- Apple has grown its FCFE (Free Cash Flow to Equity) and Earnings Per Share (EPS) at an average annual rate of over 30% over the last 5 years.
- Apple stock price is currently implying a -1.12% growth in future FCFE while analysts estimates indicate close to 12% growth over next 5 years.
- The huge gap in implied growth and expected growth opens a big opportunity in Apple stock.
Apple (NASDAQ:AAPL) stock price has been beaten down over the last few months, dropping from a high of $132 per share to its current price of close to $100, significantly underperforming the markets. With concerns over the ability of the iPhone segment to sustain growth, Apple stock sank lower as iPhone shipments missed analyst estimates over the last couple of quarters.
The beaten down Apple stock is now trading at a PE ratio of 10.94, which is significantly lower than its average earnings multiple over the last few years.
Source: Calculated using data from amigobulls.com
The fall in Apple stock price prompts an important question in the minds of investors. Is Apple stock a buy at these attractive levels? To answer this question, we can take a look at the market's implied growth rate and measure the same versus growth expectations. Market implied growth rate can be derived from the current stock price and the FCFE (Free Cash Flow to Equity) over the Last Twelve Months (LTM) using a simple constant-growth DCF model, which is given here.
To calculate the cost of equity which implies investors required rate of return (k), we can use the CAPM model. Using a risk-free rate of 1.8%, an equity risk premium of 6.12% and a Beta of 1.277, we can arrive at Apple's cost of equity of 9.62%, which will be our discounting rate.
The LTM FCFE derived from Apple financials comes to $11.19 per share. Plugging in the current Apple stock price of $103.01 (March 4 close) and the other inputs mentioned above, we arrive at the market implied growth rate of -1.12%.
Relationship Between Apple Earnings And FCFE
Apple FCFE and EPS have grown in tandem and have a 5-yr CAGR (compounded annual growth rate) of 33.7% and 33.6%, respectively. With a belief that eventually earnings will translate to cash flows at some time, cash flow growth over the long term should ideally track long-term earnings growth. Therefore, it is no surprise that Apple FCFE and EPS have a huge correlation of 0.99, indicating a direct and strong relationship between the two variables. By extension, I would assume future earnings growth to be a fair indicator of long-term growth in Apple FCFE.
Is Apple Stock Clearly Underpriced?
With analysts anticipating earnings to grow at a rate of 11%+ over the next 5 years, I anticipate FCFE to closely track the same growth. However, the FCFE growth of 11% significantly exceeds the market's implied growth rate of -1.12%. The gap in expectations versus implied growth is too large to be ignored and I anticipate Apple stock price to move higher as the market realizes this serious case of underpricing here.
Apple bears will argue that the analyst projection is for a period of 5 years and it would be inappropriate to compare the constant growth rate versus 5 year expected growth. The only thing I want to point out is that we cannot have a long-term negative growth while having an over 11% average growth over the next 5 years. Also, Using various expected (terminal/perpetual) growth rates from -1.12% to 1% in the above DCF model, we arrive at the following target prices for Apple stock.
In conclusion, the current depressed level of Apple stock price is a clear case of market mispricing unless you believe Apple is suddenly going from a 30%+ growth stage to a state of steady and constant decline. Buy Apple stock while it is cheap as this window of opportunity will close once the markets realize the mispricing. Investors who believe in the continued growth story of Apple should use this opportunity to buy Apple stock and make a good long-term return on their investment.