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Take A Bite Out of Apple?

While Apple has taken a bite out of investor,s with its share price down nearly 40% from just a few months ago, I could not be more bullish on the company.

The reason is three little words – “free cash flow”– a financial metric that at the end of the day is what really matters. It is the sum of net income plus changes in receivables, inventory, accounts payable and similar working capital accounts minus capital expenditures and debt service. It represents cash available for investors, whether for share buybacks, dividends or acquisitions of new businesses. It is the true measure of how well a company manages its overall operation. Virtually all growing companies consume vast amounts of capital as they expand, whether for inventory, cash tied up in accounts receivables or in new factories and equipment.

Yet in Apple’s case they have developed a near perfect business model where the more they grow, the more free cash flow they generate. They do this by not owning factories, not owning inventory until a few days before it is sold and by collecting cash upfront on most sales. The result is a balance sheet totally devoid of debt and little invested in fixed assets, inventory and receivables and chock full of cash.

To put this into perspective, Apple’s last quarter had revenues of $54.5 billion, net income of $13.1 billion, and free cash flow of $21.1 billion (equal to an astounding 39% of revenue) and exited the quarter with over $137 billion in cash and investments. On a per share basis Apple has nearly $150 in cash which is over a third of its share price.

Another good metric to consider is the price earnings ratio which for Apple is just under 10 compared with the overall market of around 17. A low price earnings multiple is normally associated with low growth companies such as utilities,  and in fact Apple’s P/E ratio is actually lower than the Dow utility index. Thus, by this measure it is undervalued relative to the market.

Lastly for dividend investors, Apple’s dividend yield is now around 2.5%, which is well above the interest rate on US Government 10 year bonds. I would bet over the next 10 years that Apple has a better chance of enhancing your portfolio than US Government debt!

For the record, I own Apple and am buying more at these levels. Investors should consult their advisors and no one stock should represent more than 10% of your portfolio, but in my opinion now is the time to act since Apple hasn’t been this low since more than a year ago.

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