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Imagine it's late 2005. Apple's fiscal year just ended and they reported their performance. You're an analyst whose job includes forecasting the company's performance for next year. This is a weighty responsibility.  Your forecast will be blended with those of your peers and used as a "consensus" average. That consensus for the next year will be used to measure the current value of the shares in a ratio called the forward PEG or Price/Earnings/annual earnings Growth. You are supplying the earnings and hence growth forecast while the market offers a price.  As a stock is meant to measure future earnings, your forecast is a crucial and frequently cited figure about whether a stock is priced fairly.

There is some comfort in knowing that there will be many others who will offer such a forecast and your contribution is thus not the only way investors can calibrate the price. However, you should think hard about what you are predicting as it also will reflect your skill in predicting such a visible company.

Apple just had a tremendous two years. 2004 and 2005 saw EPS grow at 274% and 337%. This is largely due to the runaway hit iPod. Given all that is known about the company, what will you put forward? While you're at it can you also forecast two years forward, namely provide a growth forecast for 2006, 2007 and 2008?

Here is what you and your cohorts publish as a consensus:

You go with a 13% growth for 2006,  15% for 2007 and 5% for 2008. The chances are, you reason, that the iPod will not carry the company's growth much longer. The competition is sprouting all over and Microsoft is rumored to be launching its own music player.

It makes sense to be conservative and offer a modest growth of 13%. At the same time you can rate the stock a buy as it is still growing. The stock just doubled in the last 12 months and the law of large numbers says that growth cannot last at the same rate as we've just seen.

 

 

It's now late 2006. Apple just closed out another big year. Contrary to your forecast last year, the company grew at a rate of 46%, more than three times faster than you expected.

It turns out the iPod still has some legs and the company's Mac business seems to be growing. Looking forward you take your 15% growth for 2007 and increase it to 20% and suggest 16% for 2008 and 32% for 2009.

There are rumors of Apple getting into the phone business.

 

It's now late 2007. Apple just launched the iPhone and even though it was available in limited numbers on one carrier for one full quarter, the company still turned in an amazing 73%. Again more than three times faster growth than you forecast. What do you do about 2008?

It might make sense to increase the previous 16% estimate to 17% but since there is a real estate bubble brewing, the 32% growth for 2009 should come down to 22% and defer that growth out to 2010, dialing in 27%.

It's now late 2008. Apple closed out another huge year. 73% growth was once again more than triple your forecast of 17% growth. It's clear that the iPhone is a huge hit.

However, there is a credit crunch and talk of a huge recession, even depression looming. Apple is a luxury/premium brand and it is unlikely that those expensive products will sell well into these "macro headwinds". You predict a decline in the earnings of 13% in 2009, inline with many other tech stocks. You are optimistic however that 2010 will be a year of recovery and predict 18% increase from recession lows followed by a more reasonable 11% growth in 2011.

It's now late 2009. To everyone's surprise, Apple grew through the credit crisis. It turned in 34% growth (vs. your predicted 13% decline). The success is hard to believe but the iPhone had a lot to do with that. There are new competitors coming and the recession has proven resilient. With unemployment still high you predict 2010 will still be a tough year. You go with -14% growth for 2010 and postpone recovery out to 2011 with 24% "bounce". Longer term you see 2012 as a flat year, with Apple earnings shrinking slightly by 1%.

2010 ends with Apple achieving 67% growth. Shocking relative to a -14% growth forecast. But then again, Apple launched the iPad and who could have thought that was a hit? Apple achieved growth throughout the recession and it looks like it might keep going. Your 2011 forecast of 24% looks weak so you increase it to 25%. The 2012 decline thesis is abandoned in favor of 16% growth and, given the likely competition in smartphones, you tone down growth in 2013 to 6%.

It's November 2011. The company turned in 83% growth. It's  more than three times faster than your forecast. Some people are suggesting that Apple may have a lot of headroom with the iPhone and iPad but the law of large numbers is what it is. The company became the largest by market cap in the world and Android is gaining huge market share. However, in deference to their strong recent performance you increase the 2012 forecast from 16% growth to 24% growth. 2013 goes from 6% to more than double: 13% and 2014 is when growth begins to slacken, though still a healthy 8%.

