Apple Stock Back at $500: Buy, Sell, or Hold?

Apple stock is at $500... again. Though it's a nice 28% return for investors who bought at $390 in April, it's still down 28% from the stock's all-time high of $705 in 2012. Is there hope for Apple to recover to $700? Is the stock a buy at $500?

It's been an emotional ride for Apple's stock lately. The underlying business has also been fluctuating. The company's gross profit margin hit an all-time high and then proceeded on a downward trend. Even worse, revenue growth rates decelerated quickly and earnings-per-share comparisons have actually dipped into the negatives.

AAPL Gross Profit Margin Quarterly Chart

AAPL gross profit margin quarterly data by YCharts.

These developments have left investors concerned, and rightly so. But has Wall Street overreacted? The stock is trading at just 12.5 times earnings, suggesting investors expect very little (if any) growth in Apple's EPS over the long haul. Even more, with a generous share repurchase program in place to help boost EPS, a 12.5 price-to-earnings ratio for Apple stock is especially conservative.

10,000-foot view
At a 10,000-foot view, however, the underlying business still looks like a cash cow poised to reward long-term investors.

Sure, year-over-year EPS comparisons have dipped into negative territory in the past three quarters. But this isn't due to declining demand for Apple's products. Instead, it's based on insanely tough gross profit margin comparisons. And, more importantly, there's no indication that its gross margin will continue to contract.

Demand for Apple's products is actually still climbing. Apple's iPhone business (51% of revenue) looks as healthy as ever. Trailing-12-month iPhone revenue is up 20%. On average, analysts expect Apple's fiscal 2014 revenue to actually exceed its 2013 revenue by more than $11 billion.

And Apple's having no problem generating cash. It managed to convert $0.25 of every dollar of revenue in the trailing 12 months into free cash flow. Paying out just 27% of earnings in dividends, the company has plenty of room to boost its dividend going forward. I've even argued that Apple is one of the best dividend stocks available for income investors (though Apple was trading at just $450 when I made that argument).

At a 10,000-foot view, the underlying business looks healthy.

Though Mr. Market sends shares all over the place in the short term, the value of every business is ultimately equal to the sum of its future cash flows discounted to present value over the long haul. So what's Apple worth?

From my perspective, Apple's business is still doing just fine, and it's reasonable to assume (with the help of the company's generous share repurchase program) that the company can grow EPS at a very slow rate going forward, say 3% -- in line with the historical rate of inflation. Assuming 3% annual growth over the long haul, a discounted cash flow valuation (based on a 10% discount rate and excluding the value of Apple's dividend cash flows) suggests the fair value of Apple's shares is $618.

A 19% margin of safety to a conservative fair value estimate isn't typically enough to get me excited. But in the valuation I didn't consider the company's dividend, which currently yields investors about a 2.5% return. Even more, Apple has already showed it is willing to increase this payout with a 15% boost on the dividend's anniversary. That said, a 19% margin of safety plus a 2.5% yield of bonus cash deposits into my brokerage account makes for a pretty convincing case for ownership in an industry leader.

I'd say Apple is still a buy at $500.

What's next for Apple?
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Fool contributor Daniel Sparks owns shares of Apple. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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