Apple sure looks cheap

Apple's decline from it most recent high of $702 to yesterday's close of $486—a decline of 30%—was brutal, but as the chart above (which is plotted using a logarithmic scale for the y-axis) shows, there have been other AAPL selloffs in the past that have been much larger in percentage terms. Long-term AAPL investors have been in this situation before and have suffered much worse, only to be rewarded handsomely in the end. Is this time going to be any different? I doubt it.

Apple closed yesterday with a trailing PE ratio of 11. That ranks as its lowest PE ratio since 1995, when the stock was trading at $9 and the company was adrift without Steve Jobs at the helm. When you consider that the company has roughly $100 per share in cash (after paying tax on its repatriated profits), then yesterday's PE ratio was less than 9. Assuming that next week the company reports profits in line with current market expectations, it's PE at yesterday's price would be 10 (or 8 if you back out the cash).

For the past 10 years, Apple's earnings have been on fire, rising at a 80% compound annual rate. For the past 7 years, earnings have grown at a 57% compound annual rate. Current expectations are for earnings to have increased 25% in the year ending December '12. So it's fair to say that Apple's earnings growth has declined significantly, especially over the past year. But for the stock to be trading at a PE ratio of 10 or less, the market must believe not only that Apple's best days are behind it and that earnings growth will continue to decline, but that earnings growth is likely to be flat or negative within the foreseeable future. The market is in effect priced to the assumption that there is almost no chance that Apple can continue to grow. In short, the stock is priced to some very disturbing developments.

The market may well be right, but the news next week is going to have to be really disappointing to push the stock much lower. Thus, the recent selloff offers new investors a risk/reward profile that is, in my opinion, quite skewed in the direction of rewards.

I think Apple's growth prospects are still excellent, especially now that it is selling iPhones and iPads all over the world, particularly in China. The global market for Apple products is almost sure to be fruitful for many years. And if Apple only has one new awesome gadget up its sleeve, earnings—and Apple's stock price—can resume their upward march for years to come.

Full disclosure: I am long AAPL at the time of this writing.