Ordinarily index investors needn't concern themselves with an individual stock's valuation. That is to say, if a stock looks cheap by price/earnings ratio (PE) and likely to go higher, or too expensive and therefore bound for a fall. But Apple (AAPL) accounts for huge chunk of some very popular ETFs and so we thought we'd give it greater scrutiny.
Even after rebalancing by the Nasdaq, Apple will still account for 12 percent of assets (down from 20 percent) of the PowerShares QQQ ETF (QQQ). Apple is also the largest holding of the iShares Dow Jones U.S. Technology Sector Fund ETF (IYW), accounting for about 14 percent of the fund's assets, according to the latest data. And at the Internet Architecture HOLDRs (IAH), Apple makes up 23 percent of the portfolio. Not that you would actually own the Internet Architecture HOLDRs.
Since Apple has so much sway in those ETFs, we thought we'd take a look at some relative valuations measures -- all of which suggest the stock is a bargain. (By the way, for you valuation geeks out there, we're not even subtracting the more $29 billion in cash Apple has on it books -- good for about $32 a share -- which would make all these numbers look even better.)
But here it is. On a trailing earnings basis (trailing PE), Apple is trading at a 44 percent discount to its own five-year average, according to data from Thomson Reuters. Apple also happens to be trading at a 22 percent discount to the S&P 500 by trailing PE. True, that doesn't mean the stock will go up, and, as Microsoft and Intel have proven, sometimes valuation comes down as a tech company grows. But on this basis, if you accept it, the stock is a bargain.
Now let's take a look at more unreliable forward PE measures, which are based on analysts' average earnings guesstimates. By forward PE, Apple offers a 48 percent discount to its own five-year average, according to Thomson Reuters data. It's also 24 percent "cheaper" than the S&P 500, the data say. Again, on this basis, if you accept it, the stock is a bargain.
Then there's the price/earnings-to-growth, or PEG, ratio, which measures how fast a stock is rising relative to its guesstimated growth prospects. By that measure, Apple's PEG of 0.5 offers a 58 percent discount to its own five-year average and a 68 percent discount to the broader market, according to Thomson Reuters data. Again, Apple looks like a bargain.
Apple's up nearly 40 percent in the last year and shares now go for about $335 a pop. So how can it look so cheap? Certainly concern over the health of Steve Jobs is weighing on what multiple investors are willing to pay for earnings per share, and then there are concerns about margin compression. We also happen to be in a period where earnings multiples tend to be lower -- or "compressed" in the language of the Street -- across the market.
Ultimately, it doesn't matter. If relative valuation matters and multiples revert to the mean like they're supposed to, this is good news for indexed tech investors. Based on relative valuation, Apple looks more likely to help rather than hurt their tech ETF holdings.