As the following chart shows, look ahead one year accuracy has not been all that great, but you are at least consistent. In any case, everything you based your decisions on showed remarkable consistency with consensus. You're just reflecting common sense.

Note:

• Though the numbers are all real, the narrative is fictitious. I suspect however that the truth is actually stranger than this fiction.

Andy Zaky at Bullish Cross wrote a great post on Apple’s valuation, showing the deep discount of Apple's earnings vs. an average company. It essentially states that Apple's money is not green.

Felix Salmon took it forward by enumerating a few explanations that might be used for the despondent valuation. None are successful arguments, but that should not be a surprise.

To understand the phenomenon a bit more precisely, I maintain and think about these charts:

This shows Apple's share price ("P" in blue) and its earnings per share ("E" in green). In addition there are multiples of the earnings in "bands". The first band is 35xE to 45xE which bounded the price during the period of 2006 through most of 2008. The second band is 15xE to 25xE which bounded the price since then. The data is updated weekly so it is current as of last Friday.

Illustrating it this way shows how the stock is seen as representing different companies at different times. The 2006 era (iPod) Apple was seen as a high growth, dynamic company with loads of headroom for growth. The current (iOS) Apple is seen as a slow growth, fairly static company with most forecasts showing 20% growth potential.

Note that the price has dropped outside the current band for the first time since the great recession. It is still below 15xE today. Perhaps a new band is forming.

 

The second chart shows the P/E on its own (in blue) but with a second measure where the P/E is divided further by the average trailing twelve months' growth (P/E/tG). This is a variation on the P/E/G (aka PEG ratio) where instead of (mostly wrongly) estimated future growth I use actual growth history--hence the t for trailing. The P/E/tG is a way to normalize P/E as a function of growth and hence a more appropriate index of value potential.

I added a horizontal line to the chart to show the minimum value P/E/tG reached during the recession (0.17 in January 2009). As you can see, the P/E/tG is now lower than at that time (0.15). It implies a deeper discount for the company's earnings growth than during the time when the world faced economic contraction.[1]

Note also the trend of that line as it shows a steady linear path toward zero.

Of course, it cannot reach zero unless Apple files for bankruptcy. But until it does file, the line can only reach zero asymptotically as E/tG increases. Which is a relief, I suppose, as it means the rate at which P/E/tG drops will decrease. This implies that as earnings growth persists, the drop in price will have to moderate.

The other threshold to keep an eye out for is when Apple's share price will reach its cash per share. That's the point when investors will consider the company to be a net value destroyer. If you performed that analysis in January 2009, and you were accurate about earnings forecasting, the answer would be well before today. See the following chart:

In other words, in January 2009 the stock was trading at a price (<$80/share) below the current cash per share (>$85/share). It took Apple 18 months to grow its cash to reflect the price set on the company. Had the stock not risen then the company would today be trading below book value.

The amazing thing is that today the valuation structure (P/E/tG) is even worse than in it was January 2009. An interesting exercise would be to project how long it would take for the cash to increase to the current share price.[2]

I imagine this time interval should have a name. How about the time to boil: the time for growth pressure to become sufficiently high to exceed disbelief that growth can happen.

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Notes:

1. Note that the low values were placed on the company after the crisis took hold, not as an anticipation of contraction. See the behavior of the index during the summer of 2008 as the credit crisis was unfolding.
2. This analysis is consistent with the analysis that Apple is not valued on earnings or earnings growth but on its balance sheet. The ratio of Price/Cash has been fairly constant but if it breaks down (as it has been--see below) then we need to assume a new dynamic is in place. 

I began thinking carefully about Apple in 2005 when the stock was priced at around $55/share. I remember that the events which made me consider Apple in a different light were the launch of the iPod shuffle and the launch of the Mac mini. Both moves signaled to me that the company was serious about competing with non-consumption. At that point I thought that the company was a potential opportunity as an investment.

