This blog post will go into detail on how to build a Discounted Cash Flow, or DCF, analysis for Apple Inc. (AAPL). Don’t become frustrated if I don’t define terms you’re unfamiliar with. One can find definitions of the many expressions used in this article in finbox.io’s Glossary.
As a quick overview, a DCF analysis is a valuation approach that can be used to find Apple’s fair value by projecting future cash flows and present valuing them back into today’s dollars. The key assumptions that have the greatest impact on cash flow projections are typically related to growth, profit margin, and investments in the business.
Growth
The chart below illustrates AAPL's YoY revenue and EBITDA growth for the last 5 years. Both had generally been trending lower since calendar year 2012.
While analyzing historical performance can be helpful, it is not always indicative of future performance and the latter being what is important. Wall Street is projecting revenue growth for the next three years at 6.3%, 5.7% and 0.3% respectively. I personally find these estimates conservative as AAPL continues to capture worldwide smartphone market share (Gartner). However, I apply Wall Street estimates in the DCF below.
DCF Analysis:
EBITDA Margin & Capital Expenditures
The chart below highlights Apple’s EBITDA Margin and Capex Margin over the last 5 years. Similar to revenue growth, I use Wall Street estimates in the DCF model above which seems reasonable compared to historical performance.
Terminal Value
At the end of the 5-year projection period, I apply the Gordon Growth method to estimate a Terminal Value. This is done by selecting a Long-term Growth Rate at which you expect AAPL's Free Cash Flows "FCF" to grow at forever. FCFs are growing at approximately 0% in the final projection period, so I’ve selected a terminal growth rate of 0% in the DCF model.
Risks
There are numerous risks that should be taken into consideration that could derail Apple from achieving the Free Cash Flows I’ve just projected. Here are a few that immediately come to mind:
- Slowing smartphone and tablet sales, in addition to Apple's already significant revenue levels suggest achieving further growth may prove be difficult.
- iPhone sales currently accounts for over 65% of total revenues (lots of eggs in one basket)
- Apple relies on new products to support growth. New categories like the Watch, Music, Apple Pay, etc., may take longer than expected to materially contribute.
Accounting for these risks is typically taken into account in the discount rate that is used to present value the projected unlevered free cash flows. The appropriate rate to use is the Weighted Average Cost of Capital, or WACC. I’ve selected 10.5% for Apple (specific calculations shown below).
Conclusion
The midpoint price target derived from the DCF analysis is $106.69 implying that Apple’s stock is about 4% overvalued as of 11/29/2016.
This DCF analysis was done in under 5 minutes and there is no reason you can’t do the same for many more companies at finbox.io. I would suggest doing additional research and analysis (i.e. comparable company analysis, Dividend Discount Model, Dupont etc.) before taking a position on a stock. However, this quick analysis can help you figure out if a company looks interesting. This is typically what hedge fund and investment banking analyst’s spend hours in Excel doing.
