AAPL's Undervalued Right Now

AAPL's not nearly as expensive as it seems. After running higher since late May ahead of major product announcements, Apple stock has pulled back and has been consolidating its gains. Given the highly successful launch of the new iPhone 3GS, though, the company will likely handily beat estimates when it reports earnings in July.

I think the stock could tack on another 20% or so in the coming weeks and months, and only at that point -- depending on the upcoming earnings report -- will the stock be fairly valued.

Apple stock looks expensive on the surface, with a P/E of about 25 on both trailing and forward earnings. Furthermore, a quick look at consensus estimates would suggest the company isn't growing at all! Of course, that could not be further from the truth.

Apple's valuation metrics are greatly skewed by the very large amount of cash on the company's books -- representing about a quarter of the company's current market capitalization -- and by the fact that the company is deferring a great amount of sales and profits from sale of the iPhone.

Apple has generated a tremendous amount of free cash flow over the last few years, and unlike many companies that buy back stock regardless of market conditions or price, Apple's board of directors has steadfastly refused to play that game. That's served the company well in light of the market crash, and at the end of March the company had almost $29 billion in cash sitting on its books. That represents about $32 per Apple share.

After subtracting that from the company's valuation, and also subtracting the interest income earned from that cash (although that isn't very much at all given the very low level of current interest rates), the P/E is a much more reasonable 20 times earnings (based on this year's consensus estimates).

This still overstates the company's valuation, however, because of the company's deferral of profit under the subscription method of accounting. If Apple were to account for iPhone sales the same way its competitors do, Apple's P/E would be closer to 14 times earnings, assuming that we exclude the cash and that non-GAAP earnings total about $8 a share.

That level of earnings equates roughly to the amount of cash flow that Apple is currently generating. And don't forget that Apple is spending about a billion dollars a year on research and development, which is expensed against current earnings!

In summary, Apple stock offers investors a great growth story in an environment where real growth is hard to find. When you look under the hood, the stock is not nearly expensive as the traditional metrics indicate, giving it room to run another 20% or more.

Long Apple