Apple Stock Can Easily Reach $450

I often get a little bit of flak from a handful of fellow value investors when I write about owning tech companies such as Apple (AAPL) or Research in Motion (RIMM). How can you call yourself a value investor and own growth stocks like these, they ask? For me it all comes down to valuation, not growth rates. If RIMM trades at 9 times earnings, why would I not want to own it as a value manager? It trades at a huge discount to the market and its peer group. Isn’t that what value investing is all about, finding stocks trading at a discount? If two stocks I am looking at both trade at 9 times earnings, but one is growing at 5% a year and the other is growing at 25% a year, I am going to favor the one growing at 25% a year (all else equal) because it has even more upside. That should not mean that I am abandoning my core investment strategy. When the stock reaches a market multiple and no longer trades at a discount, I will sell and move on.

Which brings me to Apple. How can I justify continuing to own Apple after the enormous move the stock has made over the last decade? Because for some strange reason it still trades at a discount. The company just reported quarterly earnings of $6.43 per share, more than $1 above estimates, giving them an annual earnings run rate of nearly $26 per share. Even after a solid after-hours rally the stock sits at $344 which is really more like $280 after you net out the $64 of cash and no debt on their balance sheet. Apple stock, therefore, trades at an astounding 11 times its annual earnings run-rate,  a 20% discount to the S&P 500 index, which is why my clients still own it.

When will I sell? Well, if we assign a 15 P/E to nearly $26 of earnings and add back $64 per share of net cash, we get about $450 per share. At that price the stock would no longer trade at a discount to either the market or its peer group, so I will move on. Even at $450 growth investors will likely still argue that Apple is “cheap” based on their growth rate (they often are willing to pay up to a P/E of twice a company’s growth rate), but that is a growth investor’s mentality. And although it is hard for some to belief, it is not the one I use when allocating clients’ investment capital.

Full Disclosure: Long shares of Apple and Research in Motion at the time of writing, but positions may change at any time

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6 Thoughts on “Apple Stock Can Easily Reach $450

  1. Michael Price on January 19, 2011 at 11:53 AM said:

    What kind of return do you think they can get on the cash? 6x book seems kind of high.

  2. Chad Brand on January 19, 2011 at 12:05 PM said:

    They’re getting practically nothing on the cash, which is another story entirely (I hate that they are sitting on $60 billion). That is why I simply add the cash to the valuation, whereas if they invested it and earned a 10% ROI it would be worth more to investors. As far as paying 6x book value, I don’t see why you would value a tech hardware company like Apple off of book value.

  3. Michael Price on January 19, 2011 at 3:10 PM said:

    I was originally thinking of valuing the company based on its ROE by book because of the huge cash amount. But, that does not seem to fit, as they do not really use the cash to create income.

  4. Chad Brand on January 19, 2011 at 3:16 PM said:

    Right, and they are really a tech IP and design company and therefore don’t really have much in the way of tangible assets that could make their book value figure all that meaningful to investors. I would love it if they tuned that $60 billion into some type of IT venture/investment fund or something… then they could earn a decent return on their free cash flow and could get a multiple of book value on that part of their business!

  5. Matt Greenfield on January 27, 2011 at 5:30 PM said:

    I agree with your fundamental analysis of Apple, but I would like to add one cautionary note about your “run rate”–the holiday season is Apple’s biggest quarter and they often experience a sequential decline in the following quarter, so you may not want to arrive at an annual run rate figure by multiplying the last quarter’s numbers by 4. But Apple is still very cheap.

  6. Chad Brand on January 27, 2011 at 5:36 PM said:

    That is certainly true but don’t ignore the fact that the opposite happens on the other end… Q4 2011 will be far above Q4 2010.

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