“The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset.”
– Warren Buffett
In this week’s Model Vs. Market we’re looking at Apple. Here is some background on the company:
Apple Inc. is engaged in the design, manufacture and distribution of consumer electronics products (iPhone, iPod, iPad and Mac), computer operating systems (iOS and OS X), software, hardware and accessories and a variety of networking solutions and third-party digital content and applications. It is also a provider of commercial online services such as iTunes, iBooks, App Store and iCloud. The company is consistently ranked as the most valuable brand in the world.
The firm sells its products and services globally via its retail and online stores, Apple-accredited stores and third-party partners like mobile phone carriers and retailers. It operates 453 retail stores in 16 countries in the Americas, Europe, Middle East, Africa, Greater China, Japan and the rest of Asia Pacific. The company was incorporated in 1977 and its headquarters are located in Cupertino, California.
What is Apple worth?
Our valuation model is indicating that shares of Apple are worth $126 which is $1 above the current market value. Here are the key assumptions used to arrive at this value:
- Revenue Growth – Over the last 5 years revenue has grown at an average rate of 29.4%. However, growth has slowed over the last few years into the high single digits. As such, the model assumes a 7% growth rate for the next 4 years followed by a terminal growth rate of 2.5%. Using 29.4% for the next 4 years increases the valuation to $233 per share.
- Profitability – Over the last 5 years the EBITDA margin has averaged 33.1%. The model assumes this same margin going forward.
- Depreciation – Depreciation in 2014 was 4.3% of revenue. Our model assumes this same rate of depreciation going forward.
- Income Taxes – The average effective tax rate for the last 5 years was 25.2%. Our model assumes this same effective tax rate going forward. Increasing the effective tax rate to 40% reduces the valuation to $106 per share.
- Capital Investment – Over the last 6 years the company has spent 6.3% of its revenue on capital investments, net of dispositions. The model assumes the same level of investment going forward.
- Working Capital – After netting out cash, short-term investments and short-term debt the company operates with negative working capital. The model assumes this will continue at the same rate as revenue grows.
- Discount Rate – The assumed cost of equity is 10% and the assumed cost of debt is 3.5% over the 10-year U.S. treasury rate. Since the company has no debt the average cost of capital is 10% in the model. Reducing this to 8% increases the valuation to $164 per share.
This model was created by extrapolating the last 5 years of performance into the next 5 years of performance. Before making an investment decision you should run your own model with your own assumptions based on your own research of the company. Download this model to perform your own valuation and let us know what you think shares of the company are worth on Twitter @tagnifi.
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