Warren Buffett Is Right: Apple, Inc. Stock Is Undervalued

By Markets Fool.com

On Monday, new SEC filings revealed billionaire investor Warren Buffett's Berkshire Hathaway had invested just over $1 billion into Apple by the end of Q1. Berkshire's investment is notable, as Buffett's stock-picking skills are indisputably superior to any investor in history. But is the investment merited?

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As it turns out, Buffett seems to be on to something with Apple stock. Trading at these levels, it looks like a downright bargain.

Warren Buffett.

Apple stock: trading at a 37% discount?

When Buffett's Berkshire Hathaway buys a stock, you can bet either Buffett or his two investing lieutenants, Todd Combs and Ted Weschler, are convinced the stock is undervalued. Unlike billionaire investor Carl Icahn, who actually recently just sold Apple stock, Buffett is known for holding stocks he buys for decades.

"Our favorite holding period is forever," Buffett has said.

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So, is Apple stock undervalued? A quick glance at the company's fundamentals relative to its stock price suggests it is.

To illustrate the value in Apple stock, consider what Apple is worth using a simple discounted cash flow valuation based on very conservative assumptions. Predicting Apple's annual free cash flows will grow at an average annual rate of just 3% (about in line with the historical rate of inflation) into perpetuity, the present value of the tech giant's future cash flows is $148 per share when using a discount rate of 10% to account for risk, opportunity cost, and the time value of money.

With the stock trading at about $94 at the time of this writing, this would suggest shares are trading at about a significant 37% discount to fair value, giving Buffett the sort of "margin of safety" he enjoys.

Still not convinced?

A discounted cash flow valuation, of course, is only as good as the underlying assumptions. And while these assumptions are arguably very conservative in light of Apple's long history of consistently growing intrinsic value for shareholders, this valuation method may rely on too many forward-looking assumptions for investors to be comfortable with it.

Fortunately, however, Apple stock looks relatively cheap from almost any angle. Consider how the company compares to two other megacap tech companies struggling with growth, as well as to the S&P 500, on price-to-earnings metrics.

Valuation Metric

Apple

Intel

IBM

S&P 500

Price-to-earnings

10.4

13.0

11.3

24.0

Forward price-to-earnings*

9.5

11.3

10.5

17.6

Forward price-to-earnings metric is equal to the stock's price divided by the consensus analyst estimate for Apple's earnings over the next twelve months.

Then, of course, there's Apple's massive cash hoard, which amounts to an impressive 46% per share.

And one final point on valuation: Keep in mind that Apple's conservative valuation is all arguably based on a few quarters of struggling growth, representing a very shortsighted view. Apple's inability to post EPS growth, and management's guidance for more year-over-year declines in the current quarter, have investors worried that things could continue downhill from here. Zoom out just two years, however, and you'll see a different story: revenue and EPS are both up significantly from where they were two years ago. Taking this exercise further, zoom out five years and the tech giant's current struggle with EPS growth looks like a small and acceptable blip following some enormous growth.

AAPL Normalized Diluted EPS (TTM) data by YCharts

So, is Apple's business really in decline? Or is this just the natural volatility a company with a concentrated product portfolio can run into following a huge, record year?

No matter how you slice it, Apple certainly does look tasty. No wonder Buffett's Berkshire is buying.

The article Warren Buffett Is Right: Apple, Inc. Stock Is Undervalued originally appeared on Fool.com.

Daniel Sparks owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Berkshire Hathaway. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.