Apple Inc. (NASDAQ:AAPL) produced exceptional profits on January 27 for its first fiscal quarter (Q1) ending on December 27. It also showed that the company’s free cash flow (FCF) was very powerful. As FCF rises this year, AAPL stock is expected to continue rising.
Over the past two months, Apple stock has fallen 10.47% from a high of $182.01 on January 3 to $162.95 on March 9. This may not seem like much, especially in the correction the market has been experiencing lately. But AAPL stock fell further in Q4 2021 when it hit $139.20 on October 13. So in a way, it’s actually up 17% from its recent lows.
And why not? The company produced strong FCF results in the fourth quarter. Let’s look at this further.
Apple Free Cash Flow and Outlook
The company delivered exceptional revenue and earnings growth with revenue up 11% year-over-year (YOY) and net profit up 20.4% in the fourth quarter. But more importantly, the company’s FCF was also higher.
Apple generated $44.163 billion in free cash flow, which is the result of deducting $2.803 billion in capital expenditures from $46.966 billion in operating cash flow. Apple is one of the few companies that produces a quarterly cash flow statement, which is on page 3 of the financial statements, so it’s easy to calculate.
We can tell that this is a high level by comparing it to the company’s revenue level. So if we divide FCF’s $44.16 billion by its $123.9 billion in quarterly revenue, its FCF margin was 35.6%. This is an extremely high margin. It shows how incredibly profitable the company is right now.
Also, if we project this for the next year or two, we can derive a fair value for the AAPL stock. Let’s see how it works.
AAPL Stock Value Using FCF Analysis
For example, 40 analysts polled by Refinitiv have an average revenue forecast for 2022 of $395.79 billion. And for 2023, their estimate is $418 billion. This represents growth of 8.15% in 2022 compared to 2021 and growth of 5.6% in 2023. These are not particularly high growth rates. But the amount of FCF profit it generates from that revenue is huge.
For example, if we assume that 36% of revenue by 2023 will turn into free cash flow, that means it will generate $150 billion in FCF by 2023.
Then, assuming the market values it at a yield of 5% FCF, which is equivalent to using a multiple of 20 times FCF, Apple should have a market value of $3 trillion. It is the result of dividing $150 billion of FCF by 5% or, alternatively, multiplying $150 billion by 20.
Therefore, given that the existing market capitalization is $2.659 billion, this leaves a 12.8% upside in the stock. But again, this assumes that its FCF yield will only be 5%.
For example, assuming a 3% FCF return, the market value will be $5 trillion (i.e. $150 billion / 0.3). This represents an 88% upside potential for AAPL stock.
What to do with AAPL shares
Thus, AAPL stock is worth somewhere between 12.8% and 88% more than the current price, depending on the market value for its strong free cash flow. Just taking the midpoint puts it 50.4% higher.
To be completely accurate, we need to adjust for the time value of money since we used two-year earnings estimates. Assuming a 10% discount rate for each year, the present value of earnings would be 82.64% of this number. This reduces the rise to 82.64% from the rise of 50.4%, or 41.65% more.
Therefore, the stock is worth 1.4165x its March 9 price of $162.85 per share. This means that its value, using FCF analysis, is $230.82 per share.
Another way to look at it is this: if it takes two years for the stock to rise 41.65%, the average annual return will be 19% each year. As proof, take 1.1901 to the second power, and you get 1.4165.
Here is the bottom line. Apple’s free cash flow is so strong that it increases the stock’s valuation by almost 20% per year for the next two years. This despite the company’s expectations of slow sales growth.
As of the date of publication, Mark Hake did not hold (either directly or indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.