Apple's (NASDAQ:AAPL) Valuation may be Justified Only If Investors are Bullish on Growth

Apple Inc. (NASDAQ:AAPL) has recovered from the March 7th lows and is not trading for US$2.9t. The company seems unfazed by fears of recession and is considered one of the more stable stocks in the market. We will re-evaluate the company with today's metrics, and see if investors are overpaying.

For a quick glance, we summarize the results of our analysis as:

• Apple is a safe(er), high cash flow stock, entering a mature growth phase
• The return on market equity seems to be below the cost of equity - resulting from the high stock price
• Apple has stable earnings, but the P/E implies high earnings growth
• The company can be seen as trading below intrinsic value, if investors are bullish on growth

Check out our latest analysis for Apple

We will start with the fundamentals, and see how that results in Apple's valuation.

Fundamental Performance

In the chart below, you can see that the company is expected to continue with steady state growth and keep post 2021 revenue levels.

Take a closer look at the fundamentals below.

Analysts don't expect to see much growth for Apple - which shouldn't be surprising since the company already covers a high market share. The expected annual revenue growth is 5.5%, while for earnings it's 4%.

Exploring Apple's Growth

In the last 5 years, Apple Inc. had a CAGR of 11.6%, while last year, revenues increased by 28.6%, which is mostly a reflection of the changed demand during the pandemic. Since analysts are predicting 5.5% growth, we can assume that Apple's growth is approaching mature rates.

Older companies do grow above the inflation rate - However, they find it harder to introduce new avenues of growth, which is why single digit growth is more common.

We will also review how growth scales in relation to costs. In the last 12 months, Apple's revenues grew 8.9% more than the growth of costs of goods sold. This indicates that Apple is running a more efficient operation, creating value for shareholders.

Returns & Margins

Apple has also improved its profit margin from 21.6% in 2021 to 26.6% in the last 12 months. This, has an effect on returns, and Apple's current Return on Capital Employed is 50%, up from 25.7% three years ago. Note, that metrics like ROCE and ROE are inflated, because Apple is reducing the book value of equity with buybacks.

Or, we can use the earnings yield, which is the market value of equity / earnings. For Apple, that comes up to $0.1t / $2.9t = 3.4%

By using the market value of equity, we see that Apple is making a relatively low yield. This is an indication that investors may be overpaying for the company.

We will analyze the price vs. value metrics in the next section.

Relative & Intrinsic Value

We will start by analyzing how much investors are paying for Apple based on current and forward earnings

Apple made a profit of US$100.5b in the last 12 months, this gives them a P/E of 29x, which is higher than the market P/E of 16.9x. When we see a difference like this, we should remember that the higher the P/E, the more growth in earnings is needed in order to justify the valuation.

Looking at 2022 earnings, we see that next year, analysts expect flat growth, which makes the forward P/E about the same as the current. This may not be a good sign, as investors are paying a high price for earnings with little implied growth.

There are possible catalysts that can bump Apple's future growth, which includes the implementation of the new generation chips for their devices. However, these are expected to be delayed until late 2022 for the MacBook Air and even later for other devices.

The second approach we use to see if a stock price is justified, is an intrinsic valuation.

We rely on analyst future estimates to build our intrinsic model, and for Apple we get an intrinsic value of US$195.9 per share, meaning that the stock is slightly (8.7%) undervalued.

Our model predicts that by 2031, Apple will close to double its cash flows, which should reach about US192b. If investors are comfortable with this forecast, then they may find our intrinsic model to reveal a slight upside to the stock.

Alternatively, we can just take next year's free cash flows, assume steady state growth and calculate the present value of the company as:

106.561 / (0.072-0.024) = US$2.220t, (2.2 Trillion), or US$136 per share. In this case, the stock seems to be some 30% overvalued. 

You can explore our relative and intrinsic valuations for Apple HERE.

Conclusion

The business is reaching maturity and there is less room to grow than before. This is not reflected in the current PE ratio for the stock, as the market seems to expect high earnings growth given its 29x PE.

The earnings yield also indicates that the stock is yielding less than its cost of equity. Even with the last jump in profit margins.

Investors that want to rely on analyst estimates for future growth, will find that the stock is slightly undervalued. However, if you are bearish on growth and assume that the company can hardly grow above the current 2.4% risk-free rate, you might find that the company is some 30% overvalued.

Keep in mind that valuations are highly subjective, and different analysts will come up with different results!

Part of the reason why Apple's stock may be moving higher, can be as a result of passive index funds, and investors prioritizing safer companies in their portfolios.

Next Steps:

Are you a potential investor? If you’ve been keeping tabs on AAPL, now may not be the most optimal time to buy, given it is trading around its fair value. However, the positive outlook means it’s worth diving deeper into other factors, such as the strength of its balance sheet, in order to take advantage of the next price drop.

If you'd like to know more about Apple as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that Apple has 1 warning sign, and it would be unwise to ignore it.

If you are no longer interested in Apple, you can use our free platform to see our list of over 50 other stocks with a high growth potential.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.