That kind of looks like a mountain landscape I would see from higher elevations out here in Oregon, but instead it is a 1-year chart of Apple (AAPL) stock. After Tuesday's solid but uninspiring fourth quarter earnings report, Apple's quick fall from perceived market darling to "just another large cap tech stock that is being passed by on the innovation front" has reached a crescendo. The magnitude of the drop from the September high of $705 now sits at -37%. Instead of $800 price objectives, some are suggesting $300 may be more fitting. How times have changed in just four months.
Apple earned $44 per share last year, giving the stock (at the current $445 quote) a trailing P/E of 10x. Free cash flow in 2012 was $47 billion, giving the stock a 9x free cash flow multiple. The P/E is actually lower if you use free cash flow instead of reported earnings. That hardly ever happens and shows you just how cheap the shares are right now. And don't forget the $137 billion ($145 per share) of cash that Apple has in the bank). Subtract out the cash position and investors are getting Apple's operations for just $300 per share ($285 billion). That equates to a trailing P/E of 6.8x and 6.1x times last year's free cash flow.
How do those numbers compare to others? The P/E is lower than Microsoft, Intel, Cisco, IBM, and Oracle. The free cash flow multiple is unheard of. Try finding any other company that trades at 6x free cash flow, in any industry!Now, I did write about a month ago that I thought Apple stock was cheap at $525 ("Apple Shares Now Nearly As Cheap As Microsoft: Which Would You Rather Have?") so it should come as no surprise that I think it's super cheap at $445. The point is, even if you think both their growth and margins have peaked, it is not easy to justify the stock being at $445 or $300 net of cash. The business would have to decline meaningfully from here for that to make sense.
Sure, it's not impossible, but is that the most likely outcome? Is it likely that Apple's share of the tablet market declines meaningfully? Is it likely that their share of the smartphone market declines meaningfully? Remember, those end markets are growing, so just maintaining current market share results in Apple's business growing, not declining from here. Is it likely that they never come out with any new products? A television? A lower cost tablet for the education market to replace expensive, heavy textbooks? A streaming radio competitor to Pandora? Something else that has not yet been rumored already (those three have)?
Yes, it is possible that nothing positive happens for Apple from here on out. That they have peaked and will graduate to "old tech" like Gateway, Dell, HP, Intel, or Microsoft. But that is what the stock is priced for right now. To me, that does not seem like the most likely outcome. And if some things start to get better, or if Apple's 80,000 employees use their $137 billion of excess cash to create something new and great again, then the current stock price might look a little silly.
There is a difference between growth rates and profit margins peaking and massive deterioration in sales and profits. The stock has broken down technically, emotions are running high, analysts are slashing their price targets, and there are no catalysts to turn things around in the short term. But all of that could change fairly quickly. And given how cheap the stock is and how much money the company continues to print each day in its stores and on its web site, I just don't think fair value on Apple is a 7 trailing P/E multiple.
But we will just have to wait and see. I am willing to wait this out and will likely selectively add to client positions in the stock.
Full Disclosure: Long shares of Apple, but positions may change at any time.