But I also remember that many people at the time thought that the stock price was too expensive. At $50, the company was much more expensive than the year before. The stock started 2004 at about $11/share. The reason it had climbed so much was that the iPod began to be a real world-wide growth phenomenon. Buying Apple was buying into the iPod and many said the price was unsustainable given such a strong dependency on fickle consumer tastes. It was a much riskier proposition than that of competitors like Dell and HP which made product for reliable buyers like enterprises.

Indeed, by 2006, the shine was off. In the first half of 2006 the stock collapsed from $85 a share to $50, a fall of 40%. It was becoming clear that with mobile phones taking on more music playing features, the iPod was not going to be a big story for long. What's more, Apple had just announced that they were switching to Intel for the Mac product line. Investors saw just how vulnerable the company still was and considered that the Mac brand was in jeopardy as it transitioned to becoming a Windows-friendly machine.

However, in 2007 the company's value recovered with the introduction of the iPhone. Suddenly there was a new product to drive sales. Nobody knew by how much or how but there was a sense that the iPhone was enough to keep Apple from oblivion.

Yet, again, in early 2008 the company lost 40% of its valuation. In a rather inexplicable period following the launch of the MacBook Air, the company's shares went into free fall. Inexplicable because the company continued to deliver solid growth with 2008 calendar quarters showing between 32% and 155% EPS growth.

Then the recession came. It caused another 40% share price collapse. Growth slowed to a range of 11% to 61% during 2009. As the marco "headwinds" blew over, by the end of 2009, with the help of a lukewarm response to the iPad, the company's value recovered to its 2007 level. In the mean-time its earnings more than doubled.

It may not appear to be the case, but throughout this volatile period, the investment thesis remained fairly constant: Apple is a rather small collection of product bets. Owning Apple meant riding the iPod or the iPhone or the iPad as waves of growth. As soon as one growth wave was seen to start to fade, investors would say the same thing: Apple is done.

The chart below shows just what that looks like in terms of product contribution to gross margin.

The investment thesis is the same today. I've had dozens of conversations with fund managers and if anything, it's even more about betting on products. The iPhone and the iPad make up such a large part of profits that the company seems to be nothing but those two things. So if there is any hint that those products might slow down, the stock is sold off.

What intrigues me about this investment thesis is not whether the signals of growth are interpreted correctly or not, but rather that an investor in Apple in 2006 was considered perfectly rational valuing Apple as an iPod company as much as an investor today is perfectly rational valuing Apple as an iPhone company. Why would anyone buy Apple for any other reason? There is no evidence that Apple can be anything more. Any fund manager positing a different point of view would surely be limiting her credibility.

The consensus is that the value of future, unknown products is zero. Not only that but the probability that there will be any products at all is equally zero. Not only that but whatever Apple does to create new products is not perceptibly valuable. The company is simply the sum-of-the-product-parts and nothing more. Cash flows from current products can easily be shown to be more than the current valuation so even these products are deeply discounted. If and when a new product shows up, it will be considered and maybe if it shows promise, the stock will reflect that, briefly.

A corollary to this investment thesis therefore is that the process of product development at Apple is worth nothing. It does not matter if the company has shown an ability to disrupt and to create new categories. The past is not a predictor. The value of the company is a discounted cash flow of current products--discounted for the odds of commoditization, which are seen to be quite high. A new hit product is a windfall, a winning lottery ticket. Something that you cannot count on.

Think about that in a different context. That's like valuing Pixar on the box office revenues of its current movie. If Cars 2 is not beating records, Pixar is suddenly nearly worthless. The fact that Pixar repeatably creates blockbusters would be seen as meaningless. The way they built a reliable pipeline with predictable cost structures for movie-making is not interesting.

However, the fact is that Pixar did not get acquired on the basis of the last hit it made. It was acquired for its system of production. This can be confirmed not only by the price paid but by the fact that the organization was not folded into the Disney machine. It stands alone and is given autonomy. So at least in the movie making industry, predictability is seen as valuable.

So why is Apple not valued as a process company?

I think the answer lies in the lack of understanding or belief in a theory that predictable success in product development is possible. Until and unless an explanation is available that persuades a majority that Apple is as much a hit factory as Pixar then Apple without the products will intrinsically be valued at zero.

