I’d like to use today’s post to briefly lay out the case for Apple. Apple just happens to be my favorite investment idea right now for a few reasons. First, it’s extremely undervalued. Second, it’s out of favor for the first time in many years. Third, the charts are telling me to buy it.

Let’s take a look at the fundamentals first. Apple’s current share price is $524. The company has 941 million shares outstanding. Multiplying these two numbers together we learn that Mr. Market currently values the company at $493 billion. Over the past twelve months Apple earned $42 billion in profits. So the current price-to-earnings ratio is 11.7. To put this in perspective, the stock market (S&P) currently trades at nearly 17 times its earnings. Therefore, Mr. Market is telling us that Apple is worth less than the average company in the S&P 500, nearly a third less, in fact.

To dig a little deeper, though, we’ll need to look past these simple ratios. I prefer to look at Enterprise Value-to-EBITDA rather than a simple PE ratio (for reasons I explain here). Apple has over $120 billion in cash on its balance sheet currently and no debt. So after backing the net cash of $120b Apple is currently valued at $373b. And rather than look at earnings we should look at EBITDA (earnings before interest, taxes, depreciation and amortization) so that we back cash and debt out of both the numerator and denominator of this valuation ratio. Apple generated $58.5b of EBITDA over the past year giving us an EV-EBITDA ratio of 6.4. To put this another way, if you were to buy Apple in its entirety today (and the business were to just hold even) you would immediately earn a cash-on-cash yield over 15%. Or you can go put your money in a 10-year treasury bond and earn 1.9%. So compared to the general stock market and current bond yields, Apple looks very attractive from a valuation standpoint.

But let’s make one more comparison by taking a look at Apple’s valuation history. Over the past ten years or so Apple has generally traded between 25 and 50 times earnings. On average, Apple’s stock price has traded about 37 times earnings and bottomed near 23 times earnings. If Apple were to trade today at a value that has historically marked a bottom for the share price it would be over $1,000 per share (23*42 billion in profits/941 million shares outstanding). And if it were to trade at its average valuation over the past ten years it would be more than three times higher than the current share price.

Now I’m not saying that this is fair value for the stock. I’m just saying that today’s price builds in a nice “margin of safety.” This is Ben Graham’s (Warren Buffett’s mentor) term for the difference between the price you pay and its intrinsic value. For example, if something is worth $1,000 and you pay only $500, even if you have to sell it in a distressed situation you should lose very little if any money at all. And even if the value doesn’t grow but you have the patience to wait for a buyer to pay fair value you stand to double your money. This is the kind of “margin of safety” great investors look for and Apple currently offers, in my humble opinion.

In terms of sentiment, for the first time in years folks are jumping on the Apple-bashing bandwagon. Fanboys are Apple Fellows are bragging about switching to Android. Analysts and popular bloggers (here and here among many others) are bagging the company’s business lines and talking the stock down. In fact, it’s hard to find anyone touting the stock right now. This is why it’s so cheap.

But there’s one little problem: Apple is the most successful company in the history of the world. Period. No company has ever earned more money. You could also argue that no company has garnered more brand loyalty.

The fact that the investing public doesn’t recognize this makes me happy. Like Warren Buffett counsels, I like to ‘buy when others are fearful and sell when others are greedy.’ Right now folks are fearful of Apple and this creates a great opportunity for investors willing to buy their shares from them at a significant discount.

I make a brief technical case for the stock in today’s “Chart of the Day” section. Utimately, though, Apple’s business will determine where the stock price goes from here. And I’ll be paying close attention to its next earnings announcement to see how much validity there is to the bear case. The markets are fluid and it pays to always see both sides of the trade.

Chart(s) of the Day

sc (11)

Apple saw it’s stock price last month make a new low that was not confirmed by MACD or RSI. These indicators made a bullish divergence that suggests downside momentum is waning and a reversal may be in the offing.sc (12)

Looking longer-term, the uptrend is clearly intact and the stock price is oversold.

Hit the Links

  • Beware Central Bank Put (Business Insider)
  • How Huge Returns Mess With Your Mind (WSJ)
  • 88% Of Hedge Funds, 65% Of Mutual Funds Underperform Market In 2012 (Zero Hedge)
  • Is Facebook the new Microsoft? (AVC)
  • Exports of American Natural Gas May Fall Short of High Hopes (NYTimes)
  • Gold is on its longest losing streak in 8 years. Here’s why. (Business Insider)
  • 5 Secrets To Getting What You Want From A Top FBI Hostage Negotiator (Barking Up The Wrong Tree)
  • Caffeinated Seas Found Off Pacific Northwest Coast (National Geographic)
  • Phil Knight making push to keep Chip Kelly in college (NFL)
  • The NHL Lockout Is Over! (USA Today)