Apple: Multiple Expansion

by The Compound Investor

I last covered Apple (AAPL) stock back in the first quarter. At the time, shares of the Cupertino-based giant traded for around $310 apiece, and had returned 100% on my previous article in early-2019. I concluded that it was still reasonably valued, albeit with the prospect of large swings in its valuation multiple.

Obviously a heck of a lot has happened over the past few months. We don’t need to rehash the macro stuff, but just look at Apple’s stock price chart. It headed up to the $325 area after that February article, before COVID-19 took it down to $225 in late-March. It lost almost a third of its value – some $440,000m – in the space of just over a month. That was the situation right up until we saw the enormous monetary and fiscal response, the result of which put a rocket under the stock market. Apple currently trades at around $335 per share, and is actually up circa 12% year-to-date. What a strange year, and we are not even half way through it.

Truth be told, this one has been an easy value play for much of the past five years. Apple stock did, at various points, trade as low as 10x forward earnings in that period. That does not even take into account the state of its balance sheet either. The huge amount of cash and investments that Apple has built up over the years is ultimately wrapped up into its stock price. Take the excess out of the figure, and you could buy the actual business for even less. That’s a business that Warren Buffett recently described as the best in the world.


The story here has been relatively simple. Indeed, I think we can basically distill it down to two things. Firstly, stock buybacks. I reckon I must have read over 10,000 articles on Seeking Alpha since I first came across the site six years ago. Of them, one really stands out in particular. It made the case that Apple could compound at a double-digit clip with zero underlying profit growth.

As a relatively novice investor, that was an eye-opener. Like a lot of folks, I thought that profit growth was the only game in town. Not so, and here’s how it works. Apple made roughly $53,500m in net profit back in its FY15. Wall Street estimates point to circa $61,500m in FY21 net profit. But here’s the thing – Apple has well over 1,000m fewer shares outstanding than it did over the course of FY15. We are talking over 20% of the float being taken out of the equation here.

That rapidly shrinking number meant that stockholders got an increasingly larger slice of the profit pie. Because the shares were so cheap for much of that period, the impact of this was pretty big. For instance, FY15 net income clocked in at around $9.20 on a per-share basis. If Apple makes $61,500m next year, then the per-share number would clock in at over $15. We are talking about a six percentage point per annum difference between the per-share growth figure and the underlying figure. Huge.

Multiple Expansion

The second boon to Apple stock returns has been the change to its valuation. When I published that first piece back in early-2019, the shares traded for under 13x profit. That number has since expanded to the 25x profit area. Given the stock sits somewhere between a two and three bagger, this means that most of the returns were generated via multiple expansion.

The story is not all that much different on a slightly longer timeframe. Indeed, I estimate the valuation shift explains two-thirds of the compound annual returns figure going back to FY15. Given that Apple has compounded away at a circa 25% per annum clip in that time, that is quite significant. Ultimately, I don’t see why Apple should trade at a discount to the wider market. It is a far better business than 95% of its constituents. That means circa 18x earnings as a long-term baseline average, while we are currently at 22x earnings estimates for FY21. That’s a slight headwind, but manageable over a decade or so.

Now, the company still plans to return its excess cash balance to stockholders. Given it holds circa $193,000m in cash, cash equivalents and marketable securities, I make that worth around $85,000m based on its current debt load of $110,000m. That, plus cash dividends, is worth low single-digits per annum over the next decade. If Apple can compound its per-share profit at a high-single digit annual clip – aided by $45,000m in annual retained earnings generation – then it can still do fine from these levels.


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