The premise of the stock market today is therefore that being innovative in technology is meaningless. Innovations are valuable but there is no such thing as an innovation process. If there was such a thing then we could measure it and put a number of its value. Until then innovation is nothing more than a spin of the roulette wheel.

Apple's share price has recently hit a new all-time high, over $400 per share. As often happens there was no specific new information from the company to justify this increase. On the other hand there is usually no news to justify share price drops in Apple. In fact, the stock is up on what would be considered counter-indicative news: the resignation of a very important CEO.

But readers may recall that there is a measure of performance for Apple we can turn to that seems to show strong correlation to its stock price. It's not income and it's not growth in income but it's the strength of the balance sheet.

I demonstrated this relationship last May with a post titled The market values Apple’s balance sheet, not its income statement.

It's time to look at the data again to see if the relationship still holds. I added the data for Q2 and made some estimate about the cash position since July 25th (we will know this data with more accuracy when Q3 data is reported in a few weeks).

The slope of the line above has decreased slightly but a strong correlation can still be observed. The old r-squared was 0.94 and it is now 0.90. I included the formula for the y variable (share price) as a function of x (cash).

If you plug in $100 for x you get about $500 for y. So if this relationship continues[1], the answer to the question in the title would be "When the cash and cash equivalents reach $100 billion."

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Note:

1. Note that whether the relationship holds (which it very well may not) depends on a strong correlation and "strong" is not well defined. The correlation has weakened slightly in the last six months.

CEO resignations often cause share prices to rise. Witness the effect of the latest CEO departure on Yahoo!. This typically happens because CEO replacements are not necessary when companies are successful. In times of crisis, the market sees management change as a hopeful sign. But Apple is doing well. So it was commonly believed that if Steve Jobs were to leave the helm at Apple the stock would fall. However, as the chart below shows, the stock price has since risen.

Apple's share price rise of 3% even out-performed the Dow Jones index, and this phenomenon is not for the short term only. The Jobs resignation sent Apple puts to one-year lows.

So how do we reconcile this? How can such a valuable person be priced as a liability?

First, I should mention that not everyone shared the opinion that the departure of Steve Jobs would cause a decline in the price. Over a year ago, in August 2010 Horace wrote in a comment:

Since I've shown repeatedly that Apple is trading at a discount to its growth and to its historic value and to its peer group, and since the health of their CEO is an uncertainty which must be discounted, the possibility exists that the depressed value assigned to Apple is due to Steve Jobs's continuing presence in the company. If that is true then his departure should increase the stock price.

His argument of why the departure of Steve Jobs would cause an increase in the stock price was based on the fact that the market would have discounted it and the only question would be when it would happen. Since that uncertainty of when was unresolved, it would weigh on the shares until the uncertainty would be lifted and the price would resume its value based on other factors.

To demonstrate that effect, we can turn to data. The discounting was visible in the reactions of the stock in previous events when the tenure of the CEO came into question. Those reactions are shown in the following chart:

Each of the bars above shows the cumulative abnormal returns after all the events when tenure issues cropped up in the news.

If we excluded the first time we learned about Steve Jobs’ health issues, we can see that the stock market likes certainty (January 5th, 2009: health issue but remains CEO; August 24th, 2011: definite resignation as CEO) and rejects uncertainty manifested in medical leave announcements on January 14th, 2009 and on January 17th, 2011 leaving the top organization in a temporary form. We can also see that Apple investors are becoming more comfortable with Tim Cook running the company as the negative cumulative abnormal returns diminish and turn into positives ones when he is appointed CEO.

We can conclude that Steve Jobs’ resignation as CEO, as sad as it may be, has reduced unsystematic risk from the stock and therefore “boosted” the share price performance.

 

As the market continues to exhibit signs of instability, an interesting paper[1] identified a correlation between the U.S. stock market and an index of the U.S. Financial Conditions. This index measures the assessment of the probability of a crisis.

The conclusion is that an imminent crisis mentality pervades equities markets today and implies that pricing is largely disconnected from fundamentals. On this blog we've discussed the topic of fundamentals and marveled at how pricing seems to be largely exclusive of it.

