【will command hooks work on textured walls】Apple Is a Mega-Cap Stock That You Should Consider Now

- By Ben Reynolds

Thewill command hooks work on textured wallsre are only a handful of companies that see their market capitalizations grow beyond $200 billion at any one time. There are usually only 25 to 30 such companies in the U.S. These companies are able to grow to this size because they tend to have very recognizable brands and products. To get to this size companies have to appeal to a wide range of investors, which helps drive up their share prices and market caps.

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AAPL 15-Year Financial Data

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One of our favorite mega cap companies is Apple (

AAPL

). On Aug. 2, Apple became the first publicly traded company in the U.S. to reach a $1 trillion valuation. Shares of the company are now 33% off of their all-time high. Is there more pain to follow or is this a good buying opportunity for investors?

Company background and recent news

Apple designs, manufactures and sells technology products such as smartphones and computers while also offering services such as music, apps and subscriptions. The company was founded in 1976 and makes its headquarters in Cupertino, California. While the stock no longer has a trillion-dollar valuation, the current market cap of $741 billion is still quite large. Only Microsoft (MSFT) has a larger valuation at the moment.

Apple released financial results for the fourth quarter of fiscal 2018 on Nov. 1. The company's earnings per share, or EPS, for the quarter were $2.91. This was a 41% increase versus the same quarter last year and 13 cents above the average analysts' estimate. Revenues grew almost 20% to $62.9 billion. They were $1.44 billion above what the market was expecting.

Sales were strong around the globe. The U.S., China and Europe, Apple's three largest markets, all had mid to high-double digit revenue growth. The company saw its sales in Japan increase 34%. Apple is truly a global company, with more than 60% of revenues coming from outside the U.S.

iPhones, which accounted for almost 60% of total revenues, saw a unit increase of just 0.5% from the fourth quarter of 2017. Apple shipped 46.9 million units, a half million below what the market had expected. While this level of growth is concerning given the phone's importance to the company, investors should note that revenues increased 29% for this product. The average selling price per iPhone was higher by 27% year-over-year. While Apple may have seen just a slight rise in the number of units that it sold, the company was able to charge a much higher price per phone.

Story continues

Apple has had a long-running feud with Qualcomm (QCOM) over the royalties for that company's technology in its iPhones. A Chinese court ruled in favor of Qualcomm and banned several iPhone models from being imported and sold within the country. On Dec. 20, a German court found that Apple infringed on Qualcomm's hardware patent and that iPhones could no longer be sold in that country. Apple is appealing both decisions, so this dispute with Qualcomm could linger for a while.

Apple's other businesses had a mixed quarter. Services revenue, which includes Apple Music, the App Store, Apple Pay and many others, improved 27% to $10 billion. Products in this category often charge monthly fees, generating a large source of reoccurring revenue for Apple. On the other hand, Mac units were down 6% and revenues 15%. iPad units declined 6% while sales dropped 15%. The company lowered prices to try to steam the drop in volumes. Macs and iPads accounted for just 18% of total revenues.

As stated, iPhones, and to a lesser extent Services, continue to drive Apple forward. On the day of the release, shares of Apple dropped more than 7%. Why the decline? Soft guidance from management for the first quarter of fiscal 2019 is the answer. This quarter covers the holiday season and is often Apple's best quarter. The company guided towards a midpoint for revenue of $91 billion, almost $2 billion below analysts' expectations. If Apple delivers on its revenue guidance, this would be a 3% increase from the previous year. Gross margins of 38.3% were also below consensus.

While the most recent quarter saw very little iPhone growth and the company's quarterly guidance for its most important quarter was below what investors were expecting, all is not lost for shareholders of Apple.

Dividend history, valuation and total expected return

Besides high average selling prices for its iPhones and strong growth from Services, Apple is a very shareholder-friendly company. The company had a net cash position of $153 billion at the end of fiscal 2017. It used $30 billion of this net cash on share purchases and dividends. In fact, now that companies can access their overseas cash without paying taxes on it, Apple spent $73 billion on buybacks during fiscal 2018. This resulted in a 6% lower average share count in the fourth quarter of this year than the fourth quarter of 2017. This wasn't some small level buyback.

Apple also spent $13.7 billion on dividends, giving the company a total capital return to shareholders of almost $87 billion in the most recent fiscal year. Even after all of that, Apple still has a net cash position of $123 billion at the conclusion of fiscal 2018. This gives the company a lot of cash to spend on its business, make acquisitions, buy back shares or increase its dividend.

Speaking of which, Apple is a very young dividend-paying company, having only increased its dividend for the past seven years. While this streak doesn't compare to some of the more well-known dividend growers like Johnson & Johnson (JNJ) or Coca-Cola (KO), the company has offered fairly high levels of dividend growth. The company has increased its dividend:

By an average of 10.1% per year over the past three years.

By an average of 26.6% per year over the past five years.

Apple last increased its dividend for the payment made this past May by 15.9%. This was the largest increase in some time. Shares yield 1.9%, slightly below that of the S&P 500's yield of 2.1%. Apple has had an average yield of 2% over the past five years, so the current yield isn't too far off of the historical average.

Using the annualized dividend of $2.92 and expected earnings per share of $13.79, Apple has a payout ratio of just 21.1%. The company's payout ratio since the company instituted its dividend is 22.8%. The payout range has been primarily between approximately 21% to 29% during this time. The current payout ratio is near the low end of Apple's range. This means the company could offer near double-digit dividend growth going forward, and the payout ratio would remain within the company's long-term range.

Apple closed Friday at $156.38. Using expected earnings per share for the year of $13.79, the stock trades with a price-earnings ratio of 11.3. The S&P 500 has a price-earnings ratio of 19.1. Given the company's dominance in its industry and cash on its balance sheet, we forecast that Apple could achieve a price-earnings target of 15.5 by 2023. If shares of Apple were to reach our target, this would add 6.5% to annual returns for shareholders over the next five years.

We estimate that Apple can offer investors a total annual return of 16.4% through 2023. We arrive at this forecast due to our growth rate assumption of 8%, current yield of 1.9% and possible multiple expansion of 6.5%.

Conclusion

Apple saw strong year-over-year growth in iPhone and Services' revenues in the fourth quarter. While iPhone units shipped were below expectations and guidance for the upcoming quarter was poorly received, the company still offers much that should interest investors. High capital returns, solid dividend growth and a cash balance that is the envy of nearly every other company on earth should make the stock attractive. Apple's current valuation is below both our target price-earnings ratio and that of the S&P 500 as a whole. Given all of these factors, we feel that investors should ignore the short-term noise regarding short-term quarterly sales figures and purchase shares of Apple at a price well below its recent high.

Disclosure: I am not long any of the stocks mentioned in this article.

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Warning! GuruFocus has detected 3 Warning Sign with AAPL. Click here to check it out.

AAPL 15-Year Financial Data

The intrinsic value of AAPL

Peter Lynch Chart of AAPL

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