For technology investors, this is the time of year when emotions distort rationality.
The recent surge in the Nasdaq 100 Index NDX, +0.06% is compounding that effect, but we need to be responsible in our risk assessments when it comes to valuation.
Recently, shares of Apple AAPL, +0.65% have broken out and registered new highs. When the Nasdaq 100 NDX, +0.06% goes up, Apple tends to go up, and that’s a major influence. But there is also this week’s developer’s forum and the potential of a $1 trillion market cap inducing this recent push. Those factors aside, we need to be responsible.
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First, is the increase warranted?
Our fundamental focus is on earnings growth, as that relates to valuation, but we also couple those findings with technical observations to draw conclusions. In the charts below, we show the trailing 12-month (TTM) earnings growth trend for Apple.
The yearly growth rate chart shows an increase of over 18% this year. Next year, however, earnings growth is expected to slow to 11%, and that is where concerns exist.
However, when we look at the price-to-earnings (P/E) multiple, we see that the current 18.5 P/E, based on our TTM observation, declines to about 15 next year if earnings roll in according to current expectations. In other words, the P/E multiple will fall naturally if price remains the same and earnings come in as expected.
This gives us the ammunition we need to conduct a fair-value analysis.
The current P/E multiple of 18.5 means Apple is currently fairly valued. Next year the valuation increases, but only marginally — the P/E can decline to 15, as outlined above, and if that happens it will compare with a growth rate of 11%.
The lower comparison between the P/E multiple and earnings growth can be seen in our TTM (price-to-earnings-to-growth) PEG chart below. There, we can see that Apple gets more expensive on a fundamental basis next year, but currently that is not the case.
In fact, Apple is pressing higher, and it appears to be heading toward longer-term resistance levels. These data can be used to produce trading plans. We have provided those on our website.
In conclusion, Apple will get more expensive next year, but it is not expensive now.
Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily.