Is Apple Finally Cheap?

One part of me resists the cult, though. To be a true believer, you must love the stock no matter the price. I liked it a lot in November 2006 at $84 a share. But I turned on it in the first stock screen column of this year at $198 a share. It worried me that Apple's (AAPL) market value had exceeded the combined worth of the computer giant Hewlett-Packard (HPQ) and smartphone leader Research in Motion (RIMM), companies which together produce four times Apple's sales and twice its profits. Two weeks later I wrote that Apple was still too expensive at $160 a share, but that it would be a good deal at $130, based on forecast earnings. It's around $130 now. Based on the freshest earnings forecasts, it looks like an OK value at that price, if not an obvious bargain.

Some sensitivity is in order. This is an anxious time for Apple stockholders, and I want to offer perspective without adding to the misery. Plus, let's be honest, would-be fellow cultists: You've been known to take a writer's email box and comment board to Crazy Town in retaliation for anything other than an expression of pure lust. There's the indignant: "Another bean counter trying to understand a company, which [is] way above his ability to analize [sic]. Apple cannot be judged using statistical measures." There's the accusatory: "Short position, Mr. Jack?" And there's the guy who's supportive for all the wrong reasons: "In my experience, people who use Apple products tend to be hardcore drug users. This is a very fickle crowd that could desert AAPL in a heartbeat, e.g., if the newest 'hot' band indicates they like the product of a competing company better. And remember, their flagship product, the Mac, was designed for people who are too dumb to operate a real computer." For the record, I have no position in the stock. Also, I don't use "hardcore" drugs.

Apple is expected to increase its earnings per share by 16% over the next four quarters, vs. 56% over the last four. That's more than the gradual slowdown expected of all companies as they grow larger. But the primary causes of this sharp deceleration are not especially damning for Apple. Its past four quarters were extraordinarily profitable, and were bound to make the future look less flattering. And consumers in general are expected to spend less this year. Investors are more uptight, too. As often happens when the economy slows, they've become less willing of late to pay up for forecast growth. After enjoying unusually high price/earnings ratios for the better part of two decades, the broad market has regressed to the historic average P/E of about 15. The decline has hit high-P/E stocks like Apple the most.

Of course, Apple hasn't merely matched earnings forecasts in a long time. It almost always beats them. But it has done so by a progressively smaller margin: by 36% four quarters ago, then 28%, then 17% and most recently 9%. The aforementioned 16% growth forecast assumes the company is being conservative in its guidance for its current quarter. Apple says it will earn 94 cents a share; analysts see $1.04.

I think Apple is worth more than the average stock because it's growing faster. Right now it's growing around two-thirds faster, so it's worth perhaps two-thirds more: a trailing P/E of 25 rather than 15. That puts fair value at $114. At $130, the stock goes for 29 times trailing earnings. That's an optimistic price, but not an unreasonable one. Eyeing the trend in those upside surprise numbers, we might suppose Apple will beat forecasts by an average of 5% over the next four quarters, which I figure would make $130 worth paying today.

All told, I would hang on to the stock so long as you haven't staked little Timmy's college tuition on it. If you don't own it but have long coveted the shares, there's no shame in buying today. Just nibble, though. Take a bigger bite if it falls another $15, but don't be surprised if it doesn't, since Apple is extraordinarily popular. Speaking of which, I should note that my opinion is in the extreme minority on Wall Street. Of the 27 analysts who cover the stock, 23 rate it a Buy, and none suggests selling. (That's roughly the same level of support the stock had at $198 a share.)

By the way, Apple co-founder, chief executive and No. 2 shareholder (behind Fidelity Investments) Steve Jobs commiserated with employee shareholders in an email last week that was leaked by AppleInsider.com, a fan web site. "Our stock is being buffeted around by factors a lot larger than ourselves," Jobs wrote. "I continue to believe that our fundamentals....[including] our $18 billion of cash in the bank with no debt....will serve us well in the coming months and years." His confidence seems plenty warranted, but the clinging to so much cash does not. Companies are meant to be conduits of profits, not hoarders. A one-time dividend of $15 a share or an ongoing one yielding 3% or so annually would surely be welcomed.

Apple turned up recently along with seven other companies in a recent search for fast growers that are topping earnings estimates. To run the screen yourself, use SmartMoney's stock screener and the full list of search criteria.