New Purchase: Apple

Following up on last week’s article, here’s my last purchase for my children’s future tuition fee portfolio. In January, I invested $10,775 in four companies:

3M Co (MMM)

Emera (EMA.TO)

Royal Bank (RY.TO)

Apple (AAPL)

Yup, I couldn’t resist buying more AAPL in yet another account!

I purchased 12 shares of Apple (AAPL)

source: ycharts

AAPL already represents 13% of the holdings in my RRSP account. I thought long and hard about it before adding another position in the RESP account. However, when I imagine where Apple could be 10 years from now, it appeared natural for me to buy some more for my kids. The stock has been beaten down by the street for about a year now leading to a good entry point.

Investment Thesis

AAPL is on my Dividend Stocks Rock Buy List for since April 2015. This is a very selective list of only 5 US and 5 Canadian dividend growth stocks. AAPL’s most recent financial update was quite positive but the market doesn’t see it this way. In addition to beating analysts’ estimates with record earnings, the company almost topped its 2015 record sales. To be honest, I don’t think you can ask Apple to sell more iPhone quarter after quarter. We are already at its 6th version of the world’s most useful smartphone. At one point, it is almost impossible to ask the company to sell more iphones month after month. Topping their last year’s results was already a great feat.

The company is already evolving to find other sources of revenue to stop being “the iPhone company”. Apple TV, iWatch, Apple Music and Apple Pay are their most recent innovations. The company continues to offer a great product ecosystem and add more products that could connect to each other. This perfect ecosystem continues to attract more customer aways from Androids to connect with Apple products.

The company now offers a 2% dividend yield with a very low payout ratio of 21.83%. You can expect another dividend increase this year as earnings keep growing. Management will look to reward shareholders through stock repurchases and dividend increases as has been restated in their 2016 financial update as mentioned by Luca Maestri, Apple CFO:

“We generated operating cash flow of $27.5 billion during the quarter, and returned over $9 billion to investors through share repurchases and dividends. We have now completed $153 billion of our $200 billion capital return program.”

Risk

When you look at any “techno stock”, there is always a great risk. What is a premium product (the iPhone) today could become the next joke amongst geeks in the span of 12 months. It happened to BlackBerry (BBRY) and it could happen to Apple at anytime.

The company decided to keep its premium pricing policy for all their products. While this drives earnings and margins to interesting levels, this could eventually be a brake to the iPhone sales progression. We already see that customers are becoming reluctant to pay a premium for iPads and iPods as their sales keeps dropping.

Finally, Apple also faces many competitors with large means and great distribution networks. Samsung and LG are both working against Apple to sell cheaper smartphones in order to gain market share. So far, Apple has been able to maintain its leadership position, but it doesn’t mean they will be able to keep it up forever.

Valuation

One strong reason to buy AAPL right now is that it has rarely been trading at such a low multiple over the past 10 years:

source: ycharts

Last time it traded at such a low PE ratio it was when I first entered a position in this stock. This gave me a juicy 67% return (excluding dividends) in the span of less than 3 years. I believe the company has a strong growth potential and the market could easily value AAPL at a 15 PE ratio when Mr. Market will be in a more optimistic mood.

Using the dividend discount model, I still get an undervalued company stock price. Using a dividend growth rate of 10% for the first 10 years and a reduced growth rate of 8% for the years after, I get a fair value at $143.80:

Input Descriptions for 15-Cell Matrix	INPUTS
Enter Recent Annual Dividend Payment:	$2.08
Enter Expected Dividend Growth Rate Years 1-10:	10.00%
Enter Expected Terminal Dividend Growth Rate:	7.00%
Enter Discount Rate:	9.00%

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
	Discount Rate (Horizontal)
Margin of Safety	8.00%	9.00%	10.00%
20% Premium	$348.51	$172.56	$113.98
10% Premium	$319.47	$158.18	$104.49
Intrinsic Value	$290.43	$143.80	$94.99
10% Discount	$261.38	$129.42	$85.49
20% Discount	$232.34	$115.04	$75.99

Source: Dividend Monk Calculation Spreadsheet

I’m fairly confident the company will reach this level in the upcoming 12-18 months. This is definitely the right time to get some more shares of AAPL and this is why I added it to my kid’s tuition fund.

What do you think? do you think that AAPL is too risky for my children’s fund?

Google+