AAPL is Radically More Undervalued than Others in the Tech Sector

As the U.S. equity markets continue the long process of making a bottom in what is now consider to be one of the worst bear markets in history, tech investors should begin to shift their focus on a comparative valuation analysis of the leaders in the tech industry. Tech companies with solid balance sheets, large cash hordes and solid growth rates will fair a lot better in a market recovery than those whose valuations did not dramatically deflate over the past year. Of the nine big tech companies I’ve reviewed, AAPL stands out as being the most radically undervalued in the tech sector on an objective basis.

Apple has more net cash than each of the nine big tech stocks, zero debt, trades at the lowest price-to-cash ratio of only 3.79, grew earnings faster than every other tech company except for RIMM, and is generating almost $3.00 per share in free cash flow every quarter. Just to get an idea of how undervalued Apple is compared to others in the tech sector, one need only to consider where these other tech companies would stand if they were valued in the same way as Apple i.e. if those same companies were met with the same general bearishness that Apple is faced with.

A lower price-to-cash ratio literally indicates the level of bearishness in a stock price. A price-to-cash ratio of 1 indicates that the market believes the company will not be profitable in the future. A price-to-cash ratio of less than 1 indicates that the market believes that the company will contract in the future by “pricing in” a future loss of cash. Out of the nine companies listed in the table below, the market is most bearish on Apple—considering the highly deflated price-to-cash ratio.

Valuation Table for 9 Large Cap Tech Companies

Stock Price

Trailing P/E

12Month EPS

EPS Growth

Total Cash

Total Debt

Operating Cash Flow

P/OCF

Cash
Per Share

Price to
Cash

Market
Cap

AAPL

$104.55

13.97

$7.48

78.50%

$24.49B

$0.00

$9.69B

7.06

$27.57

3.79

$92.87B

RIMM

$47.92

15.61

$3.07

100.65%

$1.55B

$6.91M

$1.73B

13.05

$2.75

17.45

$27.04B

GOOG

$358.00

22.28

$18.82

31.33%

$14.41B

$0.00

$7.42B

13.22

$45.87

7.81

$103.54B

AMZN

$56.89

39.02

$1.46

67.82%

$2.32B

$435M

$1.09B

20.66

$5.42

10.49

$24.40B

MSFT

$23.00

12.16

$1.91

20.13%

$21.17B

$0.00

$21.61B

8.49

$2.32

9.13

$204.68B

CSCO

$17.87

13.67

$1.56

16.42%

$26.24B

$6.89B

$12.09B

7.12

$4.45

4.02

$105.40B

IBM

$88.20

10.97

$8.48

27.52%

$9.85B

$34.23B

$17.35B

8.29

$7.27

12.13

$119.50B

INTC

$14.94

11.90

$1.26

18.87%

$12.20B

$2.36B

$17.67B

4.18

$2.18

6.85

$83.71B

HPQ

$35.40

10.97

$3.45

25.91%

$14.85B

$10.22B

$14.92B

4.81

$6.06

5.15

$76.36B

Apple Compared to the Four Horsemen of Tech
Below, I offer a comparison of Apple to the four horsemen of tech to help illuminate the degree to which Apple is undervalued. Apple’s stock price is devalued significantly more than Google, Research in Motion and Amazon:

Apple v. Google
Apple grew its adjusted earnings at a pace of 78.5% in 2008. Google, on the other hand, grew its 2008 earnings at a pace of only 31.33%. Apple has $24.49 billion or $27.57 per share in cash while Google only has $14.41 billion or $45.87 per share in cash. Yet, even though Apple grew its earnings at more than twice the pace of Google, Apple trades at about half the trailing P/E that Google trades at. What is even more surprising is that Apple trades at less than half the price-to-cash ratio that Google trades at. Google currently trades at 7.81 times its cash position while Apple trades at a depressed value of only 3.79 times its cash position. If Google traded at the same price to cash ratio that Apple is trading at, Google would be valued at $173.84. Yet, setting aside the price-to-cash ratio, if Google even traded at the same deflated P/E ratio that Apple is currently trading at; Google’s shares would be priced at $262.91.

