Apple Stock Is Almost $550. But Is It Actually Underpriced?

Apple Stock Is Almost $550. But Is It Actually Underpriced?

Apple reached a huge milestone this week: On Wednesday, the company's value reached $500 billion, a lofty height that only five other companies have ever reached.

This staggering figure means it is now worth more than the GDPs of countries such as Poland, Belgium, Sweden, Saudi Arabia or Taiwan. It's even impressive enough to spawn its own blog, "Things Apple Is Worth More Than," which includes mind-boggling items such as the global coffee industry.

What pushed the company up into this lofty echelon is its stock price, which has been on a tear recently, going from $400 to $500 in just 34 days.

But a number of analysts are saying that the stock, which is pushing $550 (and a year ago was only about $350), is actually underpriced.

Underpriced? How is that possible for the world's most valuable company?

And how do people determine whether a stock is appropriately priced in the first place?

Why People Buy Stocks

In order to answer that question, let's think first about people's motivation for buying stocks. (We at LearnVest actually don't recommend you buy individual stocks; more on that below.) Many people think of stocks as vehicles to grow your money. The way you are doing this is by buying a piece of the company.

Let's say your friend calls you up and says, "My gelato shop is doing great. Do you want to invest in it for a cut of the future profits?" To decide, ask yourself whether you think the gelato shop's profits will continue to grow. Or, more to the point, if you give her $1,000, will you get more than $1,000 back over the next year or several years?

And that is the same question that people try to answer when they evaluate stocks. Let's take a closer look at Apple stock to learn how people traditionally make that call.

Price-Earnings Ratio

One way people figure this out is by looking at a factor called "price-to-earnings ratio," often notated as "P/E." What this number tells people is, "How does the price of this stock compare to its performance?" (In this case, "performance" specifically means profits per share.) A relatively low P/E is good because it means the stock price is low compared to how high its profits per share are.

You can find P/E ratios for any company by looking them up on Yahoo! Finance. (This page for Apple contains two P/E figures, the one labeled "ttm" or "trailing 12 months" is for the P/E for the last year; the forward P/E is what is projected for the upcoming year.)

So, how does Apple compare? For the last year, the companies in the S&P 500 averaged a P/E of 14. But this coming year, Apple is expected to have a P/E of 11.45, which means it's a better deal than the average S&P 500 stock: For the coming year, Apple could end up even being "cheaper" than this projected P/E since the company has a track record of making even more in profits than expected. Also, its earnings are growing at a breakneck speed, and much faster than other companies'.

Dividends

Another factor people look at when considering buying a stock is whether it gives dividends, which are sums of money paid to investors out of a company's profits, usually on a quarterly basis. Apple does not currently pay out dividends, but Apple's current CEO Tim Cook, has hinted that it might start doing so, which means that people who own the stock will be making even more money off it. (You can learn more about dividends and cash flow here.)

Cash

Another good indicator of a company's overall health is how much cash it has on hand. If a company has a lot, that means it is not deep in debt. Apple has a ridiculous amount of cash, more than the United States even!

Long-Term Growth

The P/E ratio only considers the next year, which, in Apple's case, would include the projections that new products like the iPad 3, the iPhone 5 and Apple TV will be hitting the market.

But many investors hold stocks for much longer than that. So they ask themselves how Apple will do in the next three, five or ten years. Those who say Apple stock is a good buy point to the potential for huge long-term growth in the Chinese market. But maybe you are worried that without founder Steve Jobs, Apple no longer has that secret sauce. It's hard to say, of course, but it's all worth considering.

So Should You Buy?

According to all these factors, Apple would look like a good bet. Wait, wait! Get back here, we aren't done talking.

It's important to remember that all of these indicators are speculative. Unlike looking at the terms of a mortgage or your salary, stock prices are subject to many factors that we don't have the space to cover here.

What if Apple is hit with a scandal? What if they make a really dumb move (like Netflix did)? What if a startup that doesn't even exist now comes out with an amazing product and eats Apple's lunch? What if a natural disaster strikes, disrupting their manufacturing and supply chain? There are a lot of what ifs out there.

For all these reasons, we say again, don't buy individual stocks. Instead, if want a piece of the Apple pie, LearnVest recommends that you buy mutual funds and ETFs that contain Apple stock as one piece of their portfolio. That way you aren't betting the whole house on the fortunes of one company, no matter how pretty their products are.

More From LearnVest on Investing

What's your investing IQ? Test it with our quiz.
One stock we don't recommend you buy? Facebook. Here's why.
Your friends can hurt your finances. Find out why.

Image credit: rpongsaj/Flickr

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