The case is made by the following chart:

 

The first chart shows the share price (blue) and the earnings per share (EPS in green) as well as several multiples of EPS. During the period of 2006 through 2008 the stock ranged between a P/E of 35 and 45. beginning with the collapse in confidence due to the banking crisis, the share price fell to within a range of 15 and 25. Now, with Apple's growth accelerating above 100%, the stock price seems to be sliding below the 15 P/E bottom.

In the second chart I show the P/E in blue and the P/E/trailing Growth. Adjusted for earnings growth the equity is cheaper now than at the bottom of the last recession. You can also observe the trend or slope of the decline in the P/E/tG. It might be alarming to see the decline but it also might be comforting to know that the P/E/tG cannot go to zero. Either Price has to go to zero or earnings or growth have to go to infinity. The closer P/E/tG goes to zero however (it's at 0.17) the more undervalued Apple appears to be.

Naturally these metrics of P/E are arbitrary and the price is simply what the buyers are willing to pay for the equity. But the value of any metric is the trend. The value can be compared to a different time or to a different equity. The trend here is that Apple, at least, is being discounted at a time when it's growing more robustly than ever.

Which is why finding an explanation is so important. This is where the paper sheds some potential clues. The author concludes that there is a pervasive crisis phobia which affects multiples. Paulsen writes:

If cultural mentalities were less crisis-phobic today, what would the PE multiple be on the stock market coming off a 12.8 percent profit quarter with a 2.2 percent Treasury yield and only about a 1.6 percent core consumer price inflation rate? Certainly, much higher than 12 times earnings! 16 times earnings? 17 times? This simply illustrates just how much the crisis-centric mindset is depressing investment potential and it also suggest how much opportunity there is to increase stock valuations just by improving the cultural mindset. Long term, the real investment opportunity is not a dramatic improvement in economic or profit growth (although either or both could occur), but rather is just a slow but steady decay in “crisis-fears” similar to what we experienced during the last recovery.

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Reference:

1. A Crisis Phobic Investment Culture, James W. Paulsen, Ph.D. Wells Capital Management.

After Apple reported earnings growth of 125% its share price dropped to a P/E of about 15. This reduction in valuation is part of a trend I've written about for over a year so there were no surprises. The first chart below shows how the stock has traded between increasingly lowered P/E bands.

As the second chart shows, not only is the P/E ratio declining, but when seen against the trailing twelve months (TTM) average growth rate, the P/E/TTM ratio is now at the lowest since the great recession (around 0.17--a value of 1.0 is a rule of thumb for "fair value" in a growth stock).

Those values include cash. Excluding cash, the P/E as of Friday was 12.4. On a forward basis (my estimate--which has shown be be conservative lately) the P/E is around 7.

Perhaps some day in the future investors will come around to looking at Apple as a growing company, but there has been no such inclination for over two years. As I've pointed out numerous times, growth and valuation are moving in opposite directions.

The only correlation to the stock price has been found on the balance sheet, not the income statement. Looking again at the relationships between cash and the stock price, we see a clear relationship (r squared of .9)

After a lapse during the first quarter, the relationship that has been in place since October 2008 is returning.

Note the formula of the trendline which allows some interesting guesses on what the stock price will be. For example, putting $95 in cash per share results in a share price of $500. Let's see if the relationship holds until then.

 

Apple's cash for short-term and long-term marketable securities totaled $65.8 billion at the end of the March quarter. Cash increased by $6.1 billion.

The increase in cash is net of approximately $900 million for prepayments and capital expenditures related to the strategic supply agreements that Apple announced last quarter.

The following chart shows the historic cash, short-term and long-term liquid assets Apple holds.

As in previous quarters, the securities Apple holds are:

• Cash
• Money market funds
• U.S. Treasury securities
• U.S. agency securities
• Non-U.S. government securities
• Certificates of deposit and time deposits
• Commercial paper
• Corporate securitiesMunicipal securities

Although the asset classes are all liquid, those with longer maturity dates are classified as "long-term" securities (orange area in chart above) and are often not counted as "cash" in many financial databases.

