Apple’s (NASDAQ:AAPL) stock price has hit another bottom, reaching a 2022 low point with a cumulative year-to-date loss of nearly 20%. Many investors seem worried about Apple’s prospects as risk-aversion is dominating the stock market. However, I’d argue that Apple is well placed to recover over the coming year; here’s why.
Starting off with a hybrid top-to-bottom approach, it’s evident that electronic goods sales have stalled as real economic growth has stagnated. Everyone knows inflation’s effect on the stock market by now as it’s been the central talking point since late last year. I think it’s necessary to understand that economic growth won’t necessarily resurface when inflation cools down. This is because policymakers can only try to curb inflation by suppressing borrowing capacity with higher interest rates, thus suppressing the marginal utility of the average consumer (if said consumer is borrowing significant amounts of money, that is).
However, Apple’s powerful market position with a gross margin of 43.32% allows the company to weather the storm during these trying times. Companies with economies of scale, such as Apple, can easily leverage their pricing and bargaining power to stimulate demand, even during periods of high inflation.
Source: St. Louis FeD
Apple’s financial statements paint a positive picture as well. The company’s fourth-quarter sales have increased year-over-year in most of its regions, with Asia-Pacific and Japan being exceptions. Additionally, Apple’s iPhone, Mac and services revenue all grew year-over-year to accumulate total revenue of $97.28 billion.
Many investors might be concerned about global supply chain issues. However, Apple possesses enough supply chain strength to cope with these matters, in my view. Morgan Stanley (NYSE:MS) analyst Katy Huberty explained this in a recent note. According to Hubert, “The decline in D&A as a percentage of revenue has led to an average of 125 bps of gross margin tailwinds over the past four quarters, which we believe is structural in nature given Apple’s efforts to accelerate the in-sourcing of key components such as processors, sensors, displays, batteries, and cameras.”
Doing an absolute valuation on Apple stock isn’t a simple task, as it requires one to regress its financial statements and consider the value of the company’s future acquisitions.
Nonetheless, a simple relative valuation provides a clear picture of the stock’s prospects. I prefer using the PEG ratio for Apple stock as much of its performance is linked to its earnings per share growth.
Apple’s PEG ratio of 0.66 shows that stock market participants have underappreciated the stock’s historical earnings per share growth, leaving a lucrative value gap to take advantage of. Additionally, Apple’s return on common equity of 149% for the trailing 12 months exceeds the stock’s five-year dividend growth of 8.75%, indicating that its justified value is intact according to the following formula:
Justified price-book ratio = (return on equity – growth) / (cost of equity – growth rate)
The bottom line
Apple has undeniably performed poorly this year. Yet, matters could be set to change as the stock market finds calm. I believe that investors will act more rationally moving forward, meaning that Apple could be one of my top picks as it’s an undervalued asset.
This article first appeared on GuruFocus.