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Apple's Valuation Struggle Continues

asymco | Apple’s Valuation Struggle.

As despondency over Apple’s 75% earnings growth rate continues, it’s time to revisit the historic P/E in contrast to growth for the company’s earnings.

The latest chart (below) shows the company’s P/E ratio (in blue, left scale) vs. the trailing twelve months rolling growth rate (in brown, right scale) and the ratio between these two (in red, right scale).

The red line can be considered a form of PEG (Price over Earnings over Growth) with the caveat the the Growth is trailing not forward and hence is based on actual data not fictional analyst “consensus”.  I call this PETG (Price over earnings over trailing growth).

The actuals show that Apple’s price to trailing growth ratio is dropping to lows unseen since last year when the recession was still in effect.  At PETG below 20 the predominant sentiment displayed is extreme pessimism. 100 could be considered an even balance between pessimism and optimism. It now stands at 35.

  • Stu

    "As despondency over Apple’s 75% earnings growth rate continues"

    Love it.

    As Eric Landstrom on TMO finance board would say: It's taxes to small business!! Ruining the world!!

    • Lee Penick

      I was expecting 76%, so below expectations! :)

  • bfl

    "The actuals show that Apple’s price to trailing growth ratio is dropping to lows unseen since last year when the recession was still in effect."

    This could be read to mean that we have progressed pretty far into the 2nd dip of the double dip recession. Would now be an appropriate time to panic? ;)

  • http://www.bullishcross.com Andy M. Zaky

    This is a very good article. You do a great drop focusing on very key points in Apple's valuation. You know the reason Apple continues to undergo p/e compression is because of its current market capitalization. Apple is going to have to do a lot to convince the market that its very undervalued despite its low p/e ratio. Its a question of whether Apple, as a company that will probably be doing close to $100 billion in revenue on annual basis should be valued higher than a company doing $500 or so billion a year.

  • http://www.asymco.com asymco

    By definition, a company's equity value is the net present value of all future free cash flows plus current assets. I have no idea why anybody would think about sales when considering valuation.

  • Lee Penick

    asymco,
    I like your site.

    Seems like we can try to value via P/E or via NPV, but either way we are dealing with assumptions that are speculative regarding the future.

    Apple has been cranking out the hits, but we don't know how close the future will be to the past. Will iPhone evolution stay at the recent rate, continue to have strong growth, sell for a premium price, or will it become one of many smart phones with similar capabilities and sell for a more modest price, thus effecting sales, earnings, and free cash flow?

    Will new product innovation, sales, and gross margin continue like the past several years, or was the recent past the best of times?

    The Eventide Blog posts elegantly that the Law of Large Numbers doesn't apply to Apple at this time, but when will it kick in, 5 or 10 years from now?

    Health of Steve Jobs? Effectiveness of a succession plan?

    Does Johnny Ive ever leave for a startup or start his own firm?

    Lots of variables.

    But if free cash flow is "Net income plus depreciation and amortization, less changes in working capital, less capital expenditure" and net income is effected by sales, why do you say you have no idea why anybody would think about sales when considering valuation?

    • http://www.asymco.com asymco

      Sales are necessary but not sufficient to create value. I was responding to a statement that Apple's value should be judged, in large part, on sales. In other words, Andy's comment that the market may value a company doing $500 billion/yr. in sales more favorably than one doing $100 billion/yr.

    • http://www.asymco.com asymco

      Lee,
      There are many unknowns, but the future is not as unpredictable as it might seem. There is one thing I can say with confidence: Apple's "hits" are no more accidental than Pixar's.

    • http://www.asymco.com asymco

      Regarding Steve Jobs' health. Here's a thought exercise:

      Since I've shown repeatedly that Apple is trading at a discount to its growth and to its historic value and to its peer group, and since the health of their CEO is an uncertainty which must be discounted, the possibility exists that the depressed value assigned to Apple is due to Steve Jobs's continuing presence in the company. If that is true then his departure should increase the stock price.

      This of course presumes that post-departure the company continues its growth trajectory. If the trajectory continues and the stock falls even further relative to its value then we'll have to evaluate another cause.

      Regarding the law of large numbers, I posted on DawnTrader's blog that the problem with the law of large numbers is that large is undefined. Right now "large" is implied to be simply the largest of a current sample. This value (largest market cap) used to be much larger some time ago, so why can't "large" be the largest ever? Then again, why can't it be larger than that? History has shown that there is actually no limit to "large".

      Regarding Jony Ive, I don't know if he's responsible for Apple's growth. On the other hand, if he were then his net present value would be measured in the tens of billions. So here's a proposal. Why doesn't Microsoft offer, for argument's sake, a tenth of that as salary to Ive: $1 billion per year. I'm sure he'd be tempted. But then again, I doubt that Microsoft could turn that cash into a better return for itself, which is why they won't make the offer. So then we're back to where we started: what makes Apple valuable?

      My take: it's all of the above. The resources (people and intellect), the processes (how they are deployed and made into a whole), and the priorities (the vision and the culture and the motivation). This is Apple, and, in fact, every other company. Figuring out whether it succeeds or fails is simply diagnosing all the components separately and as a whole. That is the essence of analysis and it's what I try to do.

  • Lee Penick

    I agree there are lots of variables responsible for Apples success. Trying to quantify each one, like the value of Ive would be guess work for those of us on the outside. Exactly how much of the innovativeness and top notch design is he responsible for, vs. Steve, or other players that aren't in the news, hard to say.

    I could be that he's worth a billion NPV, but it taken out of the Apple system, and pirated to Microsoft, his ideas may flounder in the Microsoft structure. Or flounder with the Microsoft OS.

    Besides thinking out loud, I'm suggesting that all the stars have been lined up for Apple for a number of years now. It may be awesome management and completely due to skill…such that if Ive left, they would know exactly how to fill the void. But it's also possible that all the Star players are necessary and growth wouldn't be so great in the future if people defected for start-ups with mega-stock options.

    I doubt this is the case, but I'm trying to think why the market and average investor is valuing Apple as low as they are. And as I go through these exercises, I try to stay open minded, that they could be on to something I've missed. (like to avoid the "Pride before the Fall" sort of thing)

    In general I agree with you that Apple is undervalued. Back of the envelope calc show me that Apple could be worth $400 in 15-18 months. When I use other analysts number, who are using much more sophisticated methods than I, they get larger earnings growth and show Apple could be worth that much in shorter time.

    One area that may be a problem is the law of large numbers regarding manufacturing capacity. It's great they "could" sell large quantitates of iPhones and iPads, but if the manufacturing volume constrains sales, we don't get to grow at astronomical numbers any more. Sooner or later, we reach that point where it was a lot easier to go from 10 million to 20 million than it is to go from 100 million to 200 million. When that kicks in, I don't know. Apparently somewhat constrained now, but I don't know how quick or effective the solution will be. I'd love to be a fly on the wall at Apple to see how they worked all these things out.

    I enjoy your posts and your educational background that makes you so capable to discuss numerous aspects of Apple! Great site.

    • http://www.asymco.com asymco

      Manufacturing could ramp up a lot higher. Apple's competitors build an order of magnitude more products that it does. The point about valuation and growth is that Apple has as much growth potential today while it's growing at 70% on the back of iPhone as it did when it was growing 70% on the back of the iPod and iPad. Back then it had a P/E of 50 and today it has a P/E of 18. iPod + iPad are far bigger opportunities than iPod.

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