I am often asked if I utilize the methods I teach here on ModernGraham, and the answer is yes. I fully believe that Benjamin Graham’s methodology can be used in the market today, especially after taking time to analyze each one of his ideas and modernize it as needed. The ModernGraham method can be a great way to narrow down investment opportunities to the strongest companies, and then a little bit of further research can help one determine in which companies to invest.
This series of posts looks at each of my personal holdings, putting them through a full ModernGraham valuation and adding a level of further research to provide rationale as to why I selected the company for my portfolio. Here’s a page with more information about my portfolio, including my thoughts and goals on asset allocation and an overview of my current holdings.
The first step in my analysis is to put the company through a full ModernGraham valuation. For readers who may be new to the site, here on ModernGraham I cover the full S&P 500, putting each company through an individual valuation like this every quarter if it qualifies for either the Defensive Investor or Enterprising Investor, or every year if it does not qualify for either investor type. Premium members have access to every valuation on the site, for only $4.99/month.
Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company or by reviewing the 10 Most Undervalued Companies for the Defensive Investor – August 2015. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a stock analysis showing a specific look at how Apple Inc. (AAPL) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Apple Inc. (Apple) designs, manufactures and markets mobile communication and media devices, personal computers, and portable digital music players, and a variety of related software, services, peripherals, networking solutions, and third-party digital content and applications. The Company’s products and services include iPhone, iPad, Mac, iPod, Apple TV, a portfolio of consumer and professional software applications, the iOS and OS X operating systems, iCloud, and a variety of accessory, service and support offerings. The Company also delivers digital content and applications through the iTunes Store, App StoreSM, iBookstoreSM, and Mac App Store. The Company distributes its products worldwide through its retail stores, online stores, and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers, and value-added resellers. In February 2012, the Company acquired app-search engine Chomp.
Downloadable PDF version of this valuation:
Stage 1: Is this company suitable for the Defensive Investor or the Enterprising Investor?
|Defensive Investor; must pass 6 out of the following 7 tests.|
|1. Adequate Size of the Enterprise||Market Cap > $2Bil||Pass|
|2. Sufficiently Strong Financial Condition||Current Ratio > 2||Fail|
|3. Earnings Stability||Positive EPS for 10 years prior||Pass|
|4. Dividend Record||Dividend Payments for 10 years prior||Fail|
|5. Earnings Growth||Increase of 33% in EPS in past 10 years using 3 year averages at beginning and end||Pass|
|6. Moderate PEmg Ratio||PEmg < 20||Pass|
|7. Moderate Price to Assets||PB Ratio < 2.5 OR PB*PEmg < 50||Fail|
|Enterprising Investor; must pass 4 out of the following 5 tests, or be suitable for the Defensive Investor.|
|1. Sufficiently Strong Financial Condition||Current Ratio > 1.5||Fail|
|2. Sufficiently Strong Financial Condition||Debt to NCA < 1.1||Fail|
|3. Earnings Stability||Positive EPS for 5 years prior||Pass|
|4. Dividend Record||Currently Pays Dividend||Pass|
|5. Earnings Growth||EPSmg greater than 5 years ago||Pass|
Stage 2: Determination of Intrinsic Value
|MG Growth Estimate||15.00%|
|MG Value based on 3% Growth||$100.97|
|MG Value based on 0% Growth||$59.19|
|Market Implied Growth Rate||3.60%|
|% of Intrinsic Value||40.76%|
Apple Inc. does not qualify for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio, short dividend history, and the high PB ratio. The Enterprising Investor is concerned about the level of debt relative to the net current assets. As a result, all value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities or proceed with a cautious speculative attitude.
As for a valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $2.29 in 2011 to an estimated $6.96 for 2015. This level of demonstrated earnings growth outpaces the market’s implied estimate of 3.6% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value above the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Apple Inc. (AAPL)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Stage 3: Information for Further Research
|Net Current Asset Value (NCAV)||-$13.25|
|Number of Consecutive Years of Dividend Growth||4|
|ModernGraham tagged articles||Morningstar|
|Google Finance||MSN Money|
|Yahoo Finance||Seeking Alpha|
Most Recent Balance Sheet Figures
|Total Current Assets||$70,953,000,000|
|Total Current Liabilities||$65,285,000,000|
|Shares Outstanding (Diluted Average)||5,773,099,000|
Earnings Per Share History
|Next Fiscal Year Estimate||$9.01|
Earnings Per Share – ModernGraham History
|Next Fiscal Year Estimate||$6.96|
Other ModernGraham posts about the company
Other ModernGraham posts about related companies
Rationale & Outlook
After putting the company through a ModernGraham valuation, the next step is to look at the company to analyze its business. I like to utilize Warren Buffett’s business tenets, which are very helpful in determining the business’s strengths and weaknesses. Let’s put Apple Inc. through that analysis:
Is the business simple and understandable?
