Buffett Sold Berkshire Hathaway's Apple Stock Too Early - It Still Looks Cheap Here

Apple Inc (AAPL) stock has been treading water higher than where Berkshire Hathaway sold half its position in Q2. No wonder since Apple is still cheap here based on its strong FCF. Sell short OTM puts to play this.

AAPL is trading at $226.18 in midday trading on Monday, Aug. 26. It's been roughly flat for the past month after peaking at $234.82 in mid-July (7/16/24). These prices are higher than when Warren Buffett sold half of Berkshire Hathaway's (BRK.B) position during Q2. 

No wonder - Apple is generating large amounts of free cash flow (FCF) and will likely keep doing this. That implies that AAPL stock's value will be higher in the future. 

AAPL - Barchart - Aug. 26, 2024

I discussed this in my Aug. 5 Barchart article, “Just Because Buffett is Selling Apple Stock Doesn't Mean You Should Too.” I wrote that AAPL stock was worth 25% more at $262.50 per share.

Since then, AAPL stock has risen 7.6% from $210 when I wrote that article. Moreover, analysts have raised their revenue forecasts in the past three weeks. So, that implies AAPL stock is worth even more than $262.50. Let's look at that. 

Revised Price Target for AAPL Stock

In my last article, I wrote that analysts were projecting $385.6 billion in revenue for the year ending Sept. 2024 and $418.99 billion for Sept. 2025. Now, according to Seeking Alpha, they have raised their average sales forecasts to $390.4 billion and $420.32 billion respectively. That means that they have hiked their 2025 revenue forecast by 30 basis points, although the gain over 2024 is lower.

So, here is how that affects our price target. I used FCF margins to forecast Apple's free cash flow in 2025 and then used a 3.0% FCF yield to value the stock.

For example, last quarter the company generated 33.6% in operating cash flow (OCF) margins (i.e., $28.858 billion in operating cash flow / $85.777 billion in revenue). That implies that next year it could potentially make $141 billion in OCF (i.e., 0.336 x $420.32b).

Next, we deduct $9.5 billion in projected capex spending (i.e., 10% higher than its $8.6 billion in Q2 run rate capex spending. That leads to a free cash flow (FCF) estimate of $131.4 billion for the year ending Sept. 2025.

After dividing this $131.4 billion FCF estimate by 3.0% (i.e., using a 3.0% yield metric), Apple's market cap could rise to $4,380 billion (i.e., $4.38 trillion). That is almost $1 trillion higher than its existing $3.43 trillion market value today. 

In other words, AAPL stock could be worth 27.7% more (i.e. $4.38 tr/$3.43 tr -1 = 0.277). That sets the target price at $288.64 (i.e., 1.277 x Friday's closing price of $226.03). That is higher than my previous $262.50 price target - all based on analysts' higher revenue projections in the past 3 weeks.

Shorting OTM Puts

One way to play this, especially for existing investors, is to sell short out-of-the-money (OTM) put options as an income play. For example, look at the Sept. 27 expiration option chain, which is just over one month away (32 days from today).

The $215 strike price put option has a premium of $2.11 on the bid side (and $2.14 midprice). That means that the short put investor can make almost 1.0% in the next month (i.e., $2.11/$215.00 = 0.98%) while they wait for AAPL stock to rise.

AAPL puts expiring Sept. 27 - Barchart - As of Aug. 26

For example, the investor would secure $21,500 (i.e., $215 x 100) with their brokerage firm. Then, after receiving approval to do this trade, they can enter an order to “Sell to Open” 1 put contract at $215 for expiry on Sept. 27. The account will immediately receive $211 (i.e., $2.11 x 100).

That 0.98% return can be repeated each month for extra income while the investor waits for AAPL stock to rise. And even if it falls by 5% to $215, the investor knows that the $21,500 purchase at the strike price could still be profitable over the next year.

Moreover, the breakeven is lower at $215-$2.11, or $212.89, or 5.6% below the price today. That provides some downside protection.

The bottom line is that AAPL stock looks cheap here. One way to conservatively play this as an income trade is to sell short out-of-the-money put options in near-term expiry periods.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.