How Apple Is Valued On A Discounted Cash Flow Basis

image source: hubtechinfo.com (artist's rendering of what the iPhone 7 may look like)

On the surface, Apple (AAPL) is attractively valued with a trailing and forward PE of 11.  Apple is priced 35% below the S&P 500 which is trading with a forward PE of 17.  Since the company is such a strong generator of cash flow, I felt that a discounted cash flow analysis would be appropriate to determine how much the company is worth.  The DCF analysis will show how low Apple is trading below its intrinsic value. 

Since there are numerous assumptions that are made when doing a DCF analysis, I will give multiple scenarios.  By running multiple scenarios, investors can get a broad range of figures for the intrinsic value.   However, the results are quite profound even when using conservative assumptions.

In each scenario, I factor in Apple’s free cash flow from 2015 of $69.79 billion, the debt level of $79.9 billion, and 5.48 billion shares outstanding.   The debt is subtracted from the total present value of cash flows before dividing by the number of shares.

This profound look at Apple’s intrinsic value shows the company has a large margin of safety.  Sure, the stock can still decline more from current levels.  However, any positive catalysts in the form of better than expected iPhone sales in future quarters is likely to change investor’s perceptions and bid up the stock price.   Since the company is expected to grow revenue and earnings next year (consensus) after this year’s dip, I consider it likely that Apple’s stock will recover over the next year. 

I have used a discount rate of 10% because that is the market’s historical average annual return that I aim to beat.  Here’s how the results look:

Discount Rate

10%

10%

10%

10%

10%

FCF Growth for Years 1 – 10 (annual)

-5%

0%

0.5%

1%

3%

FCF Growth in

Perpetuity (annual)

-5%

0%

0.5%

1%

3%

Intrinsic Value

Per Share

$66

$113

$120

$128

$173

Current Price

$99

$99

$99

$99

$99

 

Even if Apple experiences zero growth going forward, the stock is trading about 12% below its intrinsic value.  That is the power of Apple’s high FCF.  However, I think that Apple will experience positive FCF growth over the long-term for reasons that I’ll explain in the next section.

It is not enough to be undervalued.  Apple needs a positive catalyst to turn the stock around. 

Apple’s stock has experienced periods of being out of favor before, but the stock did recover.  The fear of Apple experiencing a prolonged decline this time is overblown in my opinion. The dip in revenue this year seems like the beginning of the end according to many Apple critics.  However, Q2 and the current quarter are being compared to a large upgrade cycle for the 6 and 6 Plus models from Q2 and Q3 last year. 

I think the iPhone 7 will be a likely catalyst for the stock if sales meet/beat expectations. According to Fisku, about 36% of iPhone users own 5S or earlier models. Therefore, with over one third of iPhone owners using older models, there is a large opportunity for many of those consumers to upgrade to the iPhone 7.  Furthermore, about 42% of iPhone owners are using the 6 and 6 Plus models which were introduced in the fall of 2014. Many of those users are likely to upgrade as those phones will be about 2 years old (considering that many will want to gain new features and some are on 2-year upgrade plans).    

My theory that the iPhone 7 will sell well is supported by news from Taiwan’s Economic Daily News which showed that Apple ordered 72 to 78 million iPhone 7 devices this year.  This is 11% to 20% above analysts’ previous estimates of about 65 million.  Therefore, the interest level for the new model is likely high. 

India also represents a likely potential catalyst for Apple.  If just 2% of India’s population of 1.3 billion people purchase iPhones, that represents 26 million more unit sales for Apple.  That represents a 51% increase in unit sales over the 51.2 million iPhones sold in Q2.  I’m not saying that will happen all at once, but India can be a solid growth region for Apple over time.   

Conclusion

Apple is trading below its intrinsic value as a result of the large positive free cash flow and due to negative sentiment that iPhone sales growth has peaked.  My DCF analysis examples show that Apple trades at a discount to its intrinsic value even with zero FCF growth going forward.   This is a likely reason why Berkshire purchased Apple, in addition to believing in the company’s future growth prospects.

I would place Apple’s current intrinsic value closer to $173, based on an average of 3% annual FCF growth going forward.  The 3% average annual growth rate is conservative. That rate can allow for some negative growth like this year and some strong years like FY15 or the expected growth for FY17. Although the company may take a slight dip in revenue and earnings this year, I think Apple is likely to bounce back and grow revenue and earnings again next fiscal year on strong iPhone 7 sales. 

The caveat is how well Apple will grow going forward. Given the company’s ability to innovate, retain customers, and grow into new markets, I expect Apple to experience positive growth over the long-term.  Apple’s stock performed well in late 2014 and early 2015 during the last large upgrade cycle for the 6 and 6 Plus. I expect the stock to recover in late 2016 as robust sales of the iPhone 7 become more apparent. I also expect future upgrade cycles and growth in new regions to allow the company to grow over the long-term. 

Disclaimer:This article represents the author's opinions.  Investors should do their own due diligence and consult with an investment advisor to determine which stocks are right for ...

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Joe Economy 6 years ago Member's comment

And if you"re wrong, and the Iphone 7 is less of a hit than the hype suggests, the stock could be in a for a hefty crash. I think there's more room for a 10-20% decline than a 10% increase in the stock price. Global smart phones sales are on the decline and after so many repeated new releases of the Iphone, perhaps Apple is beginning to lose its sexiness. After all, its just a phone and there's only so much that can separate the Iphone from its cheaper Chinese competitors, surely? Look out Apple, China is creaping up behind you...

David Zanoni 6 years ago Author's comment

Remember Apple was trading at about $133 last year. If sales of the iPhone 7 are strong enough to grow revenue again, I think the stock price could exceed $133 within the next 2 years. The sentiment for the stock became irrationally too negative in my opinion.

Alpha Stockman 6 years ago Member's comment

I concur.