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Beginners’ Portfolio: We Buy Apple Inc.!

This article is the latest in a series that aims to help novice investors with the stock market. To enjoy past articles in the series, please visit our full archive.

The Beginners’ Portfolio is a virtual portfolio, with all costs, spreads and dividends accounted for. Transactions are for educational purposes only and do not constitute advice to buy or sell.

What’s happened to Apple (NASDAQ: AAPL.US), has it gone bust? That’s what my mum asked me yesterday, and judging by the latest media drama, she can be forgiven for thinking so.

But all that has happened is Apple’s first-quarter earnings report hasn’t quite satisfied the sky-high expectations of some of the world’s analysts.

Shock, horror!

For the three months ending December, Apple’s revenue grew by only 18% to a record $54.5 billion! Profit for the quarter also reached a new high, but it was only slightly up on the same quarter last year — $13.08 billion compared to $13.06 billion.

Apparently there was also a shortfall in iPhone sales. Instead of the 50 million units predicted by some pundits, Apple only managed to shift 47.8 million of them!

What happened to the share price? Already falling due to slowing growth fears, it crashed. At $450 today, it’s now down 36% from its September peak of $702. How does Apple’s valuation stack up against historical records? Take a look at this table…

Year Sales EPS Price P/E Dividend
2009 $43bn $9.10 $185 21 0%
2010 $65bn $15.20 $284 17 0%
2011 $108bn $27.70 $381 15 0%
2012 $157bn $44.20 $667 15 0.4%
2013 (e)
  $46.70   9.6 2.4%
2014 (e)
  $53.80   8.4 2.4%

Share prices for 2013 and 2014 are yesterday’s closing price. Dividend yields for 2013 and 2014 assume the current $2.65 per quarter payout is maintained, though it is more likely to rise than fall.

That’s Cheap

Now, if you think that P/E of 9.6 is low, also bear in mind that Apple has cash and cash equivalents on its books worth approximately $146 per share. That means the actual business itself is valued at $450 minus $146 per share, or $304. And that gives us an effective P/E of just 6.5!

Growth share valuation

With a growth share, optimism often drives its price to earnings (P/E) ratio way higher than average, based on expected future earnings growth. The long term average P/E for the FTSE is around 14, but we often see UK growth shares on P/E ratios of 30, 40, 50 or more. And they’re often justified — for a while, at least. But ultimately, earnings growth must slow as a company matures, its markets mature, and its market share steadies.

The trouble is, investors rarely see it coming in time, and rush for the exits when the first lower-then-expected earnings report comes in.

Soft landing

But what we’re seeing with Apple is a relatively slow decline in P/E, as earnings have risen to match expectations, while the share price has still gone up but at a slower rate. For the last two years, Apple shares have already been trading on P/E values of around 15, which seems modest to me, and a long way from growth-share overvaluation territory.

We’re buying

With Apple just at the start of its dividend-paying phase, and on an effective P/E of only 6.5 for the business itself, that is just too cheap and we’re buying. At a buy price of $458.40, we got two shares for £605.98, including commission and exchange rate spread. That’s more than our £500 per share allocation, but the alternative was to buy only one. I’ll add Apple to the portfolio table when I do our next valuation update.

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended Apple. The Motley Fool UK owns shares of Apple. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.