Analyzing Stocks Using Apple as the Illustration

Analyzing Stocks Using Apple as the Illustration

Last week, Apple hit a $736 billion valuation so I thought this would be a good opportunity to talk about how stocks are valued using Apple as the illustration. Note that this discussion should not be considered as a recommendation to buy, hold or sell Apple shares. I just found it to be a good stock to use for an illustration. All amounts are as of the market close on Feb. 12, 2015.

The valuation or market capitalization is the price of a share multiplied by the number of shares outstanding. In Apple’s case it is $126.46 x 5.824 billion shares. From here on out, I’ll use rounded estimates.

Now, you might wonder if Apple is overpriced. Well, so do many people particularly those that sell it each day. Let’s look at some fundamentals. The P/E is 17. This means that each share earns $7.42 ($126 / 17). For comparison, the S&P 500 Index components have a P/E of 20, and the NASDAQ P/E is 22 so this P/E looks pretty good when compared to these indexes. However, on some level 17, 20 and 22 are considered by many to be high. Comparisons can deflect from reality when all are outside a “reasonable” range, with reasonable being determined separately by each investor. The dividend yield is 1.5% ($1.88 dividend per share / $126). The S&P yield is 2% and the NASDAQ yield is 1.3%. It falls between those too indexes so not too bad. It is also higher than the 5-year U.S Treasury bond which many use as a guide to yields.

A P/E of 17 indicates 5.9% earnings per share price (1 / 17 = 5.9%). The dividend payout is 25% (1.5% / 5.9%). That means 75% of the profits are retained by Apple to either be reinvested by them or to increase their dividend or stock buyback (or all three) whichever the Board decides. This payout percent is lower than both the S&P 500 and NASDAQ. We seem to be looking at a reasonably valued company. One comment about the indexes – Apple is included in both indexes so Apple’s numbers also affects the comparisons.

Apple’s Beta is .89. A Beta of 1 indicates the stock is as risky as the market as a whole. Lower than one is less risky. Also, 60 million shares are sold short which is about a day’s trading volume indicating that the short sellers do not believe Apple could drop too much.

Now, let’s see what can happen if there are some changes. If the P/E ratio changes – either up or down by 1 becoming 18 or 16 it can result in a 6% up or downward change in the stock’s price or $9.00 at today’s price. The P/E is market driven and reflects degrees of optimism in many things such as individual company performance, movement in a sector, political activity, interest rates and the economy as a whole. If the earnings change, the P/E ratio will also be affected. Apple just reported humongous earnings. Investors need to assess the sustainability of a company’s earnings. Investing in a company reflects confidence about the continuance and growth of future earnings. A drop in earnings will increase the P/E just as an increase will decrease the P/E. If the price drops the dividend yield percent will increase as it will decrease if the price increases; but in neither case will the dollar amount of the dividend change. Dividend increases [or decreases] will also usually affect the stock’s price as will stock buybacks which reduce the number of shares outstanding. I said usually since nothing is ever as we think.

Apple just came off of a very large quarterly profit and its sustainability is what you have to have confidence in if you own the stock or are thinking of buying it. If the profits and P/E remain stable the stock’s price should hold up as is. If the profits and/or P/E increase or decrease there should also be resulting changes in the stock’s price.

One might ask whether Apple is a growth or value stock; and it would not be unreasonable to respond that “it depends.” Some might consider Apple a growth stock because of its “low” yield, but its P/E is not that high for a growth company. Others might consider it a value stock because of its relatively “high” dividend with potential for a dividend increase and a possible accompanying ambivalent attitude toward dramatic price increases. I suggest that both growth and value mutual funds will be adding Apple to their portfolios if they already do not own it.

One further consideration is Apple’s cash hoard – $178 billion with $33 billion in long term debt. That works out to net cash per share of $25. It that is subtracted from the current share price you would create an enterprise value with even better fundamentals.

The above is a simple illustration and you can see that it can get pretty nutsy and confusing even though on its surface Apple is not a very complex company to analyze. The purpose of this blog is to teach and offer some considerations in how a stock is valued. I hope you learned from this. Do not under any circumstance consider this discussion as a recommendation to buy, hold or sell Apple. I just found it to be a good stock to use as an illustration.