Remember 2016? Barack Obama was in the White House, Zika virus was the looming threat, “The Sound of Silence” by Disturbed raged on the rock charts, and Apple—yes that Apple—was a value stock.
Indeed, none other than value-stock-loving Warren Buffett went on a buying spree starting in Q1 of 2016. By all the metrics that govern future returns, Apple ranked as an ideal investment during the entire period of Berkshire’s major purchases, which lasted to Q1 of 2018. Take the mid-point of that span, June of 2017. At the time, Apple, based on fundamentals, little resembled the current version sporting a super-premium price and attracting such fabulous forecasts on Wall Street. Instead, it had all the qualities of a great value stock. Its market cap stood at $750 billion, and it was en route to posting $47 billion in GAAP net earnings for FY 2017 (ended September 30).
That put its PE at a lowly, unloved 16. As it does today, Apple was returning virtually all of its profits to shareholders in the form of dividends and buybacks. Stock returns have three components: Earnings growth, the total “yield” provided by dividends plus buybacks, and changes in the PE multiple. Because Apple’s price was so low relative to its earnings, it boasted a yield of 1.7%, and the repurchases provided an additional boost of 4.4% by giving the remaining shares a bigger portion of the earnings. So investors were getting 6.1% from those two sources combined, plus future growth in profits, just if the multiple stayed well below the market average.
Those numbers set an extremely low bar for achieving big returns. To reach 10%, Apple only had to grow net profits by 3.9%, since the dividend plus buyback combo were already contributing 6% plus, sans any increase in profits. Hitting that just under 4% bogey meant growing annual earnings by around $2 billion a year. Clinching that target looked like a light lift. Plus, any rise in that beaten-down PE would supply extra fuel.
For a few years, though, Apple’s profits remained stuck in the $50 billion range. Then, in the stay at home pandemic economy, sales of its laptops and other staple gear for remote work exploded. Starting in FY 2022, Apple was booking nearly $100 billion in annual profits, twice the number three years earlier.
The rub: Apple’s market cap ramped far faster than even the gigantic swing in earnings. By mid-June of this year, its valuation had swelled to $3.2 trillion, over four times the figure in mid-2017. Put simply, Apple’s profits doubled and its market cap quadrupled, taking its PE from a modest 16 to towering 32. The former deep value play had morphed into the model of a super-high priced tech racer.
Apple stock forecast
The surge in Apple’s price immensely reduced the power of its dividends and buybacks. Its yield has dropped from 1.7% in mid-2017 to a current, piddling 0.48%. Buybacks are now contributing an additional 3.1%, way down from the 4.4% when Buffett was loading up. Hence, the two combined provide a foundation of just 3.6%, less than two-thirds the old 6.1%. So just to provide 10% returns going forward, Apple must grow earnings by the difference of 6.4% (the 10% goal minus 3.6% from dividends plus buybacks). Of course, that formula assumes its PE stays at the current multiple exceeding 30.
How many billions does it take to raise profits 6.4% a year? The answer: $6.4 billion on top of today’s base of $100 billion. That’s over three times the bogey of $2 billion required in mid-2017. Here, Apple runs afoul of the law of large numbers. At current margins, it would need to raise sales by around $25 billion a year just to achieve that 10% return. What it would need to add annually equals 12% of Microsoft’s average total revenues over the past three years. From the close of from FY 2021 to FY 2023, Apple’s top line has grown by only $2.3 billion.
Put simply, Apple will face a tough climb to keep compounding profits at 6% a year on a Brobdingnagian starting base of $100 billion. But it faces a second problem: The likelihood that its PE won’t remain anywhere near the current level of 32.3. That’s number for turbo-charged grower, not a mature player like Apple.
9So let’s posit that Apple indeed expands earnings at our 6% requirement that, combined with dividends and buybacks, would deliver a 10% return, assuming no change in valuation. In that case, it would be generating $120.5 billion in net GAAP profits by FY 2027.
But say its PE falls to 20, which is still above the long-term average for the S&P 500. Buybacks would help by raising earnings-per-share around 10%. But that’s not enough. Even with the jump in profits and the repurchases, its shares would be selling at around $175, 17% below where they stand today.
Hence, Apple faces a pair of daunting challenges for rewarding investors. First, that it will be hard pressed growing profits fast enough from the $100 billion level, a number that’s doubled post-pandemic, to compensate for the now-low contribution from buybacks and dividends. The second, related issue: Only companies promising big profits growth sustain huge multiples, and at its current size, Apple looks more like a plodder than a sprinter.
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