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Apple Needs More Than Dr Dre to Cure Chronic P/E Discount

Apple CEO Tim Cook
Apple Inc. Chief Executive Officer Tim Cook speaks during the Apple World Wide Developers Conference in San Francisco, on June 2, 2014. The competition between Apple and Google is as fierce as ever in the smartphone space. Photographer: David Paul Morris/Bloomberg

Growing up in the 1970s, you couldn’t show your face on the playground unless you had a well-reasoned opinion on the most divisive topic of the era: the Beatles versus the Rolling Stones.

These days, the main topic of debate has shifted to the type of device used to play the music: iPhone versus Android. As the headlines coming out of Apple’s developers’ conference show, the competition between Apple and Google is as fierce as ever in the smartphone space.

Surely both are dominant companies with tons of cash and there’s no reason they can’t coexist peacefully in a portfolio in the same way “Exile on Main Street” and “Let It Be” shared space on countless record racks. Yet we all need something to argue about on the playground, so this seems like a perfect time to size up the two stocks.

Start with the Lonely Hearts Club Band-sized horde of analysts who cover Apple. The stock is rated the equivalent of buy at 43 firms, with 17 holds and 4 sells. On a scale rating a buy as a 5 and a sell as a 1, that gives Apple a score of 4.19, according to data compiled by Bloomberg. The average share-price target of $649.89 implies a 3.4 percent advance from yesterday’s close.

Google is more highly rated by analysts, with a score of 4.46 based on 39 buys, 13 holds and zero sells. Its average price estimate is $659.47, implying a 17 percent rally in 12 months.

Discount Fading

Apple’s shares gained 12 percent this year through yesterday to tighten the gap with the average price estimate, so more analysts may raise their target the way Chris Caso at Susquehanna Financial Group boosted his to $725 today.

While the big news from Apple will likely be the introduction of a smartwatch and iPhone 6 later this year, Caso said the software upgrades announced yesterday should “strengthen the AAPL ecosystem” by allowing closer interaction between iPhones and Mac computers.

Caso’s $725 price target represents a multiple of 15 times his 2015 fiscal year earnings estimate, near the upper end of the company’s valuation. Apple has traded at a discount to the S&P 500 for almost two years, both on reported and projected profit basis. Its rally this year has closed the gap and it’s now only 14 percent cheaper than the S&P 500 on a reported-earnings basis, the smallest discount since 2012.

Google Estimates

Google, on the other hand, trades at 30 times reported profit and 20 times forecast earnings over the next 12 months, which are premiums of 69 percent and 23 percent, respectfully, to the S&P 500. The discrepancies make sense when you consider that Google is forecast to increase adjusted earnings by an average of 19 percent from 2014 to 2016, more than double Apple’s rate.

That average price target of $649.89 for Apple implies a P/E of 14.7 based on fiscal 2014 earnings estimates and 13.6 based projections for 2015. So despite the excitement over Apple’s purchase of Dr. Dre’s Beats Electronics LLC and the potential launch of the iWatch, there is not a lot of faith that Apple shares will rise enough to trade at a growth-stock valuation like Google’s.

What really excites people about Apple is the potential uses for its $151 billion in cash and equivalents. Its decision to return more money to shareholders and buy Beats for $3 billion explains why the stock is up 20 percent through yesterday since April 23. Future decisions about that cash horde may be the key to determining whether it’s ever valued as a growth stock again.

It’s like Dr. Dre once rapped: “Get your money right. Go inside the safe, grab your stash that you copped tonight.”

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