AAPL bears are skeptical of rich valuations, and they might be right. But could Apple’s strong brand and management team make it a safe haven in a troubled macroeconomic environment?
- A discounted cash flow model suggests that AAPL may be overvalued, with a fair value estimate of $113 per share representing a potential 24% downside risk.
- However, despite the DCF analysis, Apple’s strong brand, competent management team, and relatively strong demand for its products and services may make it a safe haven stock in a macroeconomic environment of fear over inflation and softening consumer spending.
(Read more from the Apple Maven: Apple: This Odd Trend In Fiscal Q1 Flew Under The Radar)
AAPL Bears Don’t Like The Valuation
Apple stock continues to defy the bears. Shares have been trading at or near $150 apiece, $30 off the all-time highs but nearly 20% up for the new year so far.
A look around the web suggests that valuation might be the number one concern for AAPL bears. Take Seeking Alpha, for example.
Of the last six analysis pieces published on Apple stock, five are neutral and one is strongly bearish. In the titles alone, high valuation or rich share price are mentioned three times as the potential problems with Apple stock (see dotted red lines).
Apple Stock Could Be Overvalued
The specifics of the valuation-based bear case against AAPL vary across analysts. But rather than dissecting their work, I chose to do my own analysis.
In this case, I turned to a tool that I generally dislike: DCF, or discounted cash flow. The valuation methodology is flawed, in my opinion, due to its “garbage in, garbage out” nature. How can I seriously trust a valuation calculation that makes growth assumptions to infinity?
But I see one case in which DCF can be valuable: stress testing assumptions. In other words, what assumptions about cash flow, growth, and discount rates must be made to justify the current market price of a stock?
Apple’s DCF Does Not Look Great
I will spare the reader of the detailed math. But at a high level, I used a two-stage DCF model in which I assumed that consensus expectations for the next five years are actually understated. In other words, I am giving Apple the benefit of the doubt and considering that analysts are not optimistic enough about the company’s financial performance through 2027.
For cash flow growth in perpetuity, I assumed 2.5% annually. This is as high as a reasonable analyst should go, in my opinion, considering that “infinite growth” above this mark would be inconsistent with a global economy that grows at 2% to 2.5%, at best.
Then, I arrived at what I consider to be the biggest problem: the discount rate used to bring future cash flows to present value.
Apple is a net-cash-positive company, which means that the cash balance is larger than the debt. So, at a high level, Apple’s weighted cost of capital (or WACC, for the geeks like me) should be close to the cost of equity.
In a world where (1) the risk-free rate is hovering around 4%, (2) the equity risk premium remains at roughly 5.5%, and (3) Apple’s beta, or sensitivity to stock market movements, is 1.2, I can not comfortably use a discount rate that is any lower than 9%.
In my model, I used 9.6% as my WACC.
Given the assumptions above, I estimate that Apple stock’s fair value should be $113 per share. This represents a solid 24% of downside risk.
I tried to “massage” some of my assumptions a bit, even knowing that this is bad practice. Assuming (1) even more aggressive estimates for the next five years, (2) perpetuity growth of 3%, and (3) a discount rate of 8.5% – all of which are overly aggressive assumptions, in my view – Apple stock still looks overvalued by about 5%.
Why AAPL Bears Could Be Wrong
All the above helps to explain why Apple stock bears could be right in their pessimism. But maybe they are missing something important that a DCF model might not properly account for.
In a macroeconomic environment of fear over inflation, softening consumer spending and economic activity, and fierce competition, Apple may be perceived as a safe haven.
The Cupertino company has one of the most admired brands in the world. The management team has proven to be very competent. All combined has led to relatively strong demand for Apple products and services lately, despite a number of headwinds in the tech space.
Mathematically, it could be said that the perceived risk of owning AAPL is low, and so is the discounting factor of Apple’s future financial results.
From that perspective, maybe Apple is a good stock to buy and hold, which are currently my views on the shares of the Cupertino giant.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. The article may contain affiliate links, but these partnerships do not influence editorial content. The author may use AI tools, including OpenAI’s ChatGPT, to create some of the article’s content, particularly summaries. Thanks for supporting the Apple Maven.)