The enormity of the overall size of this cash can be put into several perspectives:

• The funds are big enough to place Apple's CFO office in the top 100 largest fund managers in the world and larger than any hedge fund manager.
• Cash growth in one quarter was higher than the market cap of many companies. For example, if pre-payments were added back, the cash increased by about the market cap of Motorola Mobility.
• Current cash is worth more than Nokia, RIM and Motorola Mobility's market caps, put together.
• Apple's cash is worth half of Google's enterprise value.
• About two years ago, in January 2009 the stock traded at a price of $78 with at least one analyst placing a target of $70 on the stock. Today Apple's cash is worth $67 70/share.
• If you owned $100,000 of Apple stock, $19,000 of that would be cash and only about $80,000 would be "at risk" capital.
• If Apple had no revenues, the current cash would sustain operations (SG&A and R&D) for over 7 years or until the middle of 2018.

When analysts cite limits to the rate of Apple's growth on the basis of the "law of large numbers" I wonder if there is an implied limit to how big this cash pile can grow. By looking at the chart its size seems to be growing faster all the time.

 

[Updated] The cash per share figure was wrong. It is $70/share.

Apple's CFO guidance statement:

We expect revenue to be about $23 billion compared to $15.7 billion in the June quarter last year. We expect gross margin to be about 38%, reflecting approximately $55 million related to stock-based compensation expense. We expect OpEx to be about $2.5 billion, including about $255 million related to stock-based compensation expense. We expect OI&E to be about $70 million and we expect the tax rate to be about 25%. We are targeting EPS of about $5.03.

Apple Management Discusses Q2 2011 Results - Earnings Call Transcript - Seeking Alpha

Last quarter Apple guided revenue growth at an aggressive 63% with an EPS growth of 47%. They delivered 83% and 93% respectively.

They are now guiding about 47% revenue growth and 43% EPS growth and my current estimates are 65% and 72% respectively based on the following:

• iPhone units: 14.7 million (75%)
• Macs: 4.3 million (25%)
• iPads: 9.8 million (200%)
• iPods: 8.0 million (-15%)
• Music (incl. app) rev. growth: 25%
• Peripherals rev. growth: 25%
• Software rev. growth: 25%
• Total sales: $25.8 billion (65%)
• GM: 38.5%
• EPS: $6.02 (72%)

The biggest uncertainty remains iPad growth. This will be the first quarter where we can dial in a y/y growth rate. I'm being bullish with 200% because I believe the ramp for the iPad 2 may get sorted out. There are also more countries being opened up this quarter (13 this week).

Apple's stock price to earnings ratio has dropped to 16.72. Ex-cash it's 13.5. On a forward basis (my estimates) it's 8.3. Apple's valuation is now a case for business historians to discuss because I don't think there are modern precedents.

 

HTC's market cap has just overtaken Nokia's. While market capitalization is a fickle thing, shifting with sentiment, this is still a remarkable feat. Nokia's market capitalization has almost halved in the space of a year while HTC has more than tripled from $10 billion to over $33 billion.

If you roll back to 2007 and the start of the modern era of smartphones, you can see how the two companies stocks traded places:

(source: Google finance)

The recession was hard on everybody but HTC soared during 2010 while Nokia never recovered. Markets reward unforeseen growth and typically that means above-market growth.

That's reflected in the following chart (admittedly units and not profits, but pricing and margins for both have remained relatively steady.)

As Nokia's growth lagged the market the stock was punished. As HTC's growth exceeded the market's growth, the stock was rewarded.

But there are a few more observations to make:

• HTC's smartphone business was under-performing the market for most of 2009. In fact, it was even in negative growth for three quarters.
• The surge in growth coincided with HTC adding Android to its portfolio and given no other changes, seems to be causal.
• Although not within the time range of the charts above, HTC had another period of rapid growth in the mid 2000s.

A year ago HTC was making excuses and apologizing. Today they are more valuable than the largest phone vendors. All thanks to Android.

But why no thanks to Microsoft?

