Novice Investing - Apple Growth Rate Explained

Date: Monday 01st 2008f December 2008 05:15:49 PM

Apple Growth Rate Explained - 11/16/2005

By: Novice Investing Staff

Predicting fair value for a growing company is tricky. Today, we will take a stab at Apple Computer (AAPL) which has surged for years due to the popularity of its iPod product line.

Apple is an interesting company. Before iPod, you could have bought the stock at $ 7 which is equal to the amount of cash it held at the time. So, wallstreet was essentially valuing Apple's Macintosh business at $ 0. To be fair, the company was losing money and no end in sight. And then, came iPod. The rest is history. Now, the stock has risen more than 9 fold to $ 64.95 as of November 16th 2005.

All right. Enough about history. Let's talk about Apple's valuation and what growth rate investors are expecting in the company. Let's look at Apple's latest balance sheet. It shows a $ 7.5 Billion of cash & equivalents with $ 0 long term debt. This translates into $ 9.03 per share of positive net cash.

At current stock price, the real price of Apple's business is therefore ($64.95 - $ 9.03 ) = $ 55.92 per share. Apple's Earning per share for the last twelve months stood at $ 1.56. Since most analysts believe that Apple can grow its earning for the foreseeable future, we will estimate Apple's growth rate from an article Calculating Fair Value With Growth. Assumptions that we use will be similar. We assume that Apple will grow its business at a certain rate and earning will stay constant five years from now. In this case, we will do the calculation backwards.

Currently, Apple is trading at 35.8 trailing P/E ratio where the 'P' here is the real price of Apple's business and not the stock price. With 0% growth and 4.5% risk free interest rate, a stock is fairly valued at a P/E of 13.4. If Apple is fairly valued now, then investors must assume that Apple will hit earning of $ 4.17 ( $55.92 divided by 13.4) within five years. Using an interest rate of 4.5%, present value of $ 4.17 will grow to $ 5.20 in five years. In other words, money that is worth $ 4.17 now will be worth $ 5.20 in five years. Calculating earning growth from the base earning of $ 1.56 currently to $ 5.20 within five years, gives us an annual EPS growth rate of 27.2%

Can Apple grow its earning at an annual rate of 27.2% within the next five years? If so, then Apple at current price is fairly valued. This means that investors need to buy the stock at a lower price to profit. If investors expect Apple to grow 30% annually within the next five years, then Apple's current stock price is lower than its fair value.

Annual earning growth of 27.2% is not unreachable for some companies. Apple itself has grown its sales from $ 5.7 Billion in 2002 to $ 8.3 in two years. Earning growth grew much faster during the period. This again depends on investors' predictive tools. If you use sane prediction and find that Apple can grow earning faster than 27.2%, then the stock is trading below its fair value. If not, then it is better to put your money elsewhere.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Apple Computer Inc. (AAPL) or any other securities.

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