Ahead of Apple's earnings, the numbers tell it all: If shares don't soar after its quarterly report, it will likely trade at valuation levels not seen since the depths of the financial crisis, making it the cheapest large-cap tech stock.
By Andy M. Zaky, contributor
FORTUNE -- As Apple prepares to report its fiscal second quarter results after the bell on Wednesday, a huge question on investors' minds is whether or not the stock's multi-year run will finally come to end. While nothing is certain, there is good reason to believe the bearishness in Apple is over, and that a new powerful rally is looming on the horizon.
If Apple is trading anywhere near the current price level come Thursday morning, the stock will become just as undervalued as it was during the financial crisis. Why? Because unless Apple's stock absolutely skyrockets over the next few trading sessions, its trailing price-to-earnings ratio -- currently at 18.5 -- is going to significantly contract due to the near 100% rise in quarterly earnings expected out of the company tomorrow. For an in-depth preview of what to expect out of Apple's upcoming earnings, see Philip Elmer-DeWitt's exhaustive earnings preview.
Based on a poll taken from top analysts who have near perfect accuracy in projecting Apple's quarterly earnings, Apple's trailing 12-month earnings per share is expected to rise from the current level of $17.92 to nearly $21.00 this week. This means that in order for Apple (AAPL) to maintain its already depressed P/E ratio, the stock would have to rise to $388.50 by Thursday. And that would only keep the stock trading at an 18.5 P/E ratio, which happens to be at the lowest end of its historical two-year range.
And if the stock doesn't move up at all or moves down on earnings, Apple's trailing P/E ratio will drop below 15.8 -- the lowest level since the market's March 2009 lows. This is exactly what makes tomorrow's earnings one for the books. Either Apple's stock will have to jump by more than $55 to keep its already miserable P/E ratio in tact, or the stock will likely fall to its lowest valuation since the depths of the financial crisis.
According to my colleague, Apple analyst Horace Dediu, who maintains a technology blog called Asymco, "On a growth-adjusted basis, Apple's P/E ratio is well within depression levels." As his chart above indicates, Apple normally trades between an 18 and 24 trailing P/E ratio. Only during the lows of the financial crisis, when the stock was outrageously undervalued after funds indiscriminately liquidated their equity positions, did we see Apple's P/E briefly drop into the 12-17 range.
In fact, on a valuation basis, if one is able to buy Apple at $320-$330 a share on Thursday morning, it will be the equivalent of buying the stock for about $100 around March 2009. Yet, even though Apple is trading at less than half of its expected five-year growth rate, one could always ask: why does the historical range even matter? Why does Apple's stock have to trade in its historical range of 18-24? Why shouldn't it trade between 10-15 like Microsoft (MSFT), Cisco (CSCO), Intel (INTC) or IBM (IBM)?
The fundamental difference between other large cap tech stocks and Apple is Apple's unique cash generating abilities, its cash position, and its extraordinary 70% growth. Apple trades at a lower cash multiple than any other large cap tech stock and has more net cash on the balance sheet than any other company in the S&P 500. At a $305 billion market capitalization, Apple trades at only five times its cash. Remove that cash from its market capitalization, and Apple trades at only a $245 billion enterprise value, or $268 a share -- that's only 14 times earnings.
But even more impressive is Apple's ability to generate cash. In the last four fiscal quarters alone, Apple's total cash rose 50% from $39.8 billion to $60 billion -- a jump from $43.26 in cash per share to $64 in cash per share. Based on very realistic projections, Apple will probably end the year with $81 billion in cash, or $86 in cash per share. For the 2012 fiscal year, it will likely post at least $120 billion in cash or $125 in cash per share.
In fact, it is very likely that Apple will have more cash than its current market capitalization in less than five years. Once Wall Street begins to catch on to this reality, Apple shares should see a major upside correction. And this is precisely why Apple shouldn't trade below a 20 P/E ratio over the next several years.
In fact, if Apple traded between a 10-15 trailing P/E ratio, it would almost immediately become a buyout candidate. On CNBC's Fast Money, host Guy Adami has mentioned on several occasions over the past month that he thinks that Apple could trade down to $270-$280 a share this fall. The most reputable Apple analysts all expect it to report at least $27 per share in earnings for the 2011 fiscal year, which ends in October. If Apple is trading at $270 a share in November, as Adami predicts, and the analysts are right, it would be trading at a mere 10 times trailing earnings.
This doesn't seem like a big deal until one considers Apple's cash, cash generation, market capitalization and forward earnings expectations. At $270 a share, Apple's market capitalization would be $248.7 billion. Yet, after backing out Apple's $81 billion in cash, the company would trade at an enterprise value of $167.7 billion -- theoretically, the price it would take to buy the company outright. This compares to Microsoft's $180 billion enterprise value.
But Apple not only posts nearly double Microsoft's revenues, it also grows at a pace that is three to four times that of Microsoft's and it has four times Microsoft's cash generating abilities. Apple would also trade near Google's (GOOG) enterprise value despite recording more than four times its revenues and having four to five times more cash than Google -- not to mention that it far outpaces Google's 17% growth.
However, that isn't even the most important reason why Apple won't likely trade down to $270-$280 a share come November. With shares at that level, Apple probably wouldn't be listed on any stock exchange except SharesPost. With the company producing nearly $50 billion in cash per year, a leveraged buyout of Apple at $200 billion -- a premium to its $167 billion enterprise value -- would pay itself off in 3-4 years at most. Who wouldn't take that opportunity? In fact, Apple would be remiss not to take itself private if it trades anywhere near $270 a share in November.
