Calculating The Fair Value Of Apple Inc. (NASDAQ:AAPL)
Key Insights
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Apple’s estimated fair value is US$240 based on 2 Stage Free Cash Flow to Equity
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With US$221 share price, Apple appears to be trading close to its estimated fair value
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The US$238 analyst price target for AAPL is 1.1% less than our estimate of fair value
Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Apple Inc. (NASDAQ:AAPL) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.
We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Apple
Is Apple Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) estimate
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
2034 |
|
Levered FCF ($, Millions) |
US$124.0b |
US$135.5b |
US$163.8b |
US$177.5b |
US$188.0b |
US$197.2b |
US$205.5b |
US$213.0b |
US$220.1b |
US$226.8b |
Growth Rate Estimate Source |
Analyst x14 |
Analyst x10 |
Analyst x2 |
Analyst x2 |
Est @ 5.92% |
Est @ 4.89% |
Est @ 4.18% |
Est @ 3.67% |
Est @ 3.32% |
Est @ 3.07% |
Present Value ($, Millions) Discounted @ 7.3% |
US$115.6k |
US$117.7k |
US$132.7k |
US$134.1k |
US$132.4k |
US$129.4k |
US$125.7k |
US$121.5k |
US$117.0k |
US$112.4k |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2t
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.5%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 7.3%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$227b× (1 + 2.5%) ÷ (7.3%– 2.5%) = US$4.9t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.9t÷ ( 1 + 7.3%)10= US$2.4t
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$3.7t. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$221, the company appears about fair value at a 8.1% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Apple as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we’ve used 7.3%, which is based on a levered beta of 1.158. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Apple
Strength
Weakness
Opportunity
Threat
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Apple, there are three pertinent aspects you should consider:
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Risks: Take risks, for example – Apple has 2 warning signs we think you should be aware of.
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Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for AAPL’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.