Investment Jungle

Today, we will be revisiting a darling of the stock market - Apple Inc. which trades on the NASDAQ under the symbol AAPL. I last had a look at this stock on July 7th. Back then, the stock was trading at a premium of 12.34% over the sticker price. It wasn’t a Rule #1 company back then and it definitely would not have changed to one now. So why look at this company again?

Super Saver over at My Wealth Builder asked various stock market bloggers to put together an article on Apple Inc. He will be hosting the next Festival of Stocks which will be dedicated to this single stock. Should be an interesting festival!

On with the analysis!

Company Profile:

From Yahoo Finance

Apple Inc., together with its subsidiaries, engages in the design, manufacture, and marketing of personal computers and related software, services, peripherals, and networking solutions worldwide. It also provides a line of portable digital music players, as well as related accessories and services, including online sale of third-party audio and video products. The company’s products and services comprise the Macintosh line of desktop and portable computers; the Mac OS X operating system; the iPod line of portable digital music players; the iTunes Store, a portfolio of peripherals that support and enhance the Macintosh and iPod product lines; a portfolio of consumer and professional software applications; and the Xserve and Xserve RAID server and storage products. In addition, Apple Inc. offers various third-party Macintosh and iPod compatible products, such as application software, printers, storage devices, speakers, headphones, and other accessories and supplies. The company provides an online service to distribute third-party music, audio books, music videos, short films, television shows, movies, and iPod games. Further, it offers products and services for the educational industry, which include iMac and the MacBook, video creation and editing solutions, wireless networking, professional development solutions, and one-to-one learning solutions.

Market capitalization of $122.55B.

Fundamental Analysis:

Right off the bat, Apple shows itself to not be a Rule #1 stock. Management has not delivered a minimum of 10% per year return on invested capital (ROIC) over the last 10 years. In fact, 5 of the last 10 years had an ROIC below 10% and two of those years had NEGATIVE ROIC! The 5 year average ROIC is 12%.

Return on equity (ROE) confirms these results with 5 years returning less than 10% ROE. In fact, the 5 year average ROE is just 9.06%.

Equity growth rate trend does appear to be positive. The 9 year rate is 16.71%. The 5 year rate stays stable at 15.86%. The 3 year rate jumps to 27.66% and last year’s equity growth rate was 30.57%. Really, the last two years have come on very strong with both years producing 30%+ equity growth rates. The years before that (from 2001 to 2004) were sub par to say the least.

And the earnings per share growth rate brings its own set of problems. No less than 2 years (1997 and 2001) delivered NEGATIVE earnings per share. That always throws my calculations off and is another sign of a company that does not belong in the Rule #1 category. But if we just focus on the last 4 years, the EPS growth rate has been absolutely astronomical! The 4 year rate is 132.5%. The 2 year rate is 146% and last year’s EPS growth rate was 53.42%.

The sales growth rate has exhibited Rule #1 behaviour. The 9 year rate is 10.06%. The 5 year rate climbs to 30.64%. The 3 year rate skyrockets to 48.08%. Unfortunately, last year’s growth rate does not improve on that and drops to 38.65%. So not exactly Rule #1 behaviour. But amazing growth rates nonetheless.

Cash flow growth rates have also been incredible. The 8 year rate is a mere 8.66%. The 5 year rate launches to a whopping 87.18%! And the 3 year rate? 118.06%! Last year’s rate comes back down to Earth at 50.36%.

Rule #1 investors look for 10 year histories of improving or steady fundamentals. Although Apple has come on incredibly strong over the last few years, it would not be considered a Rule #1 business.

Stock Analysis:

Let’s have a look at the sticker price.

For my future EPS growth rate, I start with a look at the historical equity growth rate. Of course, the historical information is like a tale of two different companies. Both the 9 year rate and the 5 year rate come in at the 16% rate. However, the last two years have delivered equity growth rates in excess of 30% each. Typically I have always taken the most conservative value. In this case, that would be 15.86%. Analysts have reduced their forecast from the last time I looked at this stock to 21.8%. That definitely seems reasonable by looking at the last couple of years. But I think I will stick with my more conservative estimate.

For my future PE, I start with the default PE which is twice my estimated EPS growth rate. In this case, it works out to 31.72. Looking at the historical PE information, I can see that the 10 year average PE is 38.25 which is in line with the current PE of 39.32. Once again, I will stick with the more conservative value of 31.72.

With this information, my sticker price works out to $120.31. At the current price of $138.41, Mr. Market is demanding a premium of 15.05%. Now, considering that I have erred on the side of caution with both my growth rate and PE, 15% does not seem so far off.

Here are my Rule #1 calculations for AAPL.

Here is the 1 year stock price chart:

AAPL has definitely had a terrific run since July 2007 where it sat around $50.

Conclusion:

Rule #1 methodology is fairly strict. It looks for consistency over a 10 year period which Apple just does not deliver. Apple is more of a momentum stock and it has definitely been on a sweet run over the last couple of years.

I will be interested to see the other methodologies used to evaluate AAPL at next Monday’s Festival of Stocks.

Stay tuned!

Full Disclosure: I do not own shares in AAPL.

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