In August, with Apple (NASDAQ:AAPL) stock at $215 per share, I warned that it would fall victim to the winner’s curse. That is to say, Apple stock was too big too succeed.
Historically, the largest market cap company in the world goes on to deliver mediocre returns going forward. Once you are already huge, it’s hard to find compelling growth opportunities large enough to move the needle.
At the time, I viewed AAPL stock as a sell. However, since shares now have pulled back sharply to the low $170s, it’s worth a fresh look.
While I still doubt the company will deliver breathtaking returns again anytime soon, the cheaper price may make Apple a decent play for more conservative growth and income investors.
Mapping the Road Ahead for Apple Stock
If you’re a shorter-term trader, it’s not that important to think about long-term valuation and earnings growth. In that case, quarterly earnings and technical analysis tend to be more relevant.
But Apple stock is, at least among tech companies, viewed as a long-term sleep well at night buy and hold play. And as such, it’s pivotal to think about where the company will be in five years to decide if it is a good buy at today’s price.
Let’s start with arguably the most important metric: how fast earnings will grow. Analysts see earnings growing at about 11%/year compounded over the next five years. Assuming that the analysts are in the right ball park, that puts AAPL’s earnings around $21/share at the end of 2023.
Now we think about what a proper PE ratio for AAPL stock should be. Working backwards from the analysts’ estimates of 11% earnings growth, we can deduce that net income should grow around 6%/year.
That’s because the company has been buying back, on average, around 5% of its outstanding stock each year in recent times. Thus share buybacks will account for just under half of earnings growth, with organic increases in operating profits making up the rest.
Analysts and Apple Stock
Let’s take the consensus outlook at face value. What is AAPL worth in five years if it is earning $21/share then? The company is at a trailing PE ratio of around 14x now.
Holding that constant, AAPL stock would be worth $336/share five years from now. That’d close to a double, not counting the modest dividend. Hardly a spectacular gain, but it’d certainly get the job done for conservative investors.
However, it’s worth thinking about where the PE ratio should be in the future. Based on the inputs above, Apple would be growing its net income in the mid-single digits range. That’s not particularly impressive.
Until recently, tech companies like Microsoft (NASDAQ:MSFT), Oracle (NASDAQ:ORCL), and Intel (NASDAQ:INTC) tended to trade closer to 10-12x earnings. The market viewed them as stable dividend plays, but without a growth kicker, there was no reason to pay up for the earnings.
It took exciting new technology, such as Microsoft’s cloud and Intel’s autonomous vehicles push to get those stocks back up to healthier PE ratios. And even now, Intel has fallen back to 11x earnings with the recent correction.
Unless Apple hits a major new earnings stream (probably off a product, as services simply isn’t big enough yet) the PE ratio should move lower. In five years, if Apple is posting anemic growth, the PE ratio should slide down toward, let’s say, 13x instead of bouncing back up, as many folks expect.
Thirteen times earnings on $21 of EPS gets us to a 2023 price target of $273. Still pretty good for conservative investors, but those wanting more flashy growth should look elsewhere.
The Analysts May Be Too Optimistic
Over time, I expect analysts to trim their EPS growth targets for Apple. There is a couple of reasons for that. For one, Apple itself decided to stop reporting on unit sales for various products.
It’s almost never a good sign when a company decides on less transparency. Management can try to control the narrative by reporting metrics that it wants the media to focus on. But unit sales are indeed very important, and it seems like Apple is nervous that news will be bad on that front.
Additionally, it wouldn’t be shocking if Apple’s share buyback slows down. For years, the company was unable to spend its overseas cash, and thus had an unusually strong balance sheet. Now however, tax reform has come and gone, and there may be less excess capital with which to buy back stock.
Certainly a large buyback program will continue, but Apple’s recent pace—5% of the share count—now amounts to $45 billion a year. That’s a lot of money, even for Apple. A reduced share buyback, would, in turn, directly lower earnings growth.
Apple Stock: Worth $234 in the Year 2023
I see Apple’s earnings growing at a more modest 8%/year compounded rate over the next five years. That’s hardly bad news for a company of its massive size. As it is, analysts are usually too optimistic, so cutting a little off their expectations is usually a good call.
Unfortunately for AAPL stock, 8% earnings growth isn’t really enough to deliver strong shareholder returns given its starting PE ratio. At 8% earnings growth, Apple hits around $18 of earnings in 2023. Multiply that at a 13x PE ratio, and your stock price in five years is $234.
That’s a pretty unremarkable return. The dividend helps a little bit though. For long-term investors with tax consequences, Apple stock may well be worth holding to avoid a large capital gains bill.
But for most people, Apple is still not a compelling investment at this price. That said, who knows how far this correction will run, If Apple stock hits the $150s, it would make all the above math look a lot more interesting.
At the time of this writing, Ian Bezek owned INTC stock. You can reach him on Twitter at @irbezek.