Why Apple is Under-Valued

Apple (NASDAQ: AAPL) is the second most highly valued company in the country -- behind ExxonMobil (NYSE: XOM). But it still has further to rise.

If Apple stock goes up another 12% and ExxonMobil's value remained unchanged, Apple could surpass the oil giant in market value.

What's great about Apple is what makes its stock scary for some -- Steve Jobs. After all, he is responsible for inventing the iPod, iTunes, iPhone, and iPad that have propelled Apple's phenomenal growth. But he is not in great physical shape and it's hard to imagine another human being who could replace him.

The question for investors is how long Apple could stay on an earnings roll if Jobs was no longer involved with Apple. Here are four reasons to consider the stock:

• Great earnings report. Apple  posted strong Q2 earnings driven by strong iPhone 4 and iPad 2 sales with revenue of $28.6 billion -- 13% above analysts' estimates -- and pro-forma EPS of $7.79 -- beating analysts' expectations by 36%. This was due to better than expected sales of iPhones (20.3 million units vs. Canaccord Genuity Technology's 16.8 million estimate) and iPads (9.3 million vs. 7.9 million estimate).
• Cheap stock. Apple's price to earnings to growth ratio of 0.89 (where a PEG of 1.0 is considered fairly priced) means its stock price is cheap. Apple has a P/E of 15.4 and is expected to grow 17.4% to $31.69 in 2012. And that growth forecast is much slower than 2011 forecast of 78% growth -- so odds are good that Apple stock is a bargain.Out-earned its capital cost. Apple is earning more than its cost of capital – and it’s improving at a phenomenally high rate. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half 2011, Apple’s EVA momentum was 17%, based on first nine months' 2010 annualized revenue of $59.8 billion, and EVA that improved from $7.3 billion annualizing the first nine months of 2010 to $17.4 billion annualizing the first nine months of 2011, using a 10% weighted average cost of capital.
• Rapid growth with pristine balance sheet. Apple has been growing fast with high profit margins. Its $65 billion in revenues have climbed at an average rate of 35.6% over the last five years and its net income of $14 billion has gone up at an even faster average rate of 62.7% over the period -- representing a 22% net margin. It has no debt and its cash grew at a 26% annual rate from $10.1 billion (2006) to $25.6 billion (2010).

This stock has further to rise -- but unless there is someone better than Steve Jobs out there to continue innovating Apple's way to success, the stock is going to top out. The problem is figuring out when that might happen and setting a stop loss so you can get out fast if you need to.