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When nearly half of businesses in the United States have price-to-earnings (or “P / E”) ratios below 17x, you might consider Apple Inc. (NASDAQ: AAPL) as a stock to be avoided entirely with its P / E ratio of 29.7x. However, the P / E can be quite high for a reason, and it requires further investigation to determine if it is warranted.
Before you begin, investors should know that Apple performs exceptionally well in many areas, such as cash flow, working capital management, earnings quality, and most importantly, returns.
You can check out our in-depth Apple report to get a clear idea of the company’s fundamentals. You can also read the qualitative factors impacting Apple’s growth here.
Today we’ll go over Apple’s fundamentals and see why some investors might like the stock even at a more expensive valuation. Of course, buying a stock at “any” price slowly builds a house of cards, and investors may want to be more patient with their stock picks.
With earnings growth exceeding that of most other companies lately, Apple is doing relatively well. The P / E is likely high as investors believe this strong earnings performance will continue.
Otherwise, existing shareholders might be a little worried about the sustainability of the share price.
See our latest review for Apple
The graph above shows us that the company is valued more expensive than the market and the sector. While the P / E isn’t absurd, it might be worth considering whether investor enthusiasm is warranted.
One thing that can help investors get a clearer picture of a company’s future is to think of a few possible events that can boost and a few that can weaken the stock.
For example, a big catalyst could be the global chip shortage, which will translate into bigger profits for Apple. A negative catalyst could be the recent settlement of the App Store court case.
Investors may also be interested in how analysts think Apple’s future compares to the industry, and may take a look at our free report.
Is there enough growth for Apple?
Apple’s P / E ratio would be typical of a company expected to experience very strong growth and, most importantly, much better performance than the market.
If we look back at the last year of earnings growth, the company posted a tremendous increase of 55%. The last three-year period also saw an excellent overall increase of 85% in EPS, aided by its short-term performance.
As for the outlook, the next three years are expected to generate 6.0% growth each year, as analysts watching the company estimate. Meanwhile, the rest of the market is expected to grow by 12% per year, which is definitely more attractive.
With this information, we are concerned that Apple is trading at a higher P / E than the market.
Investors sometimes confuse the love for the company with the future performance of the stock. If we want the best results in the market, we need to know what is happening to the stock with cash flow as the fundamental basis of our analysis.
In the chart below, there is one important point that investors might consider.
We compared sales and three measures of profit to market valuations. In a healthy market environment, investors can expect the market to adjust to growth appropriately, and a chart like this would produce relatively consistent horizontal lines.
What you will notice, however, is that after 2018, the market was less strict with Apple’s earnings. Income pricing has also deviated, but it can be argued that sales growth has followed more closely with stocks than earnings.
We can also notice that the market periodically corrects this. And the more we look to the future, the more volatile the corrections become.
Investors should keep this in mind and consider that if they want to buy Apple shares, holding them for the long term might be a better strategy to avoid some volatility.
Conclusion
Apple stock is currently more expensive than the market and the industry.
Revenue growth appears to follow the share price, however, the company cannot achieve the earnings growth rates necessary to keep up with the historical benchmark.
To be clear, Apple’s growth is still high, but the market appears to be less cash flow demanding.
Apple is still a solid company with impeccable performance, but the stock is starting to show signs of future volatility in the short term, and investors may consider longer term strategies to compensate for this.
Alternatively, one can try to time the stock because it seems to correct itself periodically. – This is a risky approach, and investors might not realize any potential gains as if they had just taken a position earlier or had a coherent investment plan.
If you want find high quality companies like Apple, explore our interactive list of high-quality stocks to get a feel for what’s out there.
Simply Wall St analyst Goran Damchevski and Simply Wall St have no positions in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material.
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