About the company
Apple Inc. is an American multinational enterprise that design and develop consumer electronics, provides paid multimedia services and sells software. Headquartered in California, the company was founded in 1976. The consumer electronics of the company includes, IPhone. I pad, IPod and MacBook, while the paid multimedia service is known as ITunes. The company trades on NASDAQ under the ticker sign of ‘AAPL’.
Rational for selection
The core objective of this paper is to analyze the financial performance of Apple Inc. which has always been in good news for introducing innovative products into the market. Although the company had ruled the multimedia and consumer electronics segment since the launch of MacBook and IPod series, the major turnaround was the introduction of IPhone in 2008 that changed the smartphone technology and then the tablet, I pad in 2009. The recent launch of IPhone 6 and IPhone 6 plus have also been a successful drive for the company. In addition, Apple Inc. which was once rated to be lagging significantly behind its competitors, Samsung Inc., has gave a big blow to the latter’s profitability. Recently, Samsung Inc. declared a drop of 79% in their operating income for Q3. Market analysts have also termed this as ‘Thermonuclear Attack’’ by Apple Inc. on Samsung that have been successful in ensuring that Galaxy and Note Series receives a big blow through IPhone 6 and IPhone 6 Plus.
Hence, it will be interesting to have a real insight into the financial numbers of the company and to evaluate the investment potential of the company’s stock based on ratio analysis and market expectations.
Suitable Investor Profile: Growth Investor
Since, Apple has a line of products to be launched or the one that are recently launched, the stock performance will surely depend upon the long- term performance of these stocks and if they will be as successful as the previous products of the company. Hence, the investment in the company’s stock will be suitable for only growth investor as the stock of the company is expected to grow steadily above industrial averages and is not likely to experience high tides in short times. Thus, the stock will only be suitable for a growth investors eyeing capital gain in its portfolio over long-term.
In this section, in order to analyze the financial health of Apple Inc. we will conduct the financial analysis of the company using the tool of ratio analysis where varied ratio sections, Liquidity Ratios, Solvency Ratios, Efficiency Ratios and Profitability Ratios will be used to find out the ongoing trend in the financial performance of the company:
These ratios access the ability of an entity to pay their short term obligations when they become due. Also known as ‘’Pure Balance Sheet Ratios’’, these ratios provides a comprehensive overview of the working capital position of the company. Below discussed are two popular liquidity ratios:
I)Current Ratio: Current Assets/ Current Liabilities
Ii)Quick Ratio: Cash+ Receivables/ Current Liabilities
Referring to the above financial data, we can infer that during 2013, Apple Inc. witnessed an appreciable increase in its liquidity position. During this period, the current ratio of the company went up from 1.50 to 1.68, while the quick ratio, which is rather a more stringent liquidity measure, shot up from 1.24 to 1.40. The increases, as we can refer from the horizontal balance sheet attached below, was sourced from higher proportion increase in the current asset that increased by 27.12% as against current liabilities that surged only by 13.27% thus providing a positive push to the liquidity ratios. The major increase in current assets was recorded in the cash reserves, inventories and receivables that increased by 39.19%, 123.01% and 19.87%, respectively.
Interestingly, the results during 2014 were astonishing as during the latest fiscal year, the liquidity position of the company has gone weak. As discussed before, during 2013, the working capital position of the company was appreciable with both current ratio and quick ratio increasing from 1.5 to 1.68 and 1.24 to 1.40, respectively. However, during 2014, amid low demand for its product and with customers waiting for IPhone 6 and I Pad Air, a significant decline was seen in the cash position which declined by 38.15% and coming up with a major source of decline in the liquidity ratios of the company. While the current assets of the company underwent a significant decline, the current liabilities on the other hand, surged high by 45.32% primarily dominated by accounts payable that increased by 35%. As a result, the current ratio of the company declined from 1.68 in 2013 to 1.08 in 2014. Just as 2013, we even tested the liquidity of the company through the most stringent measure available, i.e. Quick Ratio that also indicated the similar trend as the ratio declined from 1.40 to 0.82 indicating weak liquidity roots of the company.
