Fathers often give their kids advice. But every once in a while they pass on a nugget of truth that can be life changing. For me, that happened just after high school.
As I was getting ready to go off to college, my dad told me not to confuse excellence with perfection. He told me that excellence is within reach if you’re willing to put in a full day’s work. On the other hand, perfection lives outside the reach of mortal man.
Now, I’d like to say that I took his advice to heart. But like most teenagers, I didn’t immediately grasp the significance of what he said.
It wasn’t until a decade later that I fully understood what my dad was telling me. It’s a life lesson I’ve never forgotten. More importantly, it’s a lesson I’ve consciously tried to apply to every area of my life – including investing.
You see, perfection isn’t required to be a successful investor. Most investors can grow their money simply by not making too many mistakes. For at the end of the day, it’s our mistakes that drawdown our capital.
So, it’s important to find a strategy that fits an investors risk tolerance while limiting the mistakes.
Now, there are many investment strategies available to the average investor. But one of the most well-known strategies is the one developed by Warren Buffet’s mentor, Benjamin Graham.
Value investing has proven itself for nearly a century. As well it should. The basic premise is to buy a great company at a good price and hold the stock for as long as the basic investment thesis remains intact.
Of course, this means it’s a long term strategy and wholly unfit for anyone looking to trade their way to riches. Rather, this strategy works very well with a time horizon of a decade or more.
So, if you’re an investor with a medium to long term time horizon, reach for excellence by avoiding the mistake of not buying shares of Apple, Corp (NADSAQ: AAPL).
Apple shares have been trading within a relatively narrow band for the better part a year now. This has spooked some investors into thinking that Apple’s best days are behind it.
Nothing could be further from the truth.
Apple has a strong track record of innovation. And despite recent claims to the contrary, Apple is still an innovator today.
Now, it’s true the company generates more than 60% of its revenues from its iPhone segment. It’s also true that the smartphone industry is becoming mature with future growth rates in the single digits for the first time.
But to assume this means Apple’s growth prospects will follow the overall trend is absurd. According to IDC data, Apple’s market share of the smartphone industry is a mere 16%.
That is already starting to change…
You see, 3Q2015 saw Apple report a 30% increase in Android users switching to iPhones. This was the highest rate of switching ever recorded. And it’s likely to be a precursor to early 2016 when Apple is expected to unveil a long awaited iPhone with a smaller 4-inch screen.
Combined with its other innovative products, Apple is well situated to continue the market dominance that has made it the most valuable company on earth at nearly $650 billion.
Is Apple a Value Play?
Now, possessing an innovative product lineup and the world’s largest market cap doesn’t make the company a value play. So let’s examine the stock much the way Ben Graham would…
At its current price around $116, Apple is trading at just 12.5 times earnings on a trailing basis and just 10.7 on a forward basis. The 12.5 P/E represents a whopping 42% discount to the S&P 500 average of 21.57.
Even so, a low P/E also doesn’t prove a stock is undervalued. So let’s apply some other financial metrics to shed some light.
Calculating a stock’s intrinsic value is a great tool for determining whether a stock is properly valued. And while there are differing methodologies in making the calculations, I prefer two widely accepted methods.
The first is to calculate intrinsic value using normalized earnings. Normalized earnings are a company’s earnings adjusted for cyclical changes over time. This helps even out years in which earnings were significantly higher or lower due to unusual activity.
Normalizing Apple’s earnings gives us an intrinsic stock value of $270.80 a share. Now, by just about any definition, a stock trading at a discount of 57% to its intrinsic value on a normalized basis qualifies as a value stock.
On an unadjusted basis, Apple’s intrinsic value is $223.40. While not as impressive as the normalized value, this still represents a 48% discount to intrinsic value. Clearly, the market is undervaluing Apple shares.
Still not convinced it’s a mistake to overlook Apple?
Let’s examine the company’s expected earnings growth. Analysts expect the company to grow its earnings at more than 15.3% for the next five years.
This translates to a stock price of $251.25 by 2020 – a 116% gain from its current price. And this assumes no change in the company’s price-earnings ratio. If the stock were to be priced at its 10-year average P/E of 18.3, the stock would be priced at nearly $370.
Now, we certainly can’t predict a P/E ratio five years out. But if excellence is defined by limiting mistakes, buying Apple shares now will make you an excellent investor over the long term – and cement my dad’s legacy as a wise man.