Sometimes you can get too big for your own good.
Apple (Nasdaq: AAPL) has flirted with being the largest company in the world for a while. The consumer-tech giant makes some of the best and most successful products in the world.
That’s the problem.
Nearly everyone who wants an iPhone (and can afford it) already has one in his or her pocket.
Now that the company has sold more than 800 million iPhones, the question becomes: Who’s left to buy one?
People still love Apple. And they’re going to keep replacing their iPhones every two years.
Still, most investors love growth. And it looks like Apple’s has seriously slowed.
In its latest quarter, Apple sold 40.4 million iPhones. Overall, earnings per share clocked in at $1.42 (down from $1.85 a year ago). Gross margins fell from 39.7% to 38%. This is still a fantastic gross margin.
And a business with slower growth can still be profitable for shareholders. You just have to figure out how much to pay.
Valuing a business is not a precise science. The practice relies on tons of assumptions. But here’s a key: Many things add value to a company beyond just rapid growth expectations.
For example, consultant Interbrand calculates the value of Apple’s brand to be $170 billion. That alone covers about a third of Apple’s $571 billion market cap.
Beyond its brand, Apple owns valuable patents and trademarks. It has one of the most efficient supply chains in the world and a 115,000-strong highly skilled workforce that is just outside the top 5% in sales per employee for S&P 500 companies.
And most important, it holds gobs of cash in the bank with more flowing in every day. And cash has real value, especially when interest rates are low.
Let’s do a quick valuation of Apple’s incoming cash flow…
In the last 12 months, Apple generated $43 billion in free cash flow. Free cash flow represents real, hard money – pure profits left over after the company pays for everything. It doesn’t include accountants’ projections or assumptions about future costs or earnings. It’s what really came in the door… It’s literally money in the bank.
However, when we consider cash flows, financial folks always look at what’s called the discount factor. It’s a way of accounting for the cash expected in the future. Getting paid a dollar today is better than a dollar in 10 years.
If we assume Apple grows its free cash flow by a very conservative 1% a year, Apple will collect $454 billion over the next 10 years. If we assign it a discount rate of 4%, the total value is $436 billion in “today’s” dollars.
Put another way, if someone offered you a cash-generating machine that matched Apple’s cash flow – but you also had the option to invest somewhere else at 4% – you’d be wise to buy the machine for anything less than $436 billion.
We can go a lot further though. We’ve only totaled 10 years of cash flow. At the end of 10 years, Apple would still have value. I can guarantee it will still be an operating business. It has factories, stores, and other assets that could be sold.
We’ve thrown a lot of numbers at you, but here’s the point…
Every business has a real value. The share price, however, can vary wildly from that value on any given day, week, or month.
Over time, though, they do match up.
That’s because shares give you a partial ownership in the business. That means you are a partial owner of the incoming cash flows.
Over the life of the company, management decides if the cash flow is spent to grow the business or is paid out as dividends. But the ultimate owner of that cash flow is you.
So look at where Apple’s cash flows are going. Between dividends and buybacks, Apple will pay out $83 billion a year to shareholders over the next three years. So even if earnings don’t grow a penny, the stock should return 16% a year in what’s called “shareholder yield.”
Notice too, we’ve given no value to the possibility that Apple will have another big hit. The iPhone will likely never be replicated and Apple Watch sales have been modest. But it’s conceivable that Apple TV, an Apple car, or a product we can’t now imagine will ignite the company’s growth again.
But we’re not counting on that. (Though we do factor in the research and development spending that goes into whatever Apple will build next.)
People are obsessed with growth these days and are hypersensitive to the news. But Apple remains one of the most profitable and healthiest companies in the history of the world.
That’s why Apple is just one of the 25 high-quality, blue-chip stocks I feature in The Blue Book: An Unconventional Way to Upsize Your Retirement. In this book, I explain how to use options to earn safe, reliable income on some of the world’s best companies.
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