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Apple's Stock and the Voting Machine

Peter Lynch put it quite simply by saying, "Buy what you know." Now, I'd be remiss if I didn't mention that there was a study showing this often does not work. Here, however, it does.

The other day I walked into an Apple Store to check out the iPad mini. It was like walking into a swarm of bees in a beehive. People were everywhere. Everyone I know loves Apple's products and owns at least 1 Apple device. Those I know who don't own an Apple device plan on buying one in the near future. I've used other products, talked to others who use other products, and everyone admits these devices aren't as good as Apple devices; this includes: phones, computers, MP3 players, portable tablets, etc. Apple products are vastly superior in every category, there's really no debate. The only reason you wouldn't buy an Apple product is because you were interested in saving money, with plans to purchase one in the future when the price goes down.

As for the current state of Apple's stock ( AAPL ), Peter Lynch has something else to say about that:

There's no question that analysts are bored with Apple, but, really, who cares? Apple's stock is a no-brainer at $431.72 as I type right now, March 10, 2013. The company has $137 billion in cash. With that amount of cash Apple could buy Ford and Honda and almost have enough money left over to buy Tata Motors at the companies' current market valuations. This is an insane amount of cash for one company. If Apple has any problem, it's having too much cash, not the worst problem a company could have.

Apple, according to a recent press release, also plans on returning a lot of that cash to its shareholders:

Cash considerations aside, Apple trades at a current P/E of 9.79. This is well below the 5-year average P/E of 15.6. Furthermore, Apple's P/E has never been so far removed from the S&P 500's P/E as it is now, trading at about 40% below the S&P 500's (about 43% below the Nasdaq's), with Apple's average P/E being 64% above the S&P 500's since 2003.

If the P/E is any indication of investors' expectations, they don't seem to believe that Apple will grow much faster than about 10% per year. However, over the last 5 years Apple has increased earnings by an average of 63% per year. If Apple continues growing at even half that rate, you'd be looking at EPS of around $174 by 2017. This would equate to a share price of $1703.46 at the current P/E. Now, I must reiterate, this is the half-growth scenario . Staying at the average current growth rate would mean a share price of $4973.32. Now, my hypothesis is that we land somewhere towards the lower end near $1703, taking into consideration that the market discounts the future and that the company is not going to realistically grow into being 20% of our economy--- but this would still amount to almost a four-fold gain in under four years. Furthermore, either way growth pans out, you're looking at what could be over a trillion dollar company sometime in the 2014-2015 range.

With growth and P/E considerations in mind, read these quotes by famous P/E investor John Neff:

As shown earlier, the P/E multiple does languish more than 40% below prevailing market multiples. Also, Apple is growing much faster than 7% with a pretty astonishing dividend, for what I still deem a "growth company," of 2.46%.

Peter Lynch would love this stock, especially when looking at the P/E in terms of the growth. While Yahoo gives a PEG of 0.5, Peter Lynch looks at it a slightly different way. He takes the long-term growth rate, which I estimate on the low side to be 30% (Yahoo's estimate is 20%), adds the dividend yield, 2.46%, and divides by the P/E ratio, 9.79. This gives 3.3 for my estimate vs. 2.3 for Yahoo's. In "One Up on Wall Street" Lynch describes the interpretation of these values as the following:

He goes on to give an example of a stock that scores a "3" and deems it "fabulous." If we say that the number will most likely fall somewhere between these two estimates, 2.3-3.3, we're looking at a stock Peter Lynch would undoubtedly rate as a "strong buy."

Now, there are concerns that Apple's moat may be drying up as companies like Google continue to steal market share. However, in this analysis a margin of safety was added by considering Apple's stock in light of growth drying up 50%, which isn't likely to happen. You have the new Macbook Air coming out, iPad 5, iPad mini 2, iPhone 5s, iMac, Mac mini, just to name a few. And according to CEO Tim Cook, new products in new categories are on the horizon. Some anticipate the iWatch as one. The bottom line: it doesn't matter what is on the horizon. Apple could make a car and people would buy it just because it is an Apple product. Even if Apple didn't come out with any new products, looking at the company from a zero growth perspective, seen here (provided by Old School Value) for those interested in more advanced valuation methods, Apple's stock has significant downside protection.

As was said by many great value investors, "Protect the downside and the upside will take care of itself."

To reiterate the absolute absurdness of this price, watch this video of Bill Maher and his guests talking about Apple:


Although Apple has dropped a lot since this video, I still find it extremely relevant to this post:


As Ben Graham famously said, "In the short term, the stock market behaves like a voting machine , but in the long term it acts like a weighing machine." Long-term shareholders that buy Apple at this price can take advantage of this phenomenon.

Disclosure: Long AAPL

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    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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