Based on these metrics, Apple is far more undervalued than Google on an objective basis. There is no reason why Google should have a larger market capitalization than Apple especially when Apple is producing more in operating cash flow ($9.69 billion v. $7.42 billion) than Google, grows its earnings at more than twice the pace of Google, has almost twice the cash position of Google, and makes more in revenue than Google does. Wall Street is certainly irrational when it comes to comparative valuation, and this case is certainly no different.

Another way to think about this is to consider which of these companies an investor would buy if he or she had $110 billion in cash. Which seems to be a more obvious investment? Is Google a better buy at $103.54 billion or is Apple a better purchase at $92.9 billion? Remember, Google has only $14.4 billion in cash while Apple has $24.49 billion in cash. This means it would literally cost the investor only $68.38 billion to buy Apple while it would cost him/her $89.13 billion to buy Google. It would take that investor 7 years to pay off his/her investment in Apple while it would take over 13 years to pay off his/her investment in Google. Such an investment would make no sense considering the fact that Apple produces more in free cash flow than Google and produces more in cash earnings.

Apple v. Research in Motion
Based on the numbers above, Apple is clearly a much better investment than Research in Motion. First, AAPL trades at almost half the price to free cash flow that RIMM trades at. Also, RIMM doesn’t grow at a sufficiently higher rate than AAPL which might justify giving RIMM a price-to-cash ratio of 17.45 while giving AAPL a price-to-cash ratio of only 3.79. Secondly, RIMM’s market capitalization is simply too large when compared to AAPL. When backing out cash positions from market capitalization, AAPL’s net market cap is at $68.38 billion while RIMM’s market cap is at $25.49 billion. Considering the fact that AAPL produces $9.69 billion in operating cash flow while RIMM produces a relatively meager $1.73 billion, Apple is simply a significantly better investment. If RIMM were given the same price to cash ratio that Apple is currently trading at, RIMM would be trading at $10.42 a share—nearly 80% lower than where RIMM trades at today. If it were given the same deflated P/E ratio, RIMM would be trading at $42.89.

Apple v. Amazon
This comparison is an absolute joke. I simply cannot understand how the market could give a retailer such as Amazon a 39.02 P/E ratio while giving Apple, a company that has clearly demonstrated that it can withstand a slowdown better than most, a 13.97 P/E. I would not even go long Amazon with Kathryn Huberty’s money. Amazon has only $1.86 billion in net cash, produces less in operating cash flow than even Research in Motion, holds one of the highest price-to-cash ratios (10.49) of any other tech giant, and grew its earnings at a rate significantly lower than Apple and RIMM. Moreover, Amazon also has the highest price to operating cash flow ratio than any other tech giant in the sector (20.66). Of the nine companies listed in the table above, Amazon presents with the least attractive valuation. The market has too much trust in Amazon and I haven’t seen enough bearishness in the stock to justify an entry relative to others in the tech sector. I’m not saying that Amazon isn’t undervalued in on an objective basis, but it’s just less undervalued than GOOG, RIMM, MSFT, AAPL and others.

In terms of a comparison, Apple has $24.49 billion in net cash versus Amazon’s $1.86 billion. Apple trades at 3.79 its cash position while Amazon trades at 10.49 times its cash position. Apple trades at 7.06 times operating cash flow while Amazon trades at over 20.6 times cash flow. Amazon has a net market cap of $22.54 billion while Apple has a net market cap of $68.38 billion. Amazon grew earnings at a pace of 67.82% in 2008 while Apple grew its adjusted earnings at a pace of 78.5% in 2008. There is no reason why Amazon should deserve three times the P/E ratio given to Apple. Apple grows its earnings at a faster pace than Amazon, has 12 times the amount of cash of Amazon, makes far more in net income than Amazon, trades at less than half Amazon’s operating cash flow ratio, trades at roughly 1/3 the price-to-cash of Amazon and is better situated than Amazon going forward. While the market might not figure this out over the next few months, eventually the market will realize that Apple is a far better investment and will likely revaluate the companies accordingly. I’m not arguing that Amazon is not undervalued, but that it is far less attractive at current levels than others in the sector.

Why the Market is Bearish on Apple
The data above merely indicates that the market is extremely bearish on Apple. Yet, it does not explain why the market happens to be bearish and whether the market is right in its assessment. There are several reasons why the market happens to be particularly bearish on Apple. Yet, some of those concerns are way overblown, and some are outright irrational. Below are list of reasons why the market is bearish and whether the market is right in its assessment.

