Tim Cook recently confirmed that the iPhone is still doing great in China. Image source: Apple.
It might be something of an understatement to say that the market has been a little bonkers for the past week. More aptly, it's been downright insane out there. But bargain hunters and long-term Fools know that these are exactly the types of market conditions that present compelling buying opportunities. It's like the back-to-school sale season, except the merchandise costs hundreds of billions of dollars. At the risk of recycling an age-old metaphor, investors who are out shopping right now inevitably face the risk of catching a falling knife.
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Still, even if you get cut every once in a while, it's probably worth it if it pays off in the long run. No one truly knows when things will bottom out, but there are certainly clues that investors can look for.
Unwelcome deja vuSince much of the recent turmoil is related to macroeconomic concerns in China, Apple has taken quite a bit of the negativity. China is Apple's fastest-growing market and second-largest market in terms of revenue. CEO Tim Cook even made the rare move of emailing Jim Cramer to reassure investors that the company's business in China remains solid.
The pullback that began after Apple reported earnings has been rather punishing, with shares down 23% from the recent peak by Monday's close. At the panic-stricken low of $92 from Monday morning, shares were down 32% from the peak. If those figures sound painfully familiar, it's probably because Apple's massive pullback between late 2012 and early 2013 is still fresh in their collective memories. Back then, shares fell from a pre-split $705 to around $385, representing a gut-wrenching 45% pullback enough to test any Fool's patience.
The reason I bring this up is that there are some similarities between that pullback and the current one, although the 2012-2013 one was prolonged. When it comes to clues about when Apple might bottom out and recover, investors should look at where its valuation has bottomed out in the past. Looking at pertinent valuation metrics instead of share prices or chart support levels factors in the growth in Apple's fundamentals.
Instead of using a common metric like price to earnings, let's take a look at another valuation metric: enterprise value to free cash flow.
EV/FCF is approaching a lowApple's debt load has grown significantly in recent years as the company uses debt to finance its capital return program. This means that looking at Apple's enterprise value becomes increasingly relevant, since enterprise value factors in a company's debt. As a quick refresher, enterprise value is a company's market cap plus total debt minus cash. Meanwhile, as Apple continues to face FX headwinds and deferred revenue has been on the rise, free cash flow becomes an important figure to keep an eye on. Even as Apple increases capital expenditures, operating cash flow continues to grow so fast that free cash flow is soaring.
If we look at Apple's valuation in terms of EV/FCF, you'll see that Apple is quickly approaching the same valuation lows that it did during the 2013 lows.
This valuation suggests that a bottom may be within sight, assuming Apple's EV/FCF doesn't fall below that prior low or approximately 7.4. The only other time that Apple's EV/FCF was lower than this within the past decade was during the financial crisis.
To be clear, Apple could potentially test those lows and there could still be some downside from here, but probably not by much. It should go without saying, but these types of depressed valuations present very attractive entry points for investors looking to buy in or add to their positions, so long as they can handle the current volatility and hold on for the long run.
The article 1 Chart That Shows Why Apple, Inc. Could Be Bottoming Out originally appeared on Fool.com.
Evan Niu, CFA owns shares of Apple. The Motley Fool owns and recommends Apple. 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.
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