These ratios indicate the analyst about the profit margins being earned by the company from its business activities. Even the shareholders are very much interested on knowing the trend in profitability margins and base their investment decision on those results. Below discussed are few of the profitability ratios for Apple Inc.:
i) Operating Profit Margin: Operating Income/ Revenue
ii)Earning per Share: (Net Income- Pref Dividends)/ Weighted Average Common Shares
Noted from the above data, during 2013, the operating profitability of the company was hit largely and the margins declined significantly from 35.30% to 28.67%. Although the revenue figures of the company increased by 9.20% but it came at the cost of 21.36% increase in cost of revenue. This increase was attributed to increased contract cost with the Chinese manufacturer of the company, Foxconn. Hence, because of higher proportionate increase in cost of revenue and increased operating expenses, the operating profitability suffered a strong hit.
However, the situation turned a little better for the company, when the during the latest fiscal year of 2014, the company recorded improved operating profitability margin amid revenue figures that surged by 6.95% and controlled cost for revenue and operating expenses. Referring to the horizontal income statement attached below, we find that although the revenue increase during Fiscal 2014 was less than during 2013, however, Apple Inc. was successful in reducing the increase in the cost of revenue by significant proportion, thus, inflating the gross profit margin. However, the advantage of controlled cost of revenue was offset by operating expenses that went up by 17.83% in comparison to 14.04% during 2013. As a result, the company could only manage a marginal increase in the operating profit margin from 28.67% to 28.72%.
A similar trend was witnessed in the EPS multiple of the company that during 2013 declined from $6.31/share to $5.68/share. The decline was resulted from decreased net profit margin amid increased cost of revenue and higher operating expenses although the impact of decreased net profitability on EPS was somehow eased by decrease in number of shares outstanding that slumped by 1.07%. However, during 2014, as we discussed before, the declined proportion of cost of revenue and controlled operating expenses, resulted in an increase in EPS multiple from $5.68/share to $6.45/share that was also proliferated by the decrease in the number of shares by 6.04% to 6086 Million shares as against 6477 million shares in 2013.
Also known as Market Ratios, these ratios carries a great significance for the investors and are usually compared with the industrial averages by them. In this section, in order to evaluate the investment opportunity for Apple Inc., we will employ investment ratios such as PE ratio and Price- Sales ratios followed by an extensive discussion over the same:
I)PE Ratio: Current market price/ EPS
It is a dominant investment ratio in the finance industry that indicates the price which the investors are willing to pay for each $1 of the future earnings of the company. Hence, higher is the PE ratio, higher are the expectations of the investors for the future profitability of the company. As for Apple Inc., the company at present, have PE ratio of 18.4 in comparison to the industrial average of 19.8. This indicates that the stock, at present, investors have lower expectations regarding its future earnings. This can largely be attributed to recent launch of IPhone 6 series, I pad Air and Iwatch. Hence, if the newly launched products turned successful, just as its previous products, we can surely expect that PE ratio of the company will rise in the coming quarters and the company will yet again beat the market expectations.
ii)Price- Sales Ratio: Current Market Price/ Revenue
Investment Ratio Analysis
Also known as revenue multiple, this investment ratio by comparing the current stock price with the revenue figures indicates the value placed on each dollar of a company’s sales or revenues. It also provides direct indication relating to the investment opportunity of the stock as if the Price-Sales ratio is higher than the industrial averages, it suggest that the stock is overvalued, while a low ratio suggests a possible undervaluation. As for Apple Inc., the Price- Sales ratio of the company is 4.0 that are significantly higher than the industrial average of 2.3, thus indicating that the stock is overvalued and may not turn out to be a lucrative investment opportunity for the investors.
