Apple, Inc. (AAPL), a name synonymous with smartphones, tablets and mp3 players, has built such strong brand recognition that their merchandise has become synonymous with many product categories. For years Apple dominated areas like mp3 players (Apple’s iPod) and tablets (iPad) while expanding the smartphone category to include users other than business consumers (iPhone). Many believe Steve Jobs, the late CEO of Apple, was the visionary behind these product developments, which led to a decade-long cycle of product innovation, driven by not only this strong vision but also a unique understanding of consumer’s tastes and appetites. This robust 14-year period of product and category innovation resulted in an extremely strong stock price appreciation, from $1.47 to $110.38 (adjusted for splits, etc.) between 2001 and 2014. (See chart below.)

apple pe ratio

During this time and particularly after the iPhone launch, Apple’s price-to-earnings ratio (P/E) was lockstep and even slightly ahead of its market share gains with product introductions, as the market expected brand loyalty would continue to increase Apple’s share, thus revenues. P/E multiples are the easiest and perhaps the most generally accepted valuation metric used by investors. Simply put, if stock prices increase at a rate greater than earnings, then P/E increases and vice versa. Lower P/E ratios indicate stocks are cheap, while higher ones denote more expansive stocks.

However, the interpretation of P/E is not always clear-cut. For example, P/E can contract (drop) as the market anticipates the loss of revenues prior to the actual occurrence. For example, this can happen when a competitor launches a new product that is expected to steal market share. On the other hand, P/E can be too low if the market is slow to recognize a business’s improved operational efficiencies that will translate into higher earnings power. As the market expects higher earnings growth in the future, investors may drive the stock price up, resulting in a higher P/E.

Apple has enjoyed a solid earnings history, reflected in a strong stock price, but recently its P/E multiple has come down to levels equal to the S&P 500. This contraction has been especially evident beginning in 2011, coinciding with the death of Steve Jobs. Whether it is the market’s way of registering fear around new leadership or an increase in competition in the smartphone market from Samsung’s (OTC:SSNLF) Galaxy, Apple’s P/E reflected market fear of reduced growth. And it seems to be settling in at this new, lower level. Estimates over the next couple of years appear to be in line with the current P/E trend.  

 apple pe ratio

Source: Yahoo! Finance, Bank of America estimates, historical data

Perhaps even more useful than analyzing P/E is comparing Apple’s P/E relative to growth expectations (PEG ratio). A PEG ratio at 1.0 or below is an indicator that a stock is cheap relative to the anticipated growth. AAPL is trading at a forward PEG of 1.07 compared to the industry's of 1.41 according to Yahoo! finance data. Even more telling is analyzing AAPL's PEG ratio trend. The following chart details the trend since 2010.  

apple peg ratio

Source: Stock Traders Daily

Analysis of these data shows that Apple’s P/E is significantly lower than its industry peers and its typical PEG ratio falls around 1.0x, just about where it stands now. The risks to this analysis lie in the data and the expectations by the market. If the expected growth is too high, then the P/E to growth is understated and the attractiveness of the stock is worse.  

The Bottom Line
P/E, widely used and easily calculated and applied, is only a useful way to determine if a stock is under- or over-valued if an investor has a high level of confidence in the data that goes into the calculation. If the data are good, then it is extremely beneficial to analyze how the stock has traded in the past and what investors' expectations are for the future. When growth (the PEG ratio) is added into the analysis, the metric becomes an even more robust tool to add to an investment strategy matrix.


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