Why do analysts think Apple's stock price is going much higher?

Tweet

Investments: Episode 18

Apple's stock price seems to defy gravity and yet many analysts seem to think it is going much higher. My friend Nicolas Ward (aka @UltraNurd) asked via Twitter: "@Investments What do you think of some the analysts very high price targets for AAPL? How do they come up with such numbers?"

A quick look Apple's stock (symbol AAPL) on FinViz shows most analysts have targets well in the $300+ range with strong buy or overweight/outperform recommendations. With the stock closing at a price of $287 per share yesterday these targets suggest that Apple will have another double digit growth year in 2011.

Context

Whether a stock's price is considered a bargain or overpriced has less to do with its dollar per share price but rather its price per share compared to its earnings per share (EPS). The price to earnings ratio (or P/E) is a common measure used to assess a stock's relative price.

P/E ratios can be used in two ways:

1. As a comparison against its competitors. As an example: Apple is currently has a P/E of 21.5 while Google is priced at 22.75 and Microsoft is priced at 11.6. The technology sector as has an average P/E of 17.4. So, AAPL is cheaper than GOOG but much more expensive than MSFT and industry as a whole.
2. P/E's can also be used to assess whether a company is getting more or less expensive over time. Apple's P/E ratio at the end of its 2008 fiscal year was 17.7 compared to today's 21.5. Apple is getting more expensive.

Some Math for Price Targets

If you click the link below you can open the quick and dirty spreadsheet I pulled together for the show. Here's how the math works:

• Basically what I did was look Apple's earnings for the first three quarters of fiscal year 2010 and assumed they would report a similar number in the fourth quarter. That gave me an estimated EPS of $13.38 for 2010. This would be a 45% increase over 2009's EPS.
• I then assumed that Apple would grow earning in 2011 by 40% and that its P/E ratio would stay at 21.5. Some simple math later, $13.38 X 1.40 X 21.5 = $402.59. This is much higher than most of the analysts' targets.
• If assumed that Apple's P/E would come down to the industry average of 17.4 I got $325.82 per share. Math: $13.38 X 1.40 X 17.4 = $325.82
• Note: It's kind of funny that $13.38 X 21.5 = $287.56 which is VERY close to yesterday's (9/29/10) closing price of $287.37 for AAPL.