The Apple PE conundrum revealed
For about 2 years I’ve been confounded why apple trades for only 10 times earnings while growing 50% to 100% (100% last quarter). Typically stocks trade in line with growth times earnings. For example a 50% growth rate for a company earning $10 would be a $50 stock.
So why does apple continually trade for about a 10 PE ex-cash when it is growing 5 to 10 times faster? The answer lies in the incorrect out year estimates that have skewed apple’s valuation for years now. What do I mean? Well 90 days ago 2012 earnings were estimaged at $35/share. Today they are at $44/share. 2013 earnings were estimated 90 days ago at 39/share and today at 51/share.
What you see happening here is a constant ratcheting up of estimates in the current year and adjustments to the out years of just 10% higher then current year. If you follow along you will know that this years estimates will go up to $50 to $55 and next years estimates which are now just $51 will go up to about $75. However they will only go up once they have actually arrived. So right now the out years look like growth goes from 118% as of last quarter down to just 10% next year.
Mutual funds, hedge funds and investors alike all use the analyst growth estimates to peg a fair value. All these quant funds look at the numbers on apple and see $45/share for 2012 and 10% growth based on analyst estimates. Well if they are right then you get $45 x 10 growth which is $450/share. Add another $100 for cash and boom $550. Problem is assumptions are terribly wrong in terms of the growth rate. That said this is what everyone uses for calculations and when Apple reports and blows out numbers and raises then the stock goes up. It goes up just enough in the out years to keep 10% as the growth cap. There is the problem again.
Kids I am here to tell you Apple won’t grow 10% next year. More along the lines of 50% plus. Do you believe analysts? The same ones that just 90 days ago had $35/share as 2012 earnings and now are at $44. You get the picture.
So what does this mean for apple stock? Well unless apple decides to defend it with a huge buyback which would be massively accretive to earnings or a much higher dividend they will never see a fair multiple to their growth. They will always trade at this 10ish multiple going forward. This is the multiple that 0% growth co’s are awarded and it is apples too now. Apple has mismanaged their stock and it is apparent by the PE. It says it all. They should split the stock and start the mother of all buybacks like IBM does.
If they don’t expect apple to just bump up every quarter on actual earnings just enough to get them to that 10’ish multiple ex-cash. There won’t be PE expansion ever again as I see it now. Apple just won’t manage the stock to allow for this. So apple will grow and investors will reap the gains of the earnings growth in lock step from here. Multiple compression is just about over. Apple could actually go down to 15% growth and still be undervalued here and a good buy as earnings will keep the stock moving along at the actual earnings reported.
My recommendation is to buy the stock. It will grow aggressively the next couple years then slow maybe to above market growth rates. The stock will move with it but do not expect PE to go up and get gains based on that. It just doesn’t look like that is going to happen unless apple does the unthinkable and splits 10 or 20 for 1 and initiates a real buyback. Not the 10 billion buyback that just offsets option dilution