Few stocks garner as strong opinions as Apple does. That naturally comes with the territory of being both an incredible long-term performer and also incredibly large (its market-cap is around $2.8T at time of writing). I’m sure that the stock’s very healthy dose of valuation multiple expansion in recent years has also played its part.
On the last point specifically, Apple has re-rated from a P/E of 10x at its low point to around 30x right now. This has happened in the space of, what, seven years or so? Although counterintuitively not ideal for ‘true’ buy-and-hold investors (all else equal it would be better for them if the stock remained ‘cheap’ into perpetuity), such a move nevertheless equates to around 17ppt per annum of total returns in that period. No wonder the stock has a legion of loyal defenders and valuation skeptics. But at 30x EPS, where do we go from here?
Let us consider the drivers of future returns. These are growth in net income, capital returns to shareholders (dividends plus stock buybacks), and changes to the stock’s valuation. Future spin-offs, if they occur, can be measured distinctly and then added back on.
Expressed in a little more detail, our drivers work out to something that looks like this: net income growth rate + buyback yield + dividend yield + the rate of multiple expansion/contraction. Buybacks and net income can be rolled up into the more simple tracking of EPS growth. You can, even more simply, just track the average dividend yield plus the rate of dividend growth plus the change in the yield. They will all get you very close to the ‘real world’ total return figure.
To satisfy ourselves that our drivers do indeed do a good job of capturing total returns let us quickly look at Apple’s past performance. I mentioned seven years in the opening paragraph so let’s work with that. Starting with total returns, Morningstar has Apple stock putting in a CAGR of around 32% in that time. The various drivers are as follows: net income growth (~12.4%); average dividend yield (~1.4%); buybacks (~4.3%); and P/E expansion from circa 13x to circa 30x (~12.5%). Lo-and-behold we are within around 5% of the actual real world figure. That is good enough for our purposes (the residual can probably be explained by issues of general accuracy plus the exact sequencing of dividend reinvestment and so on). Similarly, DPS growth (~9%), dividend yield (~1.4%) and yield change (~19.9%) again gets us within around 5% of the true figure. EPS growth (~16.5%), dividend yield (~1.4%) and P/E expansion (~12.5%) produces near enough the same result.
With that we can get to the heart of the matter and be a little more forward looking. Firstly, let us realize exactly why ‘compounders’ like Apple are so popular for self-styled long-term investors. Growth is obviously one, but also it is the ability to distribute a high portion of the “E” in P/E without impacting said growth. The two can form a potent combination in terms of total returns.
You might say that at 30x earnings it would be prudent to bake in some long-term multiple contraction. But this need not exceed around 2ppt per annum over the next couple of decades so long as Apple’s earnings growth outlook does not collapse below around 3%. This is for the very simple reason that as the multiple heads ever lower, the capital returns yield would then end up doing much of the heavy lifting on its own. Even at just a few points of net income growth things eventually become too good to turn down. Tying that back to the opening paragraph, you can now see why near-term multiple contraction might even be good in the long run. And if it stays cheap, well, all the better.
With that, I would be looking for around 7% per annum growth in net income to be happy. Valueline has the next five years growth at ~5.5% per annum. It’s a tad aggressively priced I think, but even so it’s not clear to me that Apple will actually underperform the wider market from this point. Its case relative to peers Microsoft and Alphabet looks a bit weaker. Nevertheless, so long as Apple remains a money spinner its 3-4% contribution from capital returns then it could conceivably keep things ticking along at an attractive clip, notwithstanding the deceptively high current multiple.
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