Dividend Payout Ratio: Apple Inc - Case Study Example

RESEARCH PAPER Introduction to the Company The company that is studied for this paper is Apple Inc. (Ticker: AAPL), which is a leading hardware and software company which has headquarters in Cupertino, California, U.S. At the end of 2013, the company reported total revenues over $170 billion with net income of approximately $37.037 billion. The total asset of the company was $207 billion in 2013. The company has over 405 retail stores globally and is listed as a publicly traded company at NASDAQ. Apple also forms a component of S&P 500 composite index. The key competitors considered for this study are Microsoft Corp. (MSFT) and Google Inc. (GOOG). 2. Financial Ratio Analysis a. Financial Ratios in each Five Categories and Peer Group Analysis Liquidity Ratios - The most important indicators of liquidity are the cash ratio, current ratio and acid-test ratios. When the liquidity of AAPL was compared with its competitors it was found that the liquidity of the company was higher than MSFT but lower than GOOG. The cash position of AAPL was greatest and the lower level of liabilities magnified the overall liquidity of assets of the company (Bragg, 2012, p.73).. The above liquidity graph reveals that liquidity of Apple was 1.61, 1.50, and 1.68 in 2011, 2012, and 2013 respectively. The industry average liquidity for 2011, 2012, and 2013 were 4.26, 3.41, and 3.65 respectively. Activity or Turnover Ratios - These ratios typically help to analyze how fairly a company utilizes its internal assets and liabilities. The inventory turnover of AAPL was higher than industry average due to slowdown in global economies. The company’s other two activity ratios mentioned earlier was however found to be much lower than industry. The activity ratio of Apple in 2011, 2012, 2013 was 0.60, 0.56, and 0.62 respectively. The standard values of important activity ratios like inventory turnover, debtor collection period and creditor payment period for the industry are 0.406, 64 days and 166 days respectively. The industry average activity ratios in 2011, 2012, and 2013 was 0.29, 0.32, and 0.35 respectively. Solvency Ratios - The solvency of the company is determined from its ability to generate sufficient earnings to cover fixed liabilities. The fixed liabilities of a firm arise due to leverage or inclusion of long-term debt capital. The higher the debt capital the higher would be EPS and financial leverage. However, debt capital involves financial risk which could arise if the company is unable to service its periodical interest liabilities on outstanding principal and could require liquidation of assets to remain solvent (Drake, 2008, p.9). The above solvency graph reveals that solvency of Apple was 0.15, 0.16, and 0.32 in 2011, 2012, and 2013 respectively. The industry average solvency ratios for 2011, 2012, and 2013 were 0.25, 0.22, and 0.21 respectively. Profitability Ratios - The net profit margