Apple Inc. (AAPL)’s Real Value Is Its Option Value

While smartphone and tablet product cycles have become very short, the development cycle for new products can be quite long. Thus, Apple could be busy “innovating” in its development labs even if innovations have not come to market recently. The iPod was introduced in late 2001, and it took more than five years for Apple to reveal its next new product line: the iPhone. It was well worth the wait! The iPad came out three years after the iPhone release. It has now been three years since the iPad came to market, which means that we are just entering the window of time when — based on historical precedent — Apple might be ready to reveal a new (and potentially innovative) product category.

iTV? iWatch?
The global Apple obsession is strong enough that even if evidence is meager, there are still plenty of rumors about what Apple might be working on. Ever since Walter Isaacson published his biography of Steve Jobs, rumors of an “iTV” product have been rampant. Apparently, before his death, Jobs told Isaacson that he had finally “cracked” the problem of creating a TV that was simple to use. Recently, iTV rumors have been overtaken by reports that Apple is working on a “smart watch” that would sync with other Apple devices.

Both of these rumors are supported to some extent by various patent filings. However, the U.S. patent system provides a strong incentive to file patents even if you aren’t sure that you are going to use them. We cannot know whether an iTV or an iWatch might be on the way. However, we do know that Apple Inc. (NASDAQ:AAPL) is spending a lot of money on R&D: $3.4 billion in FY12. By contrast, Apple spent just $1.3 billion on R&D in FY09, when it was developing the iPad, and well under $1 billion annually while it was developing the iPhone.

Free option value
Of course, it is possible that Apple’s R&D budget is being spent inefficiently today and will not lead to useful and profitable innovations. However, the possibility that Apple will invent new successful product lines is not reflected in the current share price. Apple’s low valuation only makes sense on the assumption that EPS has already peaked. As a result, Apple shareholders have a free “option” on new products. If they go bust, no harm done; the profit from Apple’s existing product lines can support a stock price of at least $430. On the other hand, if Apple introduces a popular, profitable product line, the option value could be enormous. If you believe there is any chance that Cupertino’s tradition of innovation is not done yet, Apple is a steal at its current stock price.

The article Apple’s Real Value Is Its Option Value originally appeared on Fool.com and is written by Adam Levine-Weinberg

Fool contributor Adam Levine-Weinberg owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple.

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