They’re worried the iPhone’s decline is inevitable which would then hit Apple’s bottom line and, ultimately, Apple shares. Given that, it was probably no great surprise that Apple shares took a plunge as those fears intensified.
However, Apple’s latest financial results suggest that those fears are overblown. That one should invest in Apple shares just when they are this unloved is really an opportune time to buy them cheaply. Why investors fear the iPhone
Before we discuss the developments and why value investors should invest in Apple shares, let’s talk about the bad. The bad is that investors are afraid that the iPhone, Apple’s #1 product which brought the company to greatness, is in decline.
To illustrate the iPhone’s importance to Apple look at the infographic of the iPhone’s impact on Apple’s revenues. As you can see, roughly 69% of Apple’s revenue is from the iPhone. While that infographic relates to 2015, that figure is still true for the latest financial report.
So, why are investors so agitated? Apple’s latest financial report reveals that YoY sales of the iPhone have been stagnant. By that we mean YoY sales changed by 0%; that’s right, a big fat nothing, a goose egg, nada, zilch... you get the idea.
Indeed, that is not a good sign, especially given that the iPhone accounts for such a large share of Apple’s revenue. Apple investors, from their perspective, don’t need much more of a reason than that to fall out of love with the stock. As a result, they’ve simply avoided buying it. Their logic is simple: If the company’s main growth engine is slowing then things are about to get worse, right? Now, the good news...
Now that we’ve established the why behind the low price of Apple shares, let’s refocus. Let’s discuss why Apple shares are undervalued and worth investing in.
The most natural place we need to look is at Apple’s business performance. While, indeed, iPhone sales were flat YoY from Q1 of 2015, other segments have grown enough to counter the iPhone weakness. That allowed, and will continue to allow, Apple’s revenue to grow, even with weak iPhone sales.
Apple’s other business segments, i.e. iTunes, the Apple Watch and Beats (labeled under services and others in Apple’s financial report) bridged the gap arising from stagnant iPhone sales. Those segments added $2.8 billion to Apple’s revenue as compared to the same quarter last year.
That has allowed Apple’s revenue for Q1 2016
to reach a record $76 billion, rising 2% YoY.
Apple is still growing, despite flat iPhone sales. And that means that, so far, investors’ fears have not been fulfilled. Apple shares are solid but are they cheap?
Now, here’s a good question. If there was no tangible evidence to support investors’ fears yet Apple shares were trading at a high valuation would they still be a worthwhile investment? Probably not; that’s because the risk for a fall in revenues was still there. But what if investors had already priced that into the stock? Well, that’s a completely different story. Because then, even if iPhone sales slowed further, it’s already priced in. Thus, the downside risk for Apple shares would be limited as fears were overplayed. And in our specific case, those fears are, indeed, overplayed. “Valuation on a 10-year basis is near a historical low” —
Gene Munster, Senior Analyst, Piper Jaffray
Apple shares currently trade at a Price to Earnings ratio of roughly X10. A company’s P/E ratio is obtained by dividing the stock price with its earnings. Essentially, the higher a company’s P/E, the higher the premium. For comparison, the S&P500’s average P/E (for the entire index) is X18, while Apple’s P/E is about X10.
Now, if this were some Oil stock that was being crushed by an oil price collapse then the X10 multiple might be justified. But this is Apple, one of the most profitable public companies to ever trade on Wall Street.
But that’s just for starters. Apple revenues grew on average by 30% p.a. over the past five years, generating an average $2 billion in cash each year. Its net profit for 2015 was a whopping $53 billion, up from $39.5 billion in 2014, a solid 35% growth in profits. Now, is that a stock worth trading at only X10 P/E? Certainly not!
So, what are Apple shares really worth then? One doesn’t need to go too far to figure it out. Apple shares average P/E ratio is 14. That leaves us with a 40% upside. Apple shares are currently trading at roughly $100 per share. That means that for Apple shares to move back to $140, Apple has to move back toward its average valuation. Crunching it all
So what did we have here? We established that there is no evidence that Apple is in decline any time in the near future. In the meantime, Apple shares have already fallen off a cliff, which makes them dirt cheap. With this in mind, one should not hesitate to invest in Apple shares
, especially when they’re unloved.