1. Major Concerns regarding the Health of the Consumer
The main reason that the market is particularly bearish on Apple has to do with overblown fears regarding a consumer-lead slowdown affecting Apple’s business. The idea here is that since consumer spending and sentiment are hitting multi-year lows, Apple’s business cannot function at any reasonable level. Many in the market have argued that since Apple is “supposedly” entirely consumer discretionary, that the consumer is going to cut back its spending on products such iPhones and iPods. Many have asked: how can anyone possibly afford to buy an iPod when they can barely afford consumer staples?

This concern is obviously overblown beyond epic proportions. First, while economists have been drumming the recession 2008 beat, Apple’s Mac sales, iPhone sales, Mac revenue, iPod revenue, total revenue, EPS, net income, free cash flow, cash growth and iTunes revenue have all been accelerating. Not just growing, but accelerating. There is nothing in Apple’s 2008 quarterly earnings reports that have indicated that the consumer has slowed down. At best, the 2008 “recession” has had only a negligible if any impact on Apple’s business. The market destroyed Apple’s stock price in January over these very same concerns which never materialized. Even in Q4, analysts were extremely cautious on Apple’s earnings taking the stock down from a high of $180 to a low of $148 post Q3 earnings due to concerns regarding Apple’s fourth quarter—concerns, which once again, never materialized. While the market was busy falling off of a cliff in June on concerns of stagflation, people were lined up around the block to buy iPhones—not tickets into homeless shelters as the media had investors believe.

Moreover, the market has already priced in a complete destruction of Apple’s business. So any slowdown that may or may not occur is already fully priced in. This is clearly evident by the analyst consensus estimates for 2009. The analysts are modeling for Apple to earn $5.36 in EPS on $37.61 billion in earnings for 2009. Apple earned $5.36 in EPS on $32.48 billion in revenue in 2008. Thus, the analysts are literally modeling for 0.00% growth in earnings for 2009. As an analyst, I have never seen more irrational consensus estimates in my career.

First, the numbers are not even consistent. The analysts are modeling for Apple to earn $5 billion more in revenue for 2009, but nothing more in EPS. This has largely been the result of overblown concerns regarding Apple’s gross margin for 2009. Gross margins will probably rise rather than fall in 2009 as discussed in Turely Muller’s article entitled “Apple’s FY09 Gross Margin Expectations Are Too Low.” Turley Muller, a chartered financial analyst, makes a persuasive case that Wall Street cannot seem to wrap their heads around.

Second, the revenue estimates for 2009 are simply out of touch with reality. For starters, Apple entered into 2008 with only $346 million in currently deferred revenue from sales of the iPhone and Apple TV. That means that Apple got an $86.5 million revenue boost each quarter in 2008—current deferred revenue is recognized over the course of the year. Yet, entering into 2009, Apple has a whopping $3.518 billion in current deferred revenue that it gets to recognize in its earnings reports—that’s $880 million in revenue that Apple gets to automatically recognize each quarter in FY09. Said another way, the analysts believe that Apple is only going to make $1.958 billion in new revenue in 2009. That is a bold statement considering the fact that Apple just sold 6.9 million iPhones in Q4 2008 amounting to $3.787 billion in revenue. If Apple sells just 10 million iPhones in all of fiscal 2009, the deferred iPhone revenue from those sales alone would result in Apple earning the $1.958 billion in revenue difference even if Apple’s growth rate was flat across all of its operating segments and in all of its primary operations for the year.

2. The false perceptions regarding Apple’s dependence on iPod Sales
As I argued earlier this week, iPod sales made up only 14.2% of Apple’s total revenue in Q4 2008. As a matter of fact, iPod revenue is making up an ever decreasing portion of Apple’s overall revenue. Moreover, even if Apple were as dependent on the iPod as many would have investors believe, iPod revenue actually accelerated in 2008 indicating that the consumer opted to buy more expensive iPods in 2008 than it did in 2007. And it did so with more enthusiasm than between 2006 and 2007—hence the revenue acceleration. Most market participants invested in Apple know so little about the company that they automatically assume that all Apple does is sell iPods. Nothing can be further from the truth as indicated by the 14.2% number for Q4.