HTC was the primary Windows Mobile vendor a few years ago. They claimed at one point to have shipped over 80% of all Windows Mobile devices. They were also the leader in the Pocket PC franchise as they were the ODM behind the iPaq brand from HP/Compaq. HTC would not exist today were it not for Microsoft.

The relationship is such that HTC is paying Microsoft for protection from (potential) Android IP infringements. HTC has also licensed Windows Phone though the relationship between Nokia and Microsoft must give them pause.

But that's the whole problem. Those who live by the sword shall die by it. HTC was a Microsoft dependent and now they're a Google dependent. As the basis of innovation shifted, HTC was agile enough to make the transition. Perhaps they can execute a portfolio switch yet again as their upstream suppliers change whims or business models.

But then again, as we saw with Windows Phone, perhaps not.

If HTC wants to control its destiny it needs to control its suppliers. Now that its power and brand have grown, it needs software because in their market software is self-determination.

As shown in the Apple growth scorecard, the company's earnings growth is continuing at 75% with the top line increasing at the annual rate of 70%.

The $59 billion of cash on the balance sheet has reached the equivalent of $64 per share yielding an enterprise value of $263 per share based on closing price of January 21st.

The stock price has been rising but not outside a narrow P/E band. The following chart shows the stock price and the 15 P/E and 25 P/E bands that have bounded it for nearly three years.

As previously observed, this overall share appreciation is not accounting for the growth in earnings.

The trailing twelve months' earnings were $17.91 per share. Therefore the P/E ratio is now 18.2. Excluding cash, the P/E is at 14.7. However, that's based on 2010 levels of earnings. Those earnings are increasing very quickly.

To account for earnings and their growth, I developed the following chart which shows the P/E and P/E/trailing-Growth for the stock.

The P/E is fluctuating on either side of 20 but when considering trailing growth, comparable companies, the macroeconomic conditions and guidance the value of the company is reaching new lows.

P/E/tG nearing recession lows

Earnings were 75% higher in 2010 than the year before. So based on the growth, the rule-of-thumb ratio P/E/trailing Growth (P/E/tG) is 0.24. This ratio (where 1.0 is seen as "fair value") is the lowest since July 2009, during the first months of recession recovery. The trend for this ratio is down (see the burnt orange line in the chart above). It's not far from hitting the lowest point during the recession at 0.17.

Now I'd like to reminisce a bit about that point in time. The stock had bottomed at $78/share[1]. It was trading at barely 3x cash and a P/E of 11 but growing 3x that level (32% in the slowest recession quarter but averaging much higher).

So today we are at a similar point in valuation. The cash is at $64/share, shares are priced 5x that amount and the growth is 4x P/E[2]. Although analyst targets are less comical, there is still the sense of extreme despondency when looking at the valuation ratios.

Guidance, Comparables and Macroeconomics

Unlike two years ago there aren't the same dark clouds on the macro horizon. The company is also not as cautious on its guidance (guiding 63% EPS growth must be a new record for a post-holiday quarter) and there is talk of bubble in valuation for comparable companies. Netflix, Amazon, and ARM have eye-watering valuations relative to growth.

A discount to the S&P 500

And to round out the tragic tale, Apple's P/E is, once again, at a discount to the S&P 500 P/E (14.7 vs. 16.57 respectively).

Given the new low in valuation contrasted with optimism on behalf of many (including management), on some forums there is discussion about Apple becoming the target for a take-over.

There is some perverse merit to this logic. With $64 in cash, $25/yr in earnings and 75% growth it's so cheap that if credit were available, it would make a tempting candidate. Private equity could take it private and use the gigantic cash flow to pay off debt (in about four years). In bygone days, this would have been an easy pitch.

Alas, the capital markets may not have liquidity for the size of the market cap Apple holds and I don't see any competitors able to get the leverage for an acquisition either. Or can they?

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Notes:

1. In early summer 2009 some analysts put 12 month targets for the stock at $70, so their predictions were within $6/share to today's book value.
2. A buyer of shares two years ago would only have to wait two years to have 80% of their investment sitting in retained earnings.  An investor who read the data from Apple and knew that the iPhone existed could not fail but be amazed.