apple’s share price shot up, but is also the reason why Apple has dropped the way it did. Growth expectations are baked into the P/E ratio, which could explain why Apple’s earnings are priced as cheaply as they are. Even though companies such as Wal-Mart Stores, Inc. (NYSE:WMT) and Microsoft Corporation (NASDAQ:MSFT) are not known for their growth, for the sake of this argument we will assume growth is why the P/E ratio is so low.
I will be using the PEG ratio to take a look at how much the market values Apple’s earnings growth. The PEG ratio takes a company’s P/E ratio and divides it by expected growth rate. I will be using numbers from the NASDAQ website which uses earnings projections by Zacks Investment Research. Apple Inc. (NASDAQ:AAPL)’s PEG ratio is even more telling as it is under half of the PEG ratios of its peers. The market values Apple’s earnings cheaply not just because of earnings growth.
So what is Apple really doing wrong? As a stock only Verizon has a higher dividend yield than Apple, and like the other technology companies Apple has almost no debt. Other companies also do not have as much cash on hand to support their share price. Apple has $145 billion in cash — 37% of its market cap. This is twice as much as Microsoft Corporation (NASDAQ:MSFT)’s $70 billion, or 25% of market cap, and nearly three times as much as Google’s $50 billion, or 20% of market cap. Apple Inc. (NASDAQ:AAPL) also has plans to return $100 billion to shareholders by the end of 2015. This represents over a quarter of what you would pay per share today.
Irrational Discount
The truth is that Apple’s share price is so sharply discounted because of the lack of investors willing to invest in Apple. The market is often driven by news and emotions rather than fundamental analysis. The irrational fear surrounding Apple’s future prospects has led to an overreaction in the share price. Apple Inc. (NASDAQ:AAPL) has an enterprise value of about $250 billion and generates over $30 billion in cash a year and because of this there is not really much room for Apple to drop further. Apple has reached close to its price floor as it is hard to see it dropping any further.
I believe one should not just buy a company because it is cheaply valued. Beyond its cheap valuation Apple’s true value comes from potential future windfalls. While it is still in the works, any potential iPhone deal with China Mobile could provide a subscriber base of 700 million people and help Apple truly penetrate the Chinese market. Venturing into the world of science fiction, the iWatch could be the innovative change that people have been waiting for. It is a product that could revolutionize technology much like the iPhone and iPad revolutionized the smart phone and tablet industry. Apple’s valuation provides the safety net in case it takes time for everything to pan out.
The article Is Apple Trading at an Unreasonably Discounted Price? originally appeared on Fool.com and is written by Xuebing Wang.
Xuebing Wang has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. Xuebing is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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