This Just In: Apple Stock Upgraded

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

The cat's out of the bag (maybe). Forbes is reporting that in as little as two weeks, Apple (NASDAQ: AAPL) will reveal its long-awaited iPhone 8. If the rumor is true, Apple fans will get their first chance to buy the next iPhone on Sept. 15, when Apple begins accepting pre-orders.

Luckily, investors don't have to wait that long to buy Apple stock.

Apple wins an upgrade

Bright and early this morning, less than a day after the iPhone rumors began circulating, analysts at independent investment research firm Cleveland Research Company announced they are upgrading Apple stock to buy, and assigning it a $197 price target. With shares selling for just $161 and change today, this implies that new buyers of Apple stock can expect to earn a 22% profit over the next 12 months -- and collect a 1.6% dividend to boot -- resulting in a total expected profit of 23.6%.

If, that is, Cleveland Research is right about Apple going to $197. But is it right?

What Cleveland likes about Apple

iPhone 8 is the big news this week, and it's also the crux of Cleveland's argument in recommending Apple stock. As explained in a write-up on (requires subscription) this morning, Cleveland believes that after releasing iPhone 8 next month, Apple will go on to sell 247 million iPhones (of various stripes) in 2018.

Yes, you read that right -- nearly a quarter-billion iPhone sales.

Where will Apple find all these buyers? In China, and in Europe. Cleveland sees "encouraging" levels of "pent-up demand" in both regions. And with so much demand for new iPhones, the analyst believes Apple should have little trouble growing its average sales price (ASP) for iPhones to $700.

That will be a big jump from the $606 ASP that Apple achieved last quarter, but not that big an improvement over the $695 ASP that Apple recorded in its record-setting first fiscal quarter 2017. In fact, $700 per iPhone might even be a conservative target. Earlier this year, Morgan Stanley predicted that Apple would hit $753 per iPhone sold in 2018. So as optimistic as Cleveland sounds today, Apple might still beat expectations when its actual numbers start rolling in next year.

Beyond iPhone

Secondary to Cleveland's pro-Apple argument are two of the company's other products: Apple Watch and the even newer Apple HomePod. Cleveland expects Apple to sell nearly 20 million Watches next year, and at least half that number of HomePods. While it's hard to say how profitable these newer products will be (they certainly lack the scale of production enjoyed by 247 million iPhones), here's one clue: At $349 per unit, HomePods will be selling for nearly twice the $180 price tag on Amazon's Echo, and nearly three times the $129 list price on a Google Home voice-activated speaker.

Suffice it to say, while not as profitable as an iPhone, it's likely Apple will do just fine selling Watches and HomePods as well.

The most important thing: Valuing Apple stock

But how well will investors do buying Apple stock on Cleveland Research's say-so?

With a market capitalization of $829.4 billion today, and $31.6 billion in net debt on its balance sheet, all of Apple currently sports an enterprise value of $861 billion -- just within shouting distance of the stock's all-time high. That certainly doesn't sound like a great valuation to be buying Apple at. But how does it stack up against Apple's profits?

Valued on its GAAP net income ($46.6 billion), an $861 billion enterprise value works out to a multiple of 18.5 times earnings. Valued on actual free cash flow ($51.5 billion), Apple stock sells for a cheaper 16.7 times free cash flow. And yet, most analysts continue to predict less than a 10% profits growth rate for Apple over the next five years. If that's all Apple can manage, even 16.7 times FCF might be too high a price to pay.

Then again, if Apple does manage to sell 247 million iPhones next year, that will be a 16.5% jump from iPhones sold in 2016. With all those iPhones selling for higher average selling prices, it's all but certain Apple will grow its earnings a lot more than 10% next year. So while the longer-term outlook for Apple stock may not look encouraging, I'd be surprised if Apple investors don't get at least one more good year out of their stock in 2018.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Rich Smith owns shares of GOOG. The Motley Fool owns shares of and recommends GOOG, GOOG, AMZN, and Apple. The Motley Fool has a disclosure policy.