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Apple (AAPL) stock hit $502 a share Monday -- yielding a $469 billion market capitalization. Yet the stock is screamingly inexpensive at its current valuation. I see three reasons why it should be worth $2,300 -- and two it might not.
About four years ago, I recommended buying if it ever hit $100. Back in March 2008, I saw Apple stock as heading towards an attractive price since its shares traded at about $125. I thought that if the shares hit $100 -- it would become attractive.
That's because when I look at a stock, I think it's helpful to use its Price/Earnings to Growth (PEG) ratio as a valuation measure. If the PEG is less than 1.0, the stock is cheap. When I wrote that post over four years ago Apple traded at a P/E of 27.4 with earnings expected to grow 24.6%.
That PEG of 1.1 was slightly over-valued and I figured that if the stock dropped to $100, the PEG would start to look attractive. I was later contacted by an investor who kept this post in mind and bought Apple when it dropped to $90 in November of that year. Since then, Apple has been on a steady rise -- taking its shares up 458%.
Isn't $502 far enough for this high flying stock? Here are three reasons why the shares will fly closer to the sun:
- Customer Loyalty. Apple customers are intensely loyal to its products. They are willing to pay big price premiums -- for example, an iPad goes for around $600 compared to $200 for an Amazon (AMZN) Kindle. The Apple fan will point out all the reasons why the iPad is so much better than the Kindle. And my discussions with students about the 23 people who died building their iWorld yields an attitude that can be summed up on this family-friendly site by the phrase: "I don't care so stop talking about it."
- Winning Strategy. Up until Steve Jobs' death, Apple demonstrated its ability to introduce category transforming products that these Apple fans eagerly waited in long lines to buy. At the core of its strategy were four capabilities: Its ability to design sleek hardware that people crave; its skill at selling those products to consumers; its ecosystem-building talent that makes content providers and App developers into economic winners; and its strength at partnering with a supply chain the builds high quality products at an ever-lower cost.
- Low Valuation. Apple currently trades at a PEG of 0.27. That's based on its current P/E of 14.3 and earnings forecast to grow 54% in the year ending September 2012. If the stock was trading at fair value, its PEG would be 1.0 -- and to get there its shares would need to change hands at about $2,300 a share (a P/E of 54 times earnings for the year of $42.63 a share). That valuation would make Apple's market capitalization a mere $1.67 trillion.
An argument could be made that $2,300 a share is low. After all, Apple's earnings have grown much faster than 54% in the last year. For example, in its most recent quarter, Apple posted 116% earnings growth. And in the last 12 months its net income has grown 85%.
There are two problems with this rosy forecast. The first one is that Apple's ability to grow depends on dreaming up new products like the iPhone and the iPad that produce love-chemicals in the brains of its rabidly loyal customers -- and make them pay huge price premiums to get their fix. Apple has yet to demonstrate its ability to do that since Tim Cook became CEO.
Second, Apple's little problem that people would prefer not be mentioned -- the inhumane working conditions in the factories that make these little gems -- could hurt Apple's margins.
For example, if Foxconn hired more workers so that its employees did not have to work such long shifts, its costs would rise. And if Foxconn's manufacturing process was safer for workers, it might be difficult for it to meet Apple's demands for 10% price cuts every year.
Apple's recent decision to let "independent" inspectors into those factories is a fair piece of PR strategy. But there are questions about their independence since the corporations they are inspecting serve on their board.
And even if revealing reports are issued, what remains unknown is whether Apple's suppliers can both improve working conditions and keep delivering 10% price cuts to Apple every year.
If Apple can keep its earnings growing so much faster than its P/E, $2,300 a share could be in the cards. But unless Tim Cook can design and build new generations of industry-transforming products, Apple's growth will eventually slow down.
And then it will be even more important for Apple to keep getting suppliers to cut their prices -- something that will be hard to do if those factories become safe for their workers.
