Apple Stock Is the Real Bargain in Big Tech. It’s Not What You Think.
By Jacob Sonenshine
Aug 21, 2024 3:49 pm EDT
Big Tech is looking good right now, sporting nice gains after the market meltdown from a few weeks. But the sleeper in the bunch that looks most ripe for buying: Apple (AAPL).
You can even call it a real bargain based on free cash flow. Yes, free cash flow.
But first, let’s look back a little, to Aug. 5.
The Nasdaq 100 (NDX) — the index is made up mostly of AI heavy hitters such as Microsoft, Meta Platforms, Alphabet ( GOOGL), Amazon ( AMZN), Salesforce, and Oracle — has climbed 10% since early this month.
It stands to reason: Investors bought the meltdown since there’s plenty of profit growth to come. The catch is that not all these stocks are good buys, considering their prospects for free cash flow.
Let’s start here: Analysts as a whole think Microsoft, Meta Platforms, Alphabet, and Oracle will produce free cash flow that’s considerably below expected net income, or earnings, points out Melius Research analyst Jack Adair.
For those four behemoths, consensus 2025 free cash flow forecasts are expected to total about $236 billion, or 80% of the $294 billion in expected net income, according to FactSet.
The gap is because the companies are aggressively increasing their capital expenditures, or investments in long-term assets, both this year and next. They’re pouring money into data centers, which includes buying massive amounts of chips, as they build out their AI capabilities.
That pressures free cash flow.
The upshot is that their stocks are trading at high multiples of cash flow, while their price-to-forward earnings multiples are lower.
Extreme examples are Microsoft and Oracle, which trade at 40 times and 37 times next 12 months free cash flow, respectively. Those are more than 12 points above the S&P 500 SPX’s 24.7 times free cash flow.
To be sure, bulls argue capex will stop increasing so much eventually and the AI capabilities will keep driving sales growth. Those two things ultimately will let free cash flow recover, justifying current valuations.
That’s fair, but it’s tough to figure out which companies will compete well enough to meet revenue expectations and which ones won’t. The software names that don’t post high growth probably won’t generate enough long-term free cash flow, and their stocks probably will underperform.
Enter, Apple. On the surface, it isn’t cheaper than many other Big Techs. Its price/earnings multiple of 31 times is close to Microsoft’s and Amazon’s, and it’s above the P/E ratios for all other companies mentioned above.
But the silver lining is that it trades at just 27 times expected free cash flow. That’s because analysts’ projection of $124.9 billion in 2025 free cash flow is above their forecast of $114.4 billion in net income.
That’s because Apple doesn’t have to invest as much to weave AI into its products because it already has certain key assets in place. It has its own capex needs, and that expenditure should grow moderately to just over $10 billion next year.
While that does weigh on free cash flow, it isn’t enough to keep cash flow below earnings. Cash flow doesn’t account for noncash expenses so adding back more than $12 billion—depreciation, amortization plus certain balance sheet changes—brings the cash flow estimate to its healthy current level.
Part of the picture is that Apple expects iPhone sales to grow by a mid-single-digit percentage next year because of demand for AI-enabled upgrades. And analysts see low-double-digit growth for its vast services business. Total sales could grow almost 8% to $428.5 billion next year.
If Apple can hit those revenue targets, the market will remain comfortable with free cash flow growth from here. If revenue grows at the 5.7% annual pace for the next several years that analysts project—and assuming management doesn’t have any particular reason to grow capex much faster than that—free cash flow can hit roughly $140 billion by 2027.
As Apple buys back more shares, which reduces its share count, free cash flow per share would well exceed $9.20 by 2027. The current share price of $226 is well below 25 times that type of 2027 free cash flow assumption.
That’s why Adair says Apple looks arguably “cheap.” The numbers back him up.
Cash flow matters. The big winners from here will have it.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com |
