Apple: The Expansion Continues

by The Compound Investor

Apple (AAPL) stock has been a great investment since it was first covered on the site. Quick math suggests the iPhone maker has returned over 230% since the start of calendar year 2019 alone. Of course, its longer-term credentials are very well-known – the stock is up by a factor of almost 1,200 since IPO back in late 1980 – but its recent performance is incredible for many reasons, not least of all arriving in the midst of economic mayhem. Apple stock is up almost 70% year-to-date, while the company now sports a market-cap of circa $2.15T.

Truth be told, the numbers back in early-2019 were eye-opening. The Cupertino-based giant traded at just 13x earnings at the time. Even taken in isolation that looked like a decent deal, but sweetening it were a couple of other things. Firstly, ultra-low interest rates. A circa 8% earnings yield for Apple stock looked really good against a ten-year Treasury yield of circa 2.7%. Secondly, the firm’s fortress financial position. Apple sat on around $120B worth of cash & investments after backing out the debt pile, and it planned to return that directly to shareholders.

Processing all of the above led to one heck of a short-to-medium term investment case. The stock offered a double-digit shareholder yield, not to mention some possible extra gains from valuation multiple expansion. And by and large that is exactly the story that has played out here. Folks who bought at the start of CY19 have essentially tripled their money in under two years. Not too shabby.

The Multiple

What may surprise some folks about Apple is how little its profit numbers have moved. Granted, the not-so-small impact of COVID-19 may have had an effect here, but bear with me a moment. In its FY18 the company posted net income of around $59B, which worked out to just over $12 on a per-share basis. This year – and remember Apple’s fiscal year ends next month – analysts expect the firm to post around $57B in net profit. It has already made $44.7B over the first nine months of its FY20.

Unlike the underlying net income figures quoted above, the per-share profit number actually represents an increase. I have that $57B in FY20 net income figure as being worth just over $13 per share to Apple stockholders. That discrepancy is, of course, due to the cumulative impact of stock buybacks. Apple retired around 500m shares – or just over 10% of its float – between the end of FY18 and 3Q20. Indeed, buybacks have done much of the heavy lifting here since FY15.

Anyway, a quick analysis of the above shows that the vast majority of shareholder gains here have come from continued valuation multiple expansion. Most folks know this anyway, but it needs repeating. I mean, just check out what has happened since the last time I covered the stock. It traded at a fairly reasonable 22x FY21 earnings estimates back then. That figure has ballooned to over 32x forward earnings in the space of just ten weeks or so.


Suffice to say, the facts that made this so attractive last year have become less relevant. Buybacks don’t add much to the table when your stocks trades at 32.5x forward profit estimates. When I wrote about Apple back in early-2019, it planned to return $120B in excess cash to shareholders against a $750B market-cap. The company still has an extra $80B or so to return to stockholders, but its market-cap is now comfortably over the two trillion dollar mark.

Herein lies a potential problem going forward. Right now you can actually put forward a case for this kind for valuation. Virtually anything goes when the ten-year Treasury yield stands at 0.65%. But on a long-term basis, what happens if we have to factor in some reverse movement on that valuation? Slipping from a 3% forward earnings yield to a 5% forward earnings yield over a decade would cost investors over 4.75% per annum.

The business of selling iPhones, MacBooks, Apple Watches and activity from its Services segment (e.g. its cut of App Store sales) generates circa $45B of retained earnings each year. The company needs to use that to drive double-digit underlying profit growth before stock buybacks to make the current $500 share price work. Although Apple still has an excellent business, the investment proposition here is now the least attractive it has been for quite some time.


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