Warren Buffett's DCF: The Final Verdict on Apple

Welcome to Financial Fluency - your weekly guide to mastering financial English and understanding the world of investing.

In this issue:

• A Look at the Markets: Performance May 2025

• Warren Buffett's DCF: The Final Verdict on Apple

• Quote of the Day:

• We value your feedback

• Word of the Day:

• Test Your Knowledge

• Whenever you are ready, here is how I can help you

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A Look at the Markets: Performance May 2025

Vanguard FTSE All-Word ETF (Accumulating)

After 3 months in the red, the Vanguard FTSE All-Word ETF returned to green in May with a 5% recovery.

iShares Core S&P 500 UCITS ETF USD (Accumulating)

The iShares Core S&P 500 ETF showed a similar gain of just over 5%.

Vanguard EUR Corporate Bond ETF (Accumulating)

The less volatile Vanguard EUR corporate bond ETF showed a 0.5% gain in May.

Bitcoin Monthly Performance $BTC.X ( ▼ 1.19% ) 

May was another green month for Bitcoin taking it to all-time highs.

Warren Buffett's DCF: The Final Verdict on Apple

Is Apple Overvalued?

Where We Left Off Last Week

Last week, we began applying Warren Buffett's discounted cash flow method to Apple Inc. We calculated the present value of Apple's projected cash flows for the next five years:

• Starting Point: Apple's TTM free cash flow of $98.5 billion

• Growth Assumption: Conservative 6% annual growth

• Discount Rate: 7% (4.5% risk-free rate + 2.5% risk premium)

• 5-Year Present Value: $451.8 billion

But we noted that this was only part of the story. Apple doesn't just disappear after 2029 – it continues generating cash flows for many years beyond our projection period.

Today, we complete the valuation by calculating Apple's terminal value.

The Missing Piece: Terminal Value

Most businesses don't disappear after 5 years - they continue operating and generating cash flows hopefully for many years.

Terminal value is the estimated worth of a business at the end of your projection period (usually, and in this case, Year 5). It represents all the future cash flows from Year 6 onwards.

Think of it this way: If you were selling your business in 5 years, what would it be worth to the buyer?

Two Methods to Calculate Terminal Value

Method 1: Perpetual Growth Formula. This assumes the business will grow at a steady rate forever (usually 2-3%). The formula is complex and requires many assumptions about long-term growth rates.

Method 2: EBITDA Multiple (My Preferred Method). This method is simpler and more practical. It's based on what similar companies actually sell for in the real market.

EBITDA = Earnings Before Interest, Tax, Depreciation, and Amortisation (essentially, operating profit)

Apple Example: Finding Terminal Value

Let's use Apple to demonstrate the EBITDA multiple method:

Step 1: Find Apple's EBITDA Estimate for Year 5. We need to estimate what Apple's EBITDA will be in 5 years (2029).

For our example, let's use a professional forecast: $164.7 billion

Step 2: Find the Appropriate Multiple. Different industries trade at different multiples. Technology companies typically sell for 10-15 times their EBITDA.

For Apple, let's use a conservative 12x multiple.

Step 3: Calculate Terminal Value Terminal Value = EBITDA × Multiple Terminal Value = $164.7 billion × 12 = $1.98 trillion

This means we estimate Apple would be worth $1.98 trillion in 2029.

Step 4: Calculate the Discounted Terminal Value. Just like with cash flows from last week, we have to discount the future value of the terminal value to what it would be worth today.

Discounted Terminal Value: $1.98 trillion ÷ (1.07)⁵ = $1.41 trillion

The Complete Apple Valuation

Now we can calculate Apple's total intrinsic value by adding the 5-year cash flow present value to the discounted terminal value.