3. Particular Events leading to Apple’s Stock Collapse: A Week by Week Detail
Most of Apple’s recent fall in share value from $180 in August to $85.00 in October can be attributed to four particular events. While the stock would have undoubtedly been beaten with the rest of the broader market in this recent crash, it was far more beaten down due to events outside of the general correction. First, Apple’s September iPod event amounted to nothing more than sell the rumor, sell the news. The stock got hammered from $170 from the date of the press release of the event to $152 on the day of the event itself—concerns over Steve Jobs’ health trumped an otherwise average media event. The broader market barely started to correct at that time. As a matter of fact, the DJIA was actually flat during that week.

After Apple’s 5-day sell-off from $170 to $152, Apple headed into the next week with the bankruptcy of Lehman Brothers on Monday and the imminent collapse of AIG on Wednesday. Apple was simply the victim, as was every other stock in the market, of general liquidations, bearishness and panic selling. The stock price fell from $152 on Monday to a low of $120.00 that Thursday before participating in a two-day market rally sparked by a ban on short selling, which helped bring Apple’s stock price back up to $140.92 that Friday. That $12.00 fall in share price that week was due to general bearishness in the market and was part of the process of Apple’s correcting itself with the indices.

While the following Monday was largely uneventful for the market, Apple’s stock took a $10.00 tumble after Kathryn Huberty of Morgan Stanley cut her price target on Apple from $192 to $179 citing general weakness in the global economic environment. After struggling to stay afloat, Apple closed the week at $128.24. The following Monday, just one week after Kathryn Huberty cut her price target on Apple from $192 to $179, she allegedly felt that something fundamentally changed in five days that would warrant a second downgrade of Apple in as many weeks. She cut her price target from $179 to $115 citing the same nonsense she cited the week before. Apple’s stock price took a blood bath gapping down from $128.24 to $119.00 before collapsing into a death spiral where panic selling took the shares down $28.00 before it rebounded to $115.00 in inter-day trading. Unfortunately for Apple, congress decided not to pass the bailout bill that day which led to another $10.00 drop in the stock price before the close of trading. So in all fairness to Huberty, Apple would have probably taken a bath, but I doubt it would have collapsed $23.00 due to the failed bailout plan. Most stocks fell around 10% while Apple fell close to 20% that day.

The rest of the sell off from $105 to $85 was largely due to the collapse witnessed in the market in the ensuing weeks where 800 point down days in the DJIA became a thing of the norm. The reason I outline the specific details regarding the fall in Apple’s stock price is because it’s important to parse out exactly how much of the breakdown was due to the sell-off, P/E contraction and revaluation in the broader market, and how much of the collapse was owing to specific identifiable selling events which might have pushed Apple’s stock price lower than where it would have otherwise landed if not for those events. It’s important because Apple’s current stock price might not be a general reflection of the market sentiment regarding Apple’s fundamentals, but rather the adverse result of a series of identifiable extra-market selling. If much of the fall was due to selling events rather than to revaluation and general contraction, then the current stock price might simply be the result of Apple’s inopportunity to retrace losses against broader market selling rather than the result of a bearish valuation. A case can be made here considering the fact that Apple has outperformed the market for the month of October. On a market rebound, one might expect the stock price to rally harder than the broader market. Whatever the case might be, Apple’s current valuation presents one of the best investment opportunities for 2009. More to come.

Disclosure: Long Apple, Google, and Rimm

11 Responses to AAPL is Radically More Undervalued than Others in the Tech Sector

  1. Another OUTSTANDING article based on Facts and numbers and a run down of events leading up to where aapl stands now. This kind of professionalism and detailed analysis is is light of rationalism in a year of sensationalist rumours, hysterical conclusions and apacalyptic predictions about Apple Inc. Andy, you do a geat service to investors
    with your truth finding analysis. Thank you!

  2. I would have expected to see an industry beta calculated and maybe the valuation of a levered firm? Although Apple has cash, leverage can increase the value of shares.

    You’re focusing on a few (less than 5) ratios, and most of them have to do with cash. That’s a very, very narrow analysis and skewed in Apple’s favor. There are many, many more ratios that contribute to valuation.

