Apple Inc. (NASDAQ:AAPL) produced stellar earnings on Jan. 27 for its fiscal first quarter (Q1) ending Dec. 27. It also showed that the company’s free cash flow (FCF) was very powerful. As FCF surges this year, AAPL stock should keep moving higher.
In the last two months, Apple stock has fallen 10.47% from a peak of $182.01 on Jan. 3 to $162.95 as of Mar. 9. That may not seem like much, especially in the correction that the market has gone through lately. But AAPL stock was down much further in Q4 2021 when it hit $139.20 on Oct. 13. So, in a way, it is actually up 17% from its recent lows.
And why not? The company produced excellent FCF results in Q4. Let’s look at this further.
Apple’s Free Cash Flow and Prospects
The company produced stellar revenue and earnings growth with revenue up 11% year-over-year (YOY) and net income up 20.4% during Q4. But more importantly, the company’s FCF was higher, as well.
Apple generated $44.163 billion in free cash flow, which is the result of deducting $2.803 billion in capex spending from $46.966 billion in cash flow from operations. Apple is one of the few companies that actually produce a quarterly cash flow statement, which is on page 3 of the financial statements, so this is easy to calculate.
We can tell that this is a high level by comparing it with the company’s revenue level. So if we divide the $44.16 billion in FCF by its $123.9 billion in quarterly revenue, its FCF margin was 35.6%. This is an extremely high margin. It shows just how incredibly profitable the company is right now.
Moreover, if we project that out for the next year or two we can derive a fair value for AAPL stock. Let’s see how that works out.
AAPL Stock Value Using FCF Analysis
For example, 40 analysts surveyed by Refinitiv have an average revenue forecast for 2022 of $395.79 billion. And for 2023, their estimate is $418 billion. That represents 8.15% growth in 2022 over 2021 and 5.6% growth in 2023. These are not especially high growth rates. But the amount of FCF profit it generates from this revenue is massive.
For example, if we assume that 36% of revenue by 2023 will turn into free cash flow, that means it will generate $150 billion in FCF by 2023.
Next, assuming that the market values it at a 5% FCF yield, which is the same thing as using a multiple of 20 times FCF, Apple should have a market value of $3 trillion. That is the result of dividing $150 billion in FCF by 5%, or, alternatively, multiplying $150 billion by 20 times.
Therefore, given that the existing market capitalization is $2.659 trillion, this leaves a 12.8% upside in the stock. But again, this assumes that its FCF yield will be just 5%.
For example, assuming a 3% FCF yield, the market value will be $5 trillion (i.e., $150b / 0.3). This represents a potential upside of 88% for AAPL stock.
What to do With AAPL Stock
So, AAPL stock is worth somewhere between 12.8% and 88% more than the current price, depending on how high the market values its powerful free cash flow. Just taking the midpoint, that puts it at 50.4% higher.
To be quite exact, we need to adjust for the time value of money since we used revenue estimates two years forward. Assuming a 10% discount rate for each year, the present value of the revenue would be 82.64% of that number. That lowers the upside to 82.64% of the 50.4% upside, or 41.65% higher.
Therefore, the stock is worth 1.4165x its Mar. 9 price of $162.85 per share. That means its value, using FCF analysis, is $230.82 per share.
Another way to look at this is as follows: if it takes two years for the stock to rise 41.65%, then the average annual return each year will be 19% each year. For proof of this, take 1.1901 to the second power, and you get 1.4165.
Here is the bottom line. Apple’s free cash flow is so powerful it raises the valuation of the stock by almost 20% annually for the next two years. This is despite the company’s slow sales growth expectations.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.