Just like any other investment, even this investment will not be free from risk. Hence, it will be rational for the investor to optimize his portfolios and manage the risk related to stock investment. As for investing in Apple stock, in order to minimize the risk, the investor should diversify its portfolio by including stocks that offers low correlation than Apple’s stock. This may include stocks from any industry other than that of Apple. This is because when an investor diversifies his portfolio across assets that are not perfectly correlated, the risk in the portfolio is less than the weighted average of the risks of the individual securities in the portfolio. In addition, the investor should also include higher number of stocks in his portfolio and should avoid putting all the eggs in just one basket. Important to note, the process of portfolio diversification has been historically proven to eliminate unsystematic risk from the portfolio leaving the portfolio exposed only to systematic risk, thus forming a base for risk-return profile.
At the conclusion of this report, we would like to issue a buy rating for Apple Inc. Although, our analysis conducted through ratios indicate a negative trend for the latest year and even the market ratios justify that the stock is overvalued, however, the recent events both inter-company and intra-company indicates that the stock might just bounce back in the near future. Not only the profitability trend of the company were encouraging where the company registered a surge in its profit margins through controlled cost of revenue, there are also other factors that force us to issue a buy rating for the company. For Instance, record pre-booking of IPhone 6 and IPhone plus indicates that the revenue figures of the company will surely boost in the upcoming year and so does the cash reserves which suffered a hit as per the latest fiscal year reporting. Our expectation seems to be validated with consistent increase in the stock price of the company post the release of its IPhone 6 series. The chart below indicates the stock movement from the date of launch of IPhone 6 series, i.e. 18th September to till date, diverting us towards a bullish rating for the stock:
In addition to all the above factors, another factor that forced us to issue a hold rating for the company is that it is turning out to be successful in obliterating its competitor, Samsung profitability. The world knows that Apple Inc. is fighting a long battle against Samsung over patent infringement, but now the California based tech giant’s IPhone 6 seems to implode the Samsung latest high end Galaxy and Note Model. Recently, Samsung issued their third quarterly report declaring a 73.9% in their mobile division. The South Korean smartphone giant(Samsung Inc.) declared that it was the decreased sales, low selling price and decreased economies of scale that imploded the profit margins. On the other hand, Apple Inc. finally produced a large screen phone with GPU processing power, adequate 64-bit CPU along with specific features such as Touch ID and Apple Pay along with Continuity features that tie it into the Mac desktop, iPad and the upcoming Apple Watch, proved to be disaster for Galaxy S and Note 4 manufactured by Samsung.
Hence, we have sufficient reasons to expect that the Apple stock will head high in the near future providing capital gains to our investors.
Apple Inc- Historical Price. (n.d.). Retrieved December 1, 2014, from Yahoo FInance: https://in.finance.yahoo.com/q/hp?s=AAPL&a=08&b=18&c=2014&d=11&e=1&f=2014&g=d
Apple Inc- Industry Peers. (n.d.). Retrieved December 1, 2014, from Morningstar: http://financials.morningstar.com/competitors/industry-peer.action?t=AAPL®ion=usa&culture=en-US
Apple Inc- Key Ratios. (n.d.). Retrieved December 1, 2014, from Morningstar: http://financials.morningstar.com/ratios/r.html?t=AAPL®ion=usa&culture=en-US
Dilger, D. E. (2014, October 30). How Apple, Inc. went thermonuclear on Samsung, erasing Android's primary profit center. Retrieved December 1, 2014, from Appleinsider.com: http://appleinsider.com/articles/14/10/30/how-apple-inc-went-thermonuclear-on-samsung-erasing-androids-primary-profit-center-
Kaplan Inc. (2012). Portfolio Management-Risk and Return. In K. Inc, Schweser Notes for CFA Exam-Portfolio Management (pp. 174-176). USA: Kaplan Inc.
Price-Sales Ratio. (n.d.). Retrieved December 1, 2014, from Investopedia: http://www.investopedia.com/terms/p/price-to-salesratio.asp
Horizontal Income Statement
Horizontal Balance Sheet