5-Year Cash Flows Present Value: $451.8 billion

Discounted Terminal Value: $1.41 trillion

Total Intrinsic Value: $451.8 billion + $1.41 trillion = $1.86 trillion

The Buffett Calculation

Let’s compare our intrinsic value to Apple's current market cap:

• Our Intrinsic Value: $1.86 trillion

• Apple's Market Cap: ~$3.0 trillion

• Difference: Apple appears overvalued by 38%

This analysis suggests that Apple's current stock price may be too high relative to its fundamental value. This may explain why Warren Buffett hasn't been adding to Berkshire's Apple position recently. Indeed, he has been selling, but this could also be because Apple made up a very high proportion of Berkshire Hathaway’s holdings.

Important notes

Firstly, as you have seen with the various calculations, these calculations involve many assumptions. Altering the growth rate, discount rate, or EBITDA multiple can make a big difference to your valuation.

Note: it is important not to alter the assumptions to fit your narrative (what you want to see). Take Warren Buffett’s advice and be conservative.

Secondly, there is more than one way to value a company. DCF analysis works poorly for tech startups since they often produce no profit yet. Investors are betting on extraordinary future growth. These tend not to be companies that Warren Buffett invests in in the early stages.

For example, Apple is a mature company with predictable cash flows, whereas NVIDIA has experienced explosive growth driven by AI demand. Buffett owns Apple but not NVIDIA - this reflects his preference for predictable businesses over high-growth, high-uncertainty companies.

Finally, just because a stock is overvalued by some metric does not mean that it cannot continue to rise in value.

Next Week's Preview

What about property investors?

Can you use DCF to value that rental apartment or commercial building you are considering?

We'll explore how to apply Buffett's method to real estate next week.

As always, none of this is financial advice. Everyone should invest according to their personal circumstances, risk tolerance and financial goals.

Quote of the Day: Warren Buffett

This quote from Warren Buffett reminds us that intrinsic value alone isn't enough - we also need to invest in quality businesses. However, this is only the start of the process. It must be a good company, ideally with what Buffett describes as an economic moat.

An 'economic moat' is a term Buffett uses to describe a competitive advantage— for example, Coca-Cola's brand name and secret recipe.

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Your opinion helps us improve and lets you suggest topics or ask Business English questions for future issues.

Word of the Day: Amortisation

Amortisation - noun - the systematic allocation of the cost of an intangible asset over its useful life, or the gradual repayment of a debt through regular payments that cover both principal and interest.

From Latin "ad mortem" (meaning "to death") via Old French, literally meaning "to kill off" or "bring to death," reflecting the concept of gradually reducing something to zero over time. In British English, it's spelled with an 's' (amortisation), while American English uses a 'z' (amortization).

Note: This is primarily Business English terminology used in accounting and finance contexts. You would rarely encounter "amortisation" in general English conversation.

Context and Usage

Amortisation serves two primary purposes in finance and accounting. First, it spreads the cost of intangible assets (like patents, trademarks, or software) across their expected useful life, ensuring expenses are matched with the periods that benefit from the asset. Second, it describes the structured repayment of loans where each payment reduces the outstanding principal while covering interest charges, resulting in the debt being fully eliminated by the final payment.

Common Collocations

• Amortisation schedule – A table showing each loan payment's breakdown between principal and interest over time.

• Straight-line amortisation – A method where equal amounts are expensed each period.

• Amortisation expense – The portion of an intangible asset's cost allocated to a specific accounting period.

• Loan amortisation – The process of paying off a debt through regular instalments.

• Amortisation period – The timeframe over which an asset is amortised or a loan is repaid.

Business Example:

The software company recorded £2,500 in amortisation expense this quarter, reflecting the systematic write-off of their £50,000 customer database acquisition cost over its five-year expected useful life.

Amortisation is essential for accurate financial reporting and debt management, providing clarity on both asset utilisation and repayment obligations while ensuring costs are properly allocated across relevant time periods.

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Disclaimer:

This newsletter is for informational and educational purposes only and should not be construed as financial advice. The information contained herein is generic and does not take into account your individual financial circumstances. You should always consult with a qualified financial professional before making any investment or financial decisions.

Additionally, the authors and/or publishers of this newsletter may hold investments in securities or other financial instruments mentioned herein. These are included for illustrative purposes only and should not be taken as a recommendation to buy or sell such securities or financial instruments.