From this example we can make several observations about how stocks are valued. First, the price of a stock alone, of course, does not tell us anything about how it is valued. We have to relate that stock price to something like earnings and earnings growth. AAPL's stock price is more than five times the price of WFM's stock, but here we see that AAPL is actually the cheaper stock in relation to earnings, with a P/E of 14 compared with WFM's P/E of 31. The P/E ratio tells us how much we are paying for each dollar of current earnings. It would be nice if successful investing were simply a matter of just finding stocks with low P/E multiples, but there's more to the story. If we look at shares of Lockheed Martin (LMT, $77), the big defense contractor, we'll find a P/E ratio of about 9. That looks cheap at first, until we look at the projected annual growth in earnings for the company, which is about 6%. This leads us to another popular measure of value, the PEG ratio, which is the P/E multiple divided by the projected growth rate. The lower this number, the less we are paying for a company's future growth; any value less than one is generally considered bargain territory. So, here we have LMT at a PEG of 1.5, while AAPL has a PEG of about .90 (assuming 15% projected annual growth in earnings over the next five years, based on the most conservative of the projections I found, though the forecasts range from 15% all the way up to 30%). Once again, AAPL is the cheaper stock, even though LMT has the lower P/E ratio. As for WFM, its PEG ratio is way out of bargain territory, greater than 2.0 (assuming, again, a conservative projected earnings growth rate of about 12%).
Any number of factors can influence a stock's P/E ratio, one of which is the basic nature of the company's business. Whole Foods Market, for all of its quality, healthful offerings and its trendy appeal (as if Apple didn't have some bragging rights of its own as to trendiness), is still in the grocery store business, typically a low-margin enterprise. WFM's net profit margin is a respectable 3.4% compared with Kroger's 1.4%. (Apple clocks in at 24%.) WFM deserves a premium valuation relative to other grocery stores due to its margins and promising growth prospects, but I have to conclude that the stock is a bit pricey at 31 times earnings. And just because WFM may be overvalued does not mean that AAPL is undervalued. What is more compelling about AAPL's valuation is its lack of a premium to the overall market, especially given the company's growth prospects.
Here we need to emphasize one of our basic investing rules, that regardless of what has happened in the past, stock prices are determined by what is expected to happen in the future. We could be making money hand-over-fist as shareholders in the most profitable buggy-whip-making business in the 19th century world, but the dawn of the automobile era is going to lead to a major reversal of our fortunes. Lockheed Martin's stock is trading at low valuations because the market expects the government's defense spending to be cut as the politicians in Washington attempt, however feebly, to reduce the nation's deficit. If France were to declare war on the United Sates tomorrow, that would all change as investors change their outlook for LMT's earnings. I can insist all day long that Apple's stock is undervalued, but given the choice between hubris and humility, I'll choose to be humble and acknowledge that the market is pricing some concerns about the future into Apple's stock price.
Let's tally up, then, the bullish (positive) and bearish (negative) arguments for Apple. The bears will point to the death of Steve Jobs as a source of uncertainty for the company's future. Jobs was perhaps our generation's greatest visionary in the world of business and technology, and the loss is especially tragic given his young age. However, I don't expect the change in leadership to adversely affect the company's appeal to investors. Great companies tend to be quite good at building on past successes and thriving through such changes. Of greater concern is the competitive threat, the proverbial "better mousetrap" that hardcore Apple enthusiasts will deny could ever exist, but which investors know is entirely plausible. Samsung's Galaxy phone and Amazon's Kindle Fire lead the list here of challengers to the hegemony of Apple in smartphones and tablets.
The bulls will argue that such competitive concerns are already priced into the stock, and I'll give them that. They'll also point to the "ecosystem effect" of Apple's products, where the benefits of integration across the company's different products make it less likely that current users would switch to another brand of one product. The bulls will also point to Apple's global opportunities and the potential of new products and trends such as televisions and mobile payment technologies.
Investors are also, no doubt, cognizant of Apple's hefty market capitalization (the price per share times the number of shares outstanding, which is the market value of the entire company). With a $365 billion market capitalization, AAPL is the second most valuable company in the world, just behind Exxon Mobil (XOM) at $395 billion. If Apple's earnings do grow by 15% per year over the next five years, it will be earning about $50 per share within that time frame. And if the market were to attach a higher (premium) P/E to Apple's earnings (or if the overall market trades at a higher P/E), it is not inconceivable that the stock could be closing in on $1,000 per share in a few years. That would put Apple's market capitalization within striking distance of $1 trillion. Could any company be worth that much? That question was probably raised when the first company crossed the $100 billion mark and every $100 billion after that.
Financial history is full of buggy-whip destroyers, though. If you are fortunate enough to have bought AAPL when the iPhone was just a twinkle in the firing synapses of Steve Jobs's magnificent brain, then your immensely profitable ride likely is not over, but the best returns are probably in the rear view mirror. The "next Apple" could indeed be Apple, but I wouldn't bet the farm on it. I expect Apple to get a boost from strong holiday sales and, barring the unexpected, probably approach $500 per share over the next 12 months, for a return of 25% from the current level. The stock is far from being "priced to perfection," and that gives investors a decent entry point here.
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I plan to devote a small section of this blog to what I call "diversions." Making money is fun, but the real fun comes from using those material gains to enrich the lives of other people--the people we love and care about, our friends and family, and those in need across our broader community. I can't think of anything, really, that is more important to living a meaningful life. And that's true not just at Christmas, but each and every day of the year. So, we'll be taking a look here at some ways that we can be successful, not just at investing, but also at the business of life.
Today I'll mention how much I like to support locally-owned and home-grown Memphis businesses. I've always loved High Point Grocery (I wonder how their margins are...), just around the corner from our house. I've become even more determined to spend my grocery dollars there since the Kroger Monster invaded. High Point has an especially good butcher, Steve, and a fabulous meat department. If you go in the store, be sure to sign the email list so they can send you the list of weekly specials. Some really great deals here.
I'll also be frequenting Maggie's Pharm, in Overton Square. It's one of my favorite spots for fun gifts. While I'm roaming through Midtown, I'll also stop by Burke's Bookstore in Cooper-Young and probably grab a milkshake at Wile's-Smith Drugstore.
I have a contest with myself every Christmas to see if I can do all of my shopping without entering one single shopping mall. This year I'm going to win.
Life is short. Get busy.
Jim
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