Now that we’ve covered stock valuation for beginners, this is the first [exciting] edition of Stock Analysis Thursday where I will discuss stocks that I have done research on, usually in the same sector. As an FYI, I will tend to be bullish on the stocks I discuss. The reason why is that I will be sharing the research that I’ve already done for my own personal investments. When I come across a deal-breaker characteristic of a stock, I often stop and do not complete my full research into that stock. As a result, I cannot discuss those stocks. That said, in the future for the purpose of this site, I will attempt to complete my research into any stocks I look into and thus there will be some bearish articles too. Enough said, let’s begin.
Little overview is needed on Apple. They design and sell iPhone, iPads, computers, Apple TVs, etc. They are sitting on the tallest pile of cash of any company in the world at a whopping $216.1 billion. In second place is Microsoft (MSFT) at $113.8 billion… so Apple has a pretty healthy lead. Despite having one of the best balance sheets and most loyal customer bases, Apple faces major concerns about the sustainability of its products’ growth, particularly the iPhone. With a meh release last year of the iPhone 6s, an anticipated meh iPhone 7, and let’s not forget BREXIT, Winter is here for Apple investors (that’s a Game of Thrones Winter, not an actual winter – which is actually quite pleasant for Apple sales).
MacRumors.com has two graphics that I really like that overview Apple’s product line and revenue growth:
Looking at Apple’s financial ratios, you can see that it has a relatively small P/E ratio at 10.70, which is also on the lower end of how it has traded in the past 5 years. Its beta of 1.00 indicates that it nearly mimics the movement of the overall market (not necessarily bad considering the market returns 8-10% annually on average). That said, Apple is not a stock you should use as a hedge against a market downturn. Definitely not. But with a dividend yield of 2.4% and heavy stock buybacks, Apple is returning money to shareholders and that’s a nice perk.
Now let’s take a look at my EPS DCF valuation for Apple:
Now you may notice that I used a growth rate of 5% instead of the 9.77% predicted by analysts as reported by NASDAQ. Simply put, that is because I am less confident in Apple’s growth prospects. If you look at the year-by-year breakdown of the growth predictions by analysts, it doesn’t look very pretty. That, combined with my own predictions, makes me skeptical that Apple will be able to meet the 9.77% growth target. By using my conservative 5% growth rate, we come up with a value of $110 per share of Apple stock, representing about a 15% upside in the stock price from where it trades today. If Apple does hit a 9.77% average annual growth rate, the valuation would be $133 per share or about a 37% upside.
My skepticism aside, I do expect the next next iPhone (iPhone 8?) to be a huge success on par with the iPhone 6 and you never know when Apple could introduce a game-changing new product line. And remember, with its stock pile of cash, it could literally just buy almost any other business (related or not) and immediately generate a crazy boost to EPS. Those factors makes me long-term bullish on Apple’s growth perspectives (long-term meaning more than 5 years for me).
I think despite the admittedly significant short to medium-term risks to Apple’s earnings growth, it is cheap even at a valuation that assumes pretty conservative growth. That in addition to the great balance sheet, decent dividend, and substantial stock buybacks makes me an investor of Apple. But with a gloomy outlook likely until the iPhone 8, don’t expect the market to throw Apple a bone anytime soon. The market tends to quickly correct undervaluations like Apple only upon good news. So I would not invest in Apple unless you are willing to hold onto that investment for at least 2.5 years, noting that by that point the valuation of Apple should increase and you should be able to reap a higher upside than just 15%. If Apple hits $110 before this quarter ends, I would sell it and re-evaluate upon the earnings release.
Disclosure: I own shares of Apple (AAPL). I am not a financial advisor. Do not make any investing decision solely based upon what you read here. It’s your money, invest it wisely.
If you are looking for a potentially lower-risk way to play Apple with a higher potential upside, I would recommend taking a look at Skyworks Solutions…
Skyworks Solutions (SWKS)
Skyworks Solutions is a fast-growing semi-conductor company that is a major supplier to Apple. It has long been thought of as a hidden way to invest in Apple because Apple is its biggest customer, representing approximately 40% of revenue. Because Apple represents such a huge portion of Skyworks’ revenue, the concerns about Apple’s growth apply to SWKS as well. Accordingly, investors have beaten up SWKS stock; it is down 38% over the past year. That’s even more of a beating than Apple got itself (Apple is down 22% over the past year). The way I see it, 40% exposure to risk in Apple growth is better than 100% exposure – but hey, that’s just me. To quell the concern in SWKS growth, check out this slide from their February investor presentation showing their predicted unit sales by product line:
This shows how, while SWKS agrees that growth in the mobile device market will slow, they predict the Internet of Things (IoT) will take off. The IoT is basically the debut of internet-connected devices within our home that were previously unconnected (think connected LED lights, door locks, weight scales, etc.). SWKS is well positioned to take advantage of growth in the IoT as a major supplier. Clearly, they believe this will become their main business and Apple should become a smaller customer. This is principally why I like SWKS as compared to Apple; while it will benefit from any growth in Apple itself, it does not require it. SWKS, like the young adult finally heading into the real world, can survive on its own and should mature into a balanced, highly successful adult – I mean company. And it’s not just me, NASDAQ reports that analysts predict a 21.51% five-year average annual growth rate in earnings. So while I do think Apple faces major medium-term growth risks, I do not believe the same applies to SWKS. The pressing growth risk is simply to short-term earnings as they transition into a more diversified portfolio of customers.
Looking at SWKS’ ratios, you’ll see more of a positive story. The P/E ratio is significantly lower than the industry and is trading much closer to SWKS’ lows than highs. SWKS does have exposure to market risk, shown by the 1.24 Beta. The dividend yield, while lower than Apple, is high for the growth company that I believe SWKS to be. And while it may not have $216.1 billion in cash, it has an extremely healthy and un-leveraged balance sheet. The current ratio (current assets/current liabilities) is a whopping 6.6 so that is not a risk. I almost wonder if SWKS should be taking on more debt at current rates, but they clearly do not feel they need to. So far so good, right? Let’s take a look at the valuation.
As you can see above, like Apple, I manually lowered the growth rate from the analyst-predicted 22% to 13%. I did this in the same interest of conservatism with Apple. However, if the IoT really takes off as predicted, the 22% may very well be a fair growth rate. With the 13% growth rate, you can see that the stock is valued at $87 per share, a whopping 47% upside. With the 22% growth rate, we would come up with a price of $121 per share, a Burger King whopper-sized 104% upside. While that seems crazy, in 2014 the stock price grew almost 170%.
It’s honestly hard for me to find something I don’t like about SWKS. Despite the negative stockholder sentiment and short-term growth outlook, the medium-term growth prospects, crazy cheap valuation, and balance sheet scream BUY BUY BUY to me (sorry, I listened to Mad Money earlier today). I think Skyworks Solutions is a great play on Apple that minimizes growth risk and expands upside potential. On the negative end, SWKS obviously lacks Apple’s cash position and customer loyalty. Just remember, if you own both Apple and Skyworks Solutions, make sure they do not together represent too large of a portion of your portfolio as they often trade in lockstep and their earnings are highly correlated right now. This is also a long-term play; investors may continue to punish the stock until it surprises with earnings or proves that it is a bigger company than just its sales to Apple.
Disclosure: I own shares of Skyworks Solutions (SWKS). I am not a financial advisor. Do not make any investing decision solely based upon what you read here. It’s your money, invest it wisely.