There has been no stopping the major U.S. tech stocks over the past several years. Even the coronavirus cannot keep the tech sector down. Led by the group of companies known as “FAANG,” the Nasdaq Composite sits at an all-time record above 11,000.
Apple Inc. (AAPL) has played a big role in the dramatic returns for the broader Nasdaq. The tech giant has returned 54% year-to-date and 125% in the past one year (not including dividends), while the company now sports a market capitalization above $1.9 trillion.
Of course, Apple stock is a darling among both retail and institutional investors such as Alkeon Capital, a New York-based registered investment advisor with an investment portfolio in excess of $23 billion. But despite Apple stock’s universal popularity, investors should consider the possibility that shares are currently overvalued.
Firing on All Cylinders
Apple is a technology company that designs, manufactures and sells products such as smartphones, personal computers and portable digital music players. Apple also has a thriving services business that sells music, apps, and subscriptions. Its most well-known products and services include the iPhone, iPad, the App store, iTunes, Apple Pay, and more.
On July 30th, Apple reported strong quarterly results. For the quarter Apple generated revenue of $59.7 billion, representing 10.9% growth compared to Q3 2019. Product sales were up 9.9%, with iPhone sales –making up nearly half of revenue –up 1.7%. Service sales increased 14.8% and made up 22% of all sales in the quarter. Net income equaled $11.25 billion, a 12.0% increase, while earnings-per-share totaled $2.58 versus $2.18, an 18.3% increase driven by a substantially lower share count.
Apple also declared an $0.82 quarterly dividend, payable August 13th, 2020 representing a 6.5% year-over-year increase. In addition, the company announced a four-for-one stock split with split-adjusted trading to begin August 31st, 2020.
Going forward Apple’s earnings growth will be driven by several factors. One of these is the ongoing cycle of iPhone releases, despite the significant decline in 2019. In the long run Apple should be able to grow its iPhone sales, albeit in an irregular fashion. Moreover, in emerging countries where consumers have rising disposable incomes, Apple should be able to increase the number of smartphones it is selling over the coming years. Increasing the selling prices of its phones could be a tailwind for revenue as well
Another avenue for growth is Apple’s Services segment. This business unit, which consists of iTunes, Apple Music, the App Store, iCloud, Apple Pay, etc., has recorded a significant revenue growth rate during the last couple of quarters. Services revenues grow substantially faster than other segments and produce high-margin recurring revenues. Another factor that has played a role in the past is the shrinking share count. Due to its immense cash flows Apple is able to repurchase hundreds of millions of shares. Apple should continue to lower its share count further.
Valuation a Concern
There is little doubt that Apple is generating strong results. But there could be a possibility that at the present valuation level, this growth has been priced in, and then some. Based on our expected EPS estimate of $13.00 per share for 2020, Apple stock trades for a P/E ratio of 34.7x. This is an extremely high valuation, representing a decade-high mark for the stock. The stock held an average price-to-earnings ratio between 13-14 over the past 10 years. Even if we assign a more generous valuation multiple of 17, the stock is still overvalued.
The impact of this could be significant. If shares trade down to a P/E ratio of 17, it would bring the stock returns down by 13% per year over the next five years. Even if the company generates 10% annual EPS growth and pays its dividend, the stock returns would virtually be zero over a five-year period. This demonstrates the danger of buying shares when they are overvalued.
There is no question that Apple has been among the market’s hottest stocks over the past several years. But at the current valuation, shares may no longer be a buy for new investment. The company will still continue to reward current investors with a dividend payment along with annual dividend increases, but investors looking to buy should wait for a better price.
Bob Ciura has worked at Sure Dividend since October 2016. He oversees all content for Sure Dividend and its partner sites. Bob received a Bachelor’s degree in Finance from DePaul University, and an MBA with a concentration in Investments from the University of Notre Dame.
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