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Why Apple Inc. (AAPL) Stock Is Still a Value Play

AAPL stock - Why Apple Inc. (AAPL) Stock Is Still a Value Play

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Gotham Asset Management co-founder Joel Greenblatt certainly thinks Apple Inc. (NASDAQ:AAPL) provides good value for buyers of AAPL stock.

Why Apple Inc. (AAPL) Stock Is Still a Value Play

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In a recent interview, Greenblatt talked about how expensive the markets are at the present moment:

“When we think about the S&P 500, we go back over the last 26 years where we have good data and look at the entire market from a perspective of bottom’s up valuation. Right now the S&P 500 is in roughly the 17th percentile of expensive during those 26 years, meaning it’s been cheaper 83% of the time.”

To beat the index Greenblatt buys the cheapest S&P 500 stocks and shorts the most expensive. And wouldn’t you know it, but AAPL stock is one of his largest holdings — 31st out of 925 positions in a $7.8 billion portfolio — at 337,952 shares as of December 31, 2016.

For Greenblatt, it’s all about cash flow and the price you pay for it:

“We’ve owned Apple for a long time … They generate lots of cash flow, and we don’t have to pay a big price for it. That’s what’s attracted recent investors like Warren Buffett, where he’s looking at both that mix between growth and value … We figure out what a business is worth and try to pay a lot less.”

Is AAPL Stock a Value Stock?

He believes the markets are still valuing AAPL stock as a hardware company when in fact it’s very much a service business with iTunes, App Store, Apple Music, etc. CNBC Mad Money host Jim Cramer also feels Apple’s service business is underappreciated by investors, thoughts I shared with readers in early February when Apple was trading around $129; up almost 10% since then.

InvestorPlace contributor Chris Lau recently discussed how Apple stock hasn’t come close to peaking. I couldn’t agree more, which is why I asked the rhetorical question back in February of how AAPL stock got to $200.

Apple’s service revenue accounted for about 9% of overall sales in Q1 2017, growing 18% year-over-year to $7.2 billion. Annualize that and we’re talking about almost $29 billion. That’s huge when you consider Piper Jeffrey analyst Gene Munster estimated in 2016 that Apple’s gross margins on its service revenues were 60% and that operating margins could hit 50% in the coming year.

If that’s accurate, Apple’s operating profits in fiscal 2017 could be as high as $15 billion or $2.86 per share for this small part of its business.

In fiscal 2016, Apple had operating income per share of $10.90 ($60.0 billion in operating income divided by 5.5 billion shares outstanding); if it grows by 5% in 2017, to $11.45 per share, the services business would account for 25% of Apple’s overall operating profit.

Bottom Line on Apple Stock

Under this scenario, its iPhone business doesn’t have to be a home run in order for its profits to keep growing and that’s what drives Apple stock prices higher.

However, it’s one thing to suggest ways that AAPL stock might move higher, but it’s another to establish whether its stock is cheap. Free cash flow yield is a good way to determine a stock’s relative value.

Currently, Apple stock’s trailing 12-month free cash flow is $52.5 billion or $9.72 per share; an FCF yield of 6.9% based on its Mar. 27 closing price of $140.88. By comparison, Microsoft Corporation (NASDAQ:MSFT) has free cash flow of $3.49 per share for the trailing 12 months or an FCF yield of 5.4% based on its Mar. 27 closing price of $65.10.

The possibility of Apple’s operating margins moving higher as a result of its growing services revenue combined with talk it’s going to hike its dividend payout closer to its large-cap peers to 50% from 25% of annual earnings along with expected free cash flow growth of 10% annually in the future suggests AAPL stock might still be a value stock.

I believe Joel Greenblatt would agree.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/03/apple-inc-aapl-stock-value-play/.

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