  3. Andrew Abraham

    Very thorough article… but can’t cheap get cheaper… we have been chatting about this on Myinvestorsplace.com…. and even with this rally…many think it is a bear market rally… Maybe you join us on myinvestorsplace.com… You have a great deal of knowledge to share…thanks

    Andy

  4. Speaker to Wolves

    Anon said…
    You’re focusing on a few (less than 5) ratios, and most of them have to do with cash. That’s a very, very narrow analysis and skewed in Apple’s favor. There are many, many more ratios that contribute to valuation.

    Kathryn, is that you? Trying to justify a horribly inaccurate valuation?

    Seriously, what other ratios are you referring to? By any measure, Apple is tremendously undervalued.

  5. Constable Odo

    Ultimately, let’s face it. What smart investor wants to put money into a stock that is going to totally collapse if anything happens to the CEO. Analysts, whether, they’re right or wrong have already said that Steve Jobs is Apple and Apple without Steve Jobs will be worth 20% to 30% less the day he leaves or whatever reason.

    Although I think this is totally absurd, I’m sure WS and the media will be sure to attempt to destroy Apple if it does. Any owner of Apple stock basically has a guillotine hanging over his or her head just waiting for it to drop because of Apple’s supposed total dependence upon Steve Jobs.

    Apple will never be worth what you’re saying it is because although you see all the numbers properly, you don’t seem to comprehend that most humans are generally stupid and think in terms of emotions. Any teenager blogger can send Apple stock into a tailspin. I often wonder what type of investors Apple is made up of. Mostly day traders, I’m guessing that trade on every rumor thrown up.

    I’ve been long for years and don’t pay much attention to daily rumors. But it seems a lot of Apple investors do and that’s why Apple rises and falls so much in a day. That very frightening to watch despite the fact Apple, the company, is as solid as can be. Why the heck should Apple jump up so much on RUMOR of a buyback that is almost never likely to happen? Because Apple investors really don’t know why a buyback isn’t even necessary for such a healthy company.

    So even though you have all the reasons why Apple’s stock should be higher and stronger and less volatile, here we sit with a stock that is as fragile as the next cockeyed rumor. This makes the stock not so good an investment compared to the other horsemen of tech.

    I’m staying with Apple but I’m not sure if it’s the greatest buy as you say it is. I happen to like their products and have used them for over 20 years. Maybe I’m just a loyal fool.

  6. Kathryn, is that you? Trying to justify a horribly inaccurate valuation?

    No, it wasn’t. I have a long position with Apple but to answer your question, here are a few ratios that are used in the valuation of a company.

    Average Collection Period, Average Obligation Period, Breakeven Point, Capital to Non-Current Assets, Cash and Marketable Securities to Current Liabilities (Acid Test), Cash Balance, Cash Breakeven Point, Cash Debt Coverage, Cash Flow From Operations to Net Income, Cash Flow from Sales to Total Sales, Cash Flow Ratio, Cash Flow to Debt, Cash Maturity Coverage, Cash Return to Shareholders, Contribution Margin, Contribution Margin Ratio, Current Ratio, Days of Liquidity, Debt to Assets, Debt to Equity Ratio, Defensive Interval Period, Expenses to Current Assets, Fixed Charge Coverage, Fixed Costs to Total Assets, Fixed Coverage, Growth Rate in Retained Earnings, Inventory Conversion Ratio, Inventory Turnover, abor Costs to Net Income, Labor Costs to Sales, Labor Costs to Total Costs, Long Term Debt to Shareholders Equity, Margin of Safety, Net Income Increases to Pay Increases, Net Income to Fixed Charges, Non-Current Assets to Non-Current Liabilities, Number of Days Inventory, Operating Income to Wages and Salaries, Operations Cash Flow to Current Liabilities, Overhead to Direct Labor, Overhead to Variable Costs, Payment Period, Payment Period to Average Inventory Period, Payment Period to Operating Cycle, Profit Margin Ratio, Quick Ratio, Repairs and Maintenance to Associated Assets, Return on Assets, Return on Investment, Sales to Accounts Payable, Sales to Break-Even Point, Sales to Cash, Sales to Current Assets, Short Term Debt to Depreciation, Short Term Debt to Liabilities, Short to Long Term Debt and Times Interest Earned.

    I do very complex technical analysis on companies. Just using simple cash or earning ratios will give you a very narrow perspective.

