Apple: Bottom Of 9th Inning

For many investors, Apple (NASDAQ:AAPL) is the closest thing to divinity on earth. And selling Apple’s stock would be a sin. We have heard more than one investment personality state that “Apple is a stock you hold, not trade.” For readers who have plunged too deep into the Apple Kool-Aid, it’s best to stop reading here. We look at Apple’s valuation objectively in this article and everything that we write is not going to be rosy for Apple’s shareholders.

While Apple Will Remain a Great Company, eager, forward-looking markets are discounting a lot of good news already for future earnings growth. We demonstrate below that company and share price valuation levels have gotten to the high ends of historical ranges. Apple’s shares could get more expensive, but this needs to be a conscious bet by investors that the current environment for Apple is different from prior peaks in valuation.

Valuation Metrics: An Intermediate-Term Headwind For Apple

Much of the bullishness, and disregard for valuation in Apple today, is due to the market’s focus on Apple’s prospective growth. We have no qualms with the Apple bulls – as long as Apple’s numbers keep beating analyst forecasts, historical valuation comparisons will not matter. This is our caveat and the limitation to our not-so-rosy outlook for Apple in the coming months. We would not be sanguine as Apple investors if the company’s EPS, revenue, iPhone sales just manage to meet consensus estimates in the coming quarters. Too much optimism on company growth has likely been baked into the apple pie.

We cannot contribute much insight on the probability of Apple continuing to exceed growth expectations. This will depend on numerous factors, not the least being a re-acceleration of global economic growth. What we can show here is that Apple’s shares are now likely fully valued.

We look at a couple of traditional company valuation metrics, then examine share valuation ratios.

Enterprise Value-to-Sales

The EV-to-sales chart talks to us. With the 17-year history below, we feel comfortable that Apple’s EV-to-Sales has an established range. Perhaps Apple is set to establish a new, permanent plateau for its EV-to-Sales ratio above 5x (blue line below). This could happen. But we have found that betting on the “this time is different” scenario has a poor risk/reward ratio for investors.

Enterprise Value-to-EBITDA

The Enterprise Value-to-EBITDA metric has surged to its highest level since 2009. Passing the 2018 peak on the EV-to-EBITDA ratio was actually more significant than the 2009-2010 levels due to the base effects coming out of the Financial Crisis, as we explain below. We can conclude that on an EV-to-EBITDA basis, the company has never been as expensive as it is today.

Price/Earnings

Let’s turn to valuation of Apple’s stock. As the new economic expansion began in 2009, Apple saw rapid multiple expansion as investors massively flooded back into Apple’s stock. The numerator of the ratio outstripped the denominator as forward-looking markets speculatively priced in stronger earnings, well in advance of the realization of these earnings.

We are well aware that the consensus forward P/E today on Apple is 20.1x next 12-month earnings. Our chart below becomes less alarming, but only marginally. Since the rapid multiple expansion to kick off the bull market in 2009, the next highest P/E on Apple was just over 19x earnings, in October 2018. To be betting on much further multiple expansion at this stage, an investor would really have to be a believer in both Apple’s products and a reacceleration of global economic growth.

Price-to-Sales

Looking at Apple’s price-to-sales ratio (we use current realized sales figures here, not prospective revenue), we are again well over one standard deviation above the 10-year mean. The lofty price-to-sales does not mean a paradigm change for Apple couldn’t lift this ratio permanently higher. It is just not our central hypothesis for Apple’s shares. The price-to-sales is probably telling us that returns for Apple’s stock will be muted for those buying at current levels.

Price-to-Tangible Book Value

In our WMA fundamental ranking methodology, we normally do not even look at price-to-book value per share for technology companies (although we do for financials). We throw in our price-to-book value chart of Apple here because anytime we see a parabolic spike on a chart, we take notice. Recall that tangible book value excludes intellectual property and the value of Apple’s brand name. Apple’s stock price is indeed reflecting the value creation of the company, but are Apple’s shares worth 13 times the assets on the company’s balance sheet (ex-goodwill, etc.)? We can’t be certain today, but in 2007 the answer was a resounding “no.”

Price-to-Earnings Growth

To be fair to Apple supporters who will say that the stock price correctly reflects the company’s growth prospects, we looked at one more important valuation metric incorporating earnings growth. The historical Price-to-Earnings Growth (PEG) is shown below. Buying the stock today means that an investor accepts that next year’s earnings growth is (exceptionally) being priced higher than prior growth anytime in Apple’s history. Maybe this is justifiable. But probably not.

WMA Relative Valuations

We finally look at how Apple ranks in our relative ranking methodology. We always compare apples-to-apples (so to speak) so our scores reflect Apple’s consensus expected earnings and revenue growth, valuations, and financial strength relative to other tech companies. To be sure, Apple’s consensus forecasted growth rate (we use an aggregate of earnings and revenue estimates) is still in the top third of tech peers (we rank Apple as a “Buy” in our composite growth rating). The consensus revenue growth is seen at approximately 6% for next year while EPS is seen growing at 12%. Turning to valuation, Apple is ranked as a “Hold” at WMA. That is, our relative valuation measures say that Apple is neither extremely cheap nor extremely expensive compared to technology peers. Overall, our system ranks Apple as a “Hold,” and we reaffirm this assessment.

Still The Apple Of Analysts’ Eyes

Of the 43 analysts who follow Apple, only 4 analysts have a “Sell” on the company. We have seen a couple heretics who have downgraded Apple this year. The Goldman Sachs (GS) Apple analyst issued a negative note on Friday, September 13, lowering his price target from $187 to $165. Paradoxically, Apple’s stock closed at $265.76 on Friday. Just last Thursday, November 14, Apple’s shares got a rare sell rating from the Maxim Group analyst on concerns about lower iPhone sales next year. Maxim downgraded Apple to sell from hold and set a 12-month price target of $190, a 28% downside for the stock. We will say that the consensus analyst recommendation for any stock has been typically a horrible indicator to time entries or exits from a stock. Whether the consensus optimism on Apple and the $273 median price target prove to be a bearish contrarian indicator remains to be seen.

Conclusion

There is no sense today anticipating a lasting pull-back in Apple’s price due to excessive valuation. However, the laws of finance apply to all companies, including Apple, meaning that excessive valuations will have to be worked off. We would expect, like in the recent past, for any pull-back in Apple’s price to find buyers – and likely well before the company even gets back to “fair” valuation (the norm of the past 10 years on our above charts).

Our outlook on Apple is mixed. Short-term, we don’t know where the stock price will stop and level out. Short term, we are now neutral on the stock. Intermediate term, historical valuations and technical analysis argue that price will pull back significantly at some point, likely within a year. We are bearish on Apple on a 3- to 12-month horizon. And long term, provided that Apple remains a dominant player in each of its businesses, we have to remain bullish on Apple’s shares. Bottom line, if readers don’t own Apple today, risk/reward seems very unfavourable for buying the stock here.


Like to give your opinion? Join our Community Discussion