If you are looking to build a better value trap, it might be hard to beat Apple.
Arguably the world’s most admired company has a price-to-earnings ratio—after Tuesday’s earnings announcement—of 10. That’s lower than the average P/E ratio of the stocks in the S&P 500, which is 19. It’s lower than the 22 P/E ratio of Fastenal, which makes actual nuts and bolts. It’s also lower than the company that sells those nuts and bolts, Home Depot, which has a P/E ratio of 23. It’s also cheaper than supermarket chain Kroger, which has a P/E of 23 and sells actual apples.
And Apple’s (AAPL) P/E ratio includes its cash. If you exclude that, which is something analysts do, Apple’s P/E, even after factoring in taxes, would drop to around 7.
Indeed, there are a lot of reasons to think that Apple’s stock is cheap. Its earnings have increased by nearly 20% in the past year, although that slowed dramatically in the fourth quarter. And the company has very high profit margins, something that typically yields a high P/E. On top of that, it has 1 billion users that buy songs and movies and games and other applications through the company’s iPhones, iPads, and other devices.
A low P/E ratio is supposed to signify to investors that you are getting a good investment, as it measures how much in earnings a given company is producing for every dollar you are investing in that company. For Apple, that’s a little over $0.14 a year per every dollar invested. By comparison, for the S&P 500 overall, that figure is $0.06.
But in the past, buying a low price tech stock of a company that has seemingly reached the apex of its business prowess is not a surefire win. For instance, IBM (IBM) had a P/E ratio of 11 in 1984, when the company dominated the personal computing business. That year, the company’s earnings rose 19%, its third year of double digit growth. However, shares of IBM went nowhere over the next two years. During the same period, the S&P 500 rose nearly 45%. Over the next five years, IBM’s shares fell 23%. Meanwhile, the stock market rose a little over 111%.
The same thing happened with Microsoft (MSFT). Shares of the ubiquitous software maker were trading at a P/E of 18 in early 2004, which was cheap particularly for a tech stock. In some quarters, earnings at Microsoft were growing by as much as 80%. It actually wasn’t a good time to buy. Microsoft’s shares went on to drop 26% over the next five years.
Then there’s Fannie Mae (FNMA). Not a technology stock, but it too dominated its business of mortgage insurance and was often referred to as a value stock. At the start of 2004, its shares traded at a P/E of just 10. Five years later, the housing bubble burst, the financial crisis was raging, and Fannie’s stock was down 99%.
None of this means Apple’s shares aren’t a buy right now. But it’s a reminder that Mr. Market often gets wind of problems before they arise. Those 1 billion users should be a source of massive recurring revenue for Apple, sort of like how a razor maker continues to bring in money off of blade sales. But Apple is still dependent on selling more iPhones, which generates 70% of its revenue. Years after the first iPhone came out, that could be a problem, just ask Mr. Market.