It's clear that Apple should trade at a P/E ratio somewhere between 18 and 22, with a 20 P/E being where it's appropriately valued. In the short-term, it may take time for some on Wall Street to grasp the recent outright supernova in Apple's cash generation -- which is up nearly 20% last quarter alone -- in the end, Apple tends to gravitate towards fair value. I suspect that once Wall Street sees the cash growth in Apple's fiscal second and third quarter, we'll start to see another significant run-up in the stock price.
Based on my expectations of Apple recording $27.30 in EPS on $111.7 billion in revenue for fiscal 2011, Apple should trade well into $500 a share sometime between October and December this year. That is up from my previous price target of $400 share that I published this past August. For the short term, expect Apple to trade up quite significantly over the new two trading weeks as it will probably reach fresh all-time highs by next Friday. Given the recent rare opportunity to buy Apple at an extremely cheap valuation, I've been betting on some 2011 Apple leaps over the past few weeks and plan to remain long Apple for an extended period of time.
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The fact that your so upset only serves to prove that Apple's platform does matter. If it didn't, why would you even care? It seems you're just spiteful of Apple's decision to not to allow Flash, apparently the only development platform you know of.
If people like you weren't so blinded by their own opinions, you would actually understand that Apple doesn't allow any 3rd party sub-systems or runtimes on their platform. It really doesn't have anything to do with Flash.
@Stephane Beladaci
Wow, you are an angry guy. Just would like to say, Flash is awful (see all Android devices supporting it).
@Stephane: Mucho sorry that Apple screwed you over so badly that it's created such incredible hate in you. But I do want to let you know that it's really rough in a capitalism-based society, especially for application developers like us (despite Apple having already paid out over $2B to developers; unclear how much the rest of the industry has paid out).
And it's even tougher to succeed when you don't know and understand the true facts.
Flash simply sucks. Adobe should have skipped that and better move on with the cool stuff they used to come up with. I mean, really? I hated Flash since its beginning for not being open, for circumventing web standards. What about SVG (by adobe)? So, go on write up about your world in that snow bowl and give it a rest.
@ Stephane Beladaci: I dare you to short AAPL.
@Stephane Beladaci
What about the fact that you are a senior Adobe Flex designer? Also Apple is sticking out for the open web not your closed platform, LOL
If you guys spent time improving Flash may be it will work better than the crash prone crap that it is.
Again, over and over again, stop saying wall street doesn't love apple. It is literally the most loved stock by wall street. Merrill, Goldman, and Morgan all had it as 2011 top pick, over 90% of analysts following are bullish, target prices are over 30% the current price. Stop misstating simple facts. Apple is the apple of Wall Street's eye.
As to why it trades at such a low multiple...well, that's just because you will either make a TON of money, or in 3 to 4 years, it will not be selling the hottest product on the planet (just like it was not doing so 3 to 4 years ago...) It's a 50/50 of doubling or 50% loss. Thus is and always will be the life of a consumer electronics company.
Nice work Andy. Lots of good points that will, most likely, go unheeded.
@Stephane: why don't you take your copy-and-paste troll and go back to your sandbox
RE: Post By Stephane Beladaci, Los Angeles, CA: April 19, 2011 12:01 PM
Really "Stephanie"??? Adobe shill much ???? So you write one of the viral programs I have to use "FLASHBLOCKER" against! Get back to your job at Adobe. You still have a lot of work to do since there are still some computers not infected with virus and trojans yet.
@Stephane Beldaci - please stop copying and pasting the same (very long) comment onto every AAPL story.
We get it, you develop Flash apps and don't want to jump through hoops to work with Apple. Guess what - the tens of thousands of developers who code for App Store make a lot more money than the bitter ones crying about "openness" and universality.
In the entirety of your rant, you don't make a single argument about the strength or weakness of AAPL as an investment idea. Your blog post re: Flash is irrelevant in this setting.
Great article and analysis Andy! Thanks for putting this information together.
Seriously? The dividend argument? This is 2011, not 1971.
Write covered calls against the common stock. Even with extremely conservative strikes that will never be exercised, you can easily earn 2-5x the dividend return of other shares.
You cannot generate the same returns on those other dividend shares precisely because their boring growth rates do not generate enough IV to make CCs worth the effort.
70% institutional ownership. Who do you think is writing options every week and month, and then pinning it nearly every week and month at max pain? Dividends are peanuts compared to this income stream.
Well, what about the fact that Apple has been so desperate to maintain its artificial dominance (entirely due to the fact they got on the market first) by having anti competitive, illegal and arrogant behaviors?
What about the fact that the mobile market is not driven by devices or platform but by us, application developers?
What about the fact that while Apple was desperately trying whatever it can to screw everyone (developers, businesses, publishers, advertisers and even its own customers) and destroy the web, Adobe has been laughing all the way to the bank by imposing its Flash Platform as the #1 application development platform that allows us, developers to build once and deploy everywhere?
What about the fact that Steve Jobs attempted to kill Flash not because it is outdated but because it is too good and a threat to Apple's "divide and rule" strategy and a direct threat to iTunes and AppStore?
What about the fact that the European Competition Commissioner gave Steve Jobs a reality check by constraining Apple to reverse its change of TOS aimed at blocking the port of Flash application to iOS?
What about the fact that FTC constrained Apple to approve Google Voice?
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