Apple makes computers and related technological devices. While the individual products may be extremely complicated to produce, the underlying business model remains one of manufacturing and sale of products. The company puts a large emphasis on marketing its products in order to maximize the market interest, and that strategy has worked considerably well.
Buffett prefers to have companies with a simple business model because it is key for the investor to be able to know what the company is doing. There are some caveats to this in that it isn’t necessary for the investor to understand the details of how the product works, but rather the goal that the product achieves. Here, I do not know how to engineer a smartphone, computer, or tablet, but I do understand the need for such products (and even own quite a few of them myself). As a result, I am able to understand Apple’s business in a simple manner.
Does the business have a consistent operating history?
Steve Jobs, Steve Wozniak, and Ronald Wayne founded Apple in 1976 as a personal computer manufacturer. Throughout that time, the company has maintained a consistent operating history as a personal computer manufacturer, and its expansion has been limited to related markets such as music devices, smartphones, and tablets; all of which are essentially just smaller versions of personal computers.
Apple specifically is “committed to bringing the best user experience to its customers through its innovative hardware, software and services.” (as stated in the company’s latest 10-K report). This strategy plays out in the overall design of its products which are often seen as market-leading in terms of usability.
With regard to dividends, the company has only paid a dividend for about four years, but has increased the dividend payment each of those four years. Dividend growth is a key element in a long-term investing strategy, as it can provide a solid yield on investment over a large period of time.
Does the company have favorable long-term prospects?
Apple would appear to have very favorable long-term prospects. There is a lot of opportunity for growth remaining as even if one considers the US market for smartphones to be saturated, Apple products are expanding further and further into other nations. In addition, the company still has plenty of room to grow in the personal computer market, though it must find a way to leverage its popularity in the smart phone arena and turn more of those customers into computer buyers. For example, I do not use a Macintosh computer, but I must admit to being intrigued by the possibility of having enhanced integration between my devices. I am not alone in this regard among members of my generation and the company just needs to find a way to tip the scales a little bit more in their favor.
Is management rational?
Apple’s management has a clear strategy that is focused on long-term growth. As such, that management appears to be very rational in my opinion. In addition, the company has outlined its Sustainability initiatives in a way that will be attractive to many millennials. Environmental conservation is a key concept for management to address as the world increasingly turns to awareness of climate change. In particular, as millennials become decision makers, I predict that more companies will need to put more effort into environmentally friendly programs in order to attract business from leaders from the millennial generation and beyond.
Is management candid with shareholders?
Management candor is a key tenet, and the easiest way for management to be candid in today’s environment is to post informative statements on the company website, including links to earnings calls or transcripts of those calls. Apple’s investor information page is not the most well organized I have seen, and frankly is a bit disappointing given the company’s ability to create easily navigable content. In addition, the management has a history of seeming to be less than forthcoming with some data – sales data in particular – and that makes me slightly weary of the management’s condor. That said, the management has done nothing to detract me from trusting them to continue to perform well.
General Thoughts and Outlook
Clearly, some red flags come up in the fact that Apple does not qualify for either the Defensive Investor or the Enterprising Investor; however, this is a rare situation where I am willing to speculate on the company due to extrinsic factors. In particular, the company has a large amount of investments in long-term marketable securities held by its foreign subsidiaries. While a chunk of those assets would have to be subject to various US taxes if they are brought back to the US, there seems to be more than enough to cover capital needs and bring the company’s financial position to a point where I am willing to speculate about the value.
As for the value, the ModernGraham valuation model returns a growth estimate at the high end limit of 15% annually for the next 7-10 years, generating a substantially high level of the value when compared to the current market price. I’m not entirely convinced the company will achieve that growth rate, but I do believe it will sustain a growth rate significantly higher than the market’s implied estimate of only 3.6% annually. Therefore, I do believe the company to be undervalued at this time and I am excited about the long-term prospects for my investment here.
The author held a long position in Apple but did not hold a position in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. This article is not investment advice; any reader should speak to a registered investment adviser prior to making any investment decisions. ModernGraham is not affiliated with the company in any manner. Please also take a moment to read our full disclaimer.