Is it time to buy Apple Shares?

Is it time to buy Apple shares? I’m going to get to the point quickly in this post by saying in my opinion the answer is No. As I write this blog Apple is trading at circa $120. The last 3 months of action in Apple shares suggest that I am wrong and maybe I am but the valuations are just too expensive for me. 

I will explain my rationale throughout the post but I just wanted to clarify and stress that  I’m looking for stocks that I believe have 20% or more upside over the next 12 to 18 months. In my opinion, Apple shares do not fit into that category. 

Let me go through a fundamental analysis of Apple shares. But before we continue.. in our stock market community we give regular technical updates on Apple … click here to join… it is free!

Historic Fundamental Analysis:

Anytime I look to invest in a company I want to see a track record of sales and profit (earnings) growth. Apple is a cash cow and nobody can deny that. It certainly has grown over the last 3 years but does this growth warrant the lofty valuation it currently has? I’m not so sure…. 

Note: TTM stands for trailing 12 months up to this point in time. 

  • Sales Growth: As you can see Apple have driven annual revenue growth from $229 billion to $273 billion over that period. That is an average annual sales growth rate of just over 6% per annum. Not bad for a company of Apple’s size… remember it is one of the largest companies in the world so it becomes more challenging to achieve sales growth over the 10% level.
  • Net Income Growth: Net income has grown from $48 Billion to $58 Billion over that period which is approximately 7% growth in profits over that period of time. Again that is still impressive for a company of Apple’s size. 
  • EPS Growth: Earnings per share have risen from $2.30 per share to $3.30 per share. That is a very impressive 14% average annual growth rate for earnings per share.

Now here is the first thing that should be screaming at you … how can net profits grow at half the rate of EPS? Remember earnings per share is simply the Net Profit of the company divided by the amount of shares issued. The answer is that Apple has been actively buying back their own shares. In 2017 Apple on average had 20.7 billion shares outstanding. Right now they have 17.1 billion shares on issue. This is a reduction of a little over 17% of the common shares on issue. 

Whilst the company remains a cash cow it will continually buy back its own shares to bump up the earnings per share number. This is a positive for investors but does it warrant Apple shares being valued as if it was a growth stock? 

I think the answer lies in the expected future growth rates and they are impressive…….

Apple expected Sales and Earnings growth:

  • Future Sales Growth Expectations: Apple is expected to deliver sales growth of 13% between 2020 and 2021. That is impressive and I wonder have the anticipated new 5g phones been priced into that growth rate also. 
  • Future EPS growth expectations: Apple is expected to deliver EPS growth of 19% between 2020 and 2021. That is also impressive for a company of Apple’s size. 

Anticipated growth rates do give some reason for investors to pay a little more for Apple stock. But how much more are they really paying right now? 

Apple Valuation:

Apple is currently valued at $1.94 trillion! Yes, that’s trillion! It is trading at a Price to Earnings ratio (PE) of 35 based on trailing 12 months eps. This is quite expensive at first glance for a company of Apple’s size. But sometimes these valuations can be warranted if future growth expectations are high which they are as already explained. 

The company is trading at 31 times 2021 earnings expectations. To me this is too expensive. The average PE ratio for Apple over the past 5 years is just 17. If we apply a simple formula of PE * EPS to get a share price estimate for 2021 it would look as follows:

$3.87 (expected eps for 2021) * 17 (average PE) = $65.79. 

Now, I’m not suggesting that Apple should trade at $65 but I just wanted to point out just how much premium investors are willing to give Apple at the moment. The share price is currently at the $120 level ….. So that is almost double normal valuations! Is Apple really worth that right now? 

Let’s look at another common valuation method price to sales. The 5 year average price to sales ratio is 3.76. Apple is forecasted to generate $18 of sales for every share of stock on issue. 

Applying that simple formula:

$18 (Forecasted sales per share) * 3.76 (Average Price to sales ratio) = $67.68

So the Apple share price target on a price to sales basis is a little higher but still nowhere near $120! 

Having a quick look at other valuation ratios:

  • Price to Cash Flow: Currently 25.16. The 5 year average is 13.09. This suggests that the current stock price could drop to $62.46. 
  • Price to Book Value: Currently 26.85. The 5 year average is 8.33. This suggests that the current stock price could drop to $37.22. 
  • PEG Ratio: Currently 2.7. The 5 year average is 1.69. This suggests that the current stock price could drop to $75.11.

Clearly, the fundamental valuations suggest that the stock needs to drop to at least $70 to $80 (25% lower) before it could be considered anywhere near good value. 

So why have investors bid up the price of Apple so much?

This is a great question and one which I’m not sure I fully have an answer to. But here are some of my thoughts for what they are worth:

  1. The Federal Reserve: The Fed has basically underwritten the stock market (for now) and investors just don’t see any risk in holding stocks. High Yield corporate debt is at its lowest level in history as the Fed continues to buy corporate bonds keeping the liquidity high. But to me this is one giant experiment which nobody truly knows what can go wrong yet… surely excessive debt has to catch up on us some day?
  2. Bond Yields: Government Bonds are simply uninvestable..rates are at historic lows and QE continues. This makes stocks more attractive to the safer government bond. 
  3. Softbank: This is new and to me could be a scary development. The Japanese based hedge fund invested $9.3 billion into call options in tech stocks throughout August including Apple. This forced ‘call writers’ to buy stocks in order to cover their positions as the share price continued to rise. This then became a self fulfilling prophecy of rising share prices as demand outstripped supply. 
  4. Retail Traders: During the Covid 19 outbreak online trading platforms have seen record rises in the number of ‘retail’ investors opening accounts and buying stocks. They appear to have a heavy focus towards technology companies which have increased demand for Apple shares.
  5. Apple Growth: Just maybe have another product in the pipeline that will be a toal game changer and lead to enormous growth. 

So whilst these are all explanations for the growth in Apple’s share price it doesn’t necessarily mean that it will last. Explanation 1 & 2 above will be around for sometime unless we have another calamity which may tip everything over the edge. Assuming no further drags on the global economy an accomodative Federal Reserve does warrant a premium in share prices. 

But an 80% premium for me is too expensive! I would rather sit that one out. If Apple came back to $70/$80 then I would be a fan but not at these prices. For me there is better value out there which just hasn’t got a bid yet … when investors rotate out of technology stocks I think the currently unloved sectors will do very well. 

In summary, Apple is a great company, I love their products but their share price is just too expensive for me. I’d be a buyer closer to $80! 

Happy Investing 

Stephen 

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