Is Apple Stock is Cheap Now? (NASDAQ:AAPL)

Even after running up roughly 160% in the last year, Apple Inc. (NASDAQ:AAPL) stock may be at bargain basement levels.  It appears that with a slight modification in accounting method that will allow Apple to account for iPhone sales immediately, instead of spread out over a 24-month contract period, the P/E ratio for the stock may plummet to some very attractive levels.  Jason Schwarz walks us through how it is easy to conclude that Apple’s P/E will be at some of its lowest levels, making a setup for some strong future gains.  Schwarz provides the most compelling arguments for buying Apple stock, especially as he concludes his discussion with the upcoming tablet, which will flat out change the newspaper/magazine/book print industry as well as the mobile Internet and gaming sectors.

First, let’s start with a simple but profound statement Schwarz makes, “On my first day in college, I’ll never forget my Accounting 101 professor (Norm Nemrow) tell me that the P/E ratio is the single most important number in the world. This number can make investors very rich if interpreted correctly.”  This is extremely important to value investors.

Jason Schwarz  - “Most of us have heard that Apple is about to implement a new accounting method that will allow them to account for iPhone sales immediately rather than spread the effect over a 24 month subscription period. A few analysts here and there have made an attempt to explain the implications of this change but most simply ignore it. Why? Because they don’t understand the depth of its impact. I’m going to simplify the explanation so everyone can understand. On my first day in college, I’ll never forget my Accounting 101 professor (Norm Nemrow) tell me that the P/E ratio is the single most important number in the world. This number can make investors very rich if interpreted correctly.

Steve Jobs took over the company in 1997 and Apple has generated a profit each fiscal year since 2003. Since 2003, Apple has consistently traded at an average P/E ratio of 32.17 which is consistent with today's current P/E of 33. You can tell that traders have done their homework and are strict followers of the P/E valuation. If you’re like me, you don’t care too much about current P/E ratios because they are calculated from past results. The number that really matters is the forward P/E ratio because it is calculated from future estimated earnings. Well, the average forward P/E ratio for Apple since 2003 is 22.48. Any guesses what it is now? Based on the new accounting rules soon to be put in place, and the 37 billion in cash that Apple has on their books, Apple’s forward P/E is below 13. This stock has not been priced this cheaply since Steve Jobs came back to Apple in 1997.

What should Apple stock be priced at according to its historical P/E norms? Based on expected earnings per share of only $11.70 in fiscal 2010 (many think earnings per share according to the new accounting standard will end up closer to $13) the stock should be priced at $263 today and should reach $376 by September 30, 2010. These prices do not reflect great years for Apple, they simply reflect the averages.

You want to know what a great year would look like on September 30, 2010? Let’s use the P/E ratio from just before the recession began in 2007. With the iPhone added to the Mac and iPod lines, Apple stock was soaring. Its forward P/E was 28.63 and its current P/E on September 30th 2007 was 39.05. If we used those ratios in 2010 it would put Apple stock at $456 by the close of its fiscal year on September 30th.

Making a comparison between 2007 and 2010 is noteworthy because both are years of new product releases. On January 9th 2007 Steve Jobs unveiled the first iPhone and it went on sale June 29th. On January 27th 2010 Steve Jobs will unveil the Tablet and it should be available sometime in Q2. Both products are revolutionary but the Tablet arguably is more so because it will single handedly change the newspaper/magazine/book print industry as well as the mobile Internet and gaming sectors. The iPhone was not nearly as big of a game changer in 2007. Are the future prospects for Apple better or worse than they were back in 2007? Today Apple has approximately $40 billion in cash on its balance sheet, it has 3 billion apps downloaded through the App Store, the iPhone’s international expansion is just taking off, and of course the Tablet is on its way. All of a sudden seeing Apple stock at $210 doesn’t seem very expensive at all. “

Read Jason Schwarz’s article in its entirety.

Disclosure: No positions by WallStNation Staff.  Schwarz is long AAPL.