What's Apple Stock Really Worth?

Apple reported 15% profit growth late Wednesday, trouncing Wall Street’s projections. It’s making more money now than when the stock last hit $200 a share, on the first trading day of 2008. On that day, I urged SmartMoney.com readers to sell. Now shares go for $122. Considering the earnings growth and the newly low price, is Apple (AAPL) cheap? Let’s see.

Don’t assume you should buy just because the stock used to go for $200. Stocks aren’t cans of peas at the supermarket. There’s no regular manufacturer’s price against which to measure markdowns. Apple’s 39% decline from $200 could easily leave it too expensive, even if profits have improved, for two reasons. First, other stocks have fallen more during that stretch — the broad market is down 41%. So while Apple might be cheaper relative to its own past price, it might not be relative to investors’ other options. Second, a markdown on a good that was too pricey to begin with isn’t always a bargain.

So let’s compare the price with earnings. Wednesday’s results put Apple shares at 22 times trailing earnings. That’s well higher than price/earnings ratio for the S&P 500 index, which tracks America’s 500 largest companies, including Apple. It trades at 17 times trailing earnings, and that number might be artificially high, since it includes gigantic bank write-downs that erased fourth-quarter earnings completely. Normalize fourth-quarter numbers and the index is closer to 14 times earnings. Either way, Apple is clearly much pricier than the average stock relative to recent earnings.

Of course, a high P/E ratio is generally a bet that a company’s earnings are going to grow quickly. Apple’s earnings per share jumped 73% in fiscal 2007 and 36% in fiscal 2008. Growth rates like those could easily make the stock worth 25 times earnings, if they could be expected to continue. Unfortunately, a sharp pullback in consumer spending has slowed Apple’s growth considerably, at least for now. Until Wednesday, analysts expected earnings for the company to shrink slightly in its fiscal year ending Sept. 27, before growing 14% next year. Earnings underlying the S&P 500, for comparison, are expected to rebound 22% this year after a 40% plunge last year.

I have little confidence in the broad market meeting that growth projection, and plenty of confidence that Apple will continue beating expectations as it did Wednesday. So maybe it’s worth 20 times earnings. But 22 times earnings?

I’m a fan, just so you know. I now have two MacBooks and Apple’s big LED monitor to plug them into, plus an iPhone and the white Wi-Fi thing with the hard drive inside. So I get it, about the company’s growth potential, and the almost creepy devotion of its customers, who filled my email box in January 2008 when I called the stock expensive at $200. But I’d feel much more confident that investors were getting a good deal with shares at or below $100.

Now, four pieces of good news for stockholders. First, the 37 estimates that make up Apple’s earnings consensuses for this year and next are tightly clustered, which studies show tends to foretell strong financial results. (Companies with good things to say, it seems, send clearer signals.) Second, upside earnings surprises in one quarter are likely to be followed by the same in coming quarters, and by stock outperformance. Researchers call that post-earnings announcement drift, or PEAD, and while it doesn’t work in every case, or forever, it’s nice to have on your side.

Third, I called on a research group called Transparent Value for thoughts on Apple. Transparent Value specializes in assigning companies a probability of delivering sales and profit growth in future quarters that will justify their stock prices today — sort of the reverse of what analysts do when they come up with a price target based on future growth assumptions. The firm reckons Apple has an 88% chance of growing fast enough to justify a price of $122 a share.

Fourth, Apple sits on cash and marketable securities worth $32 a share. Subtract that from the stock price and the P/E shrinks to 16, easily worth paying. And I’d be happy to subtract the cash from the stock price if I had any indication that Apple was planning to return most of it to its rightful owners, stockholders. But there’s no dividend. Instead, the cash just sits there, tempting management to buy something overpriced. Studies show, after all, that while all companies tend to overpay for takeovers, cash-bloated ones overpay by the most. Of course, it’s because of Apple’s success that it accumulated so much cash, and the 5% or so of its cash balance that it will spend on research over the next year will surely be put to good use. But it’s long past time for a dividend, and Apple can easily afford a 4% or 5% yield at today’s price. That, more than anything else, would justify the $122 a share.