    A complex corporation is not just cash and earnings. Too many people dwell on just those numbers. Those reflect the PAST, not the FUTURE of a company.

    Isn’t it important to know how much inventory a company holds and how long the turnover rate of that inventory is? Who in the industry holds the largest amount of inventory for the longest period? If inventory isn’t moving, the company isn’t making money.

    How the the company using its cash? What are the labor costs and how do they compare to operating income and cash flow? What is the cost of warranty and repairs?

    Again, the analysis described in this blog is not deep enough to represent a comprehensive analysis. It’s just looking at cash.

  7. “Isn’t it important to know how much inventory a company holds and how long the turnover rate of that inventory is? Who in the industry holds the largest amount of inventory for the longest period? If inventory isn’t moving, the company isn’t making money.”

    What a dumb comment. Did you not find time to listen to the conference call? Inventory and supply turnover was addressed. Either be an astute investor or not, no matter to me…. But please don’t try to intellectualize your comments when no intelligence is in your comments are forthcoming.
    RC

  8. Inventory and supply turnover was addressed.

    Great, what were the ratios? How do they compare with competitors in the industry?

    It is a VERY important metric.

    What is their inventory strategy? LIFO or FIFO? (Hint: The answer is in the 10-K.)

    It costs money to create inventory, warehouse inventory, distribute inventory, and rotate inventory. Too much inventory is a bad thing, the inability to move inventory into the market is a bad thing, and inventory sitting on retail shelves is also a bad thing. All of these things are measured and allow a company to calibrate the demand for its products.

    The call didn’t address these things. The 10-K provides the data necessary to create the ratios. Just listening to the call really doesn’t give you a thorough enough insight.

    An astute investor would not only understand these things, but they would acknowledge their importance.

  9. Turley M Muller

    Regarding the inventory comments- Apple’s inventory days and collection period shorter than its payment term. Inventory period is about a week, and doesn’t have to make payment for 60-90 days, so, Apple doesn’t have any working capital cash needs.

    “You’re focusing on a few (less than 5) ratios, and most of them have to do with cash”

    That’s right. Assets are valued on expected cash flows. How is a bond valued? cash flows.
    The point that Andy is getting to as that Apple has generated so much cash that one has to look at if it were a bond that makes coupon payments. Yet, since they are reinvested, better to imagine it as a zero-coupon bond.

    Most of those ratios you list have little pertinence to Apple. Or Google.

  10. Interesting way to look at Apple, but it’s not a bond. Can’t use the same valuation for it.

    Apple does have a ton of cash. It can increase shareholder value by issuing a one-time dividend to all share holders and lever the company. That would increase shareholder.

    It is also increasingly hard to do a valuation on Apple because it does not issue a dividend. Since it doesn’t evaluating its value based on cash isn’t very effective.

    Yes, you could “think” of it as a bond, but it’s not. Apple is an equity investment not a debt investment. The structure of each and your position in each is radically different. Apple’s cash is not reinvested either, it’s retained earnings. Their reinvestment (per their 10-K) is not the total sum of retained earnings. If they were to reinvest their cash, their cash flow statements would be zero and the balance sheet would not record any retained earnings. At the end of 2007, Apple invested $3,249M in cash with $9,101M of retained earnings.

    And you can’t compare Apple to Google. They are in two different sectors. Google doesn’t hold any inventory and doesn’t manufacture products. Google generates most of its revenues through advertising.

    Apple is a hardware manufacturer and they always have been. It could be argued that they are moving toward being a hybrid hardware manufacturer, software, and services company, but the largest amount of revenue is generated by their hardware sales. They are similar to HP, Dell, Lenovo, Gateway, Toshiba, etc.

    To do ao complete technical analysis you need to compare Apple against its sector, and Google isn’t in the same sector.

  11. Turley M Muller

    “If they were to reinvest their cash, their cash flow statements would be zero and the balance sheet would not record any retained earnings”

    Not correct. The only way not to add to retained earnings if Apple were to NOT reinvest and distributed earnings as dividends. Retained earnings is reinvestment, it can’t be anything else. Retained earnings is a equity account which offsets the increase in asset account from net income. whether, that cash earnings goes to cash, securities, PPE. acquiring other assets, it’s reinvested. “Retained ” means kept in the business. That’s reinvested because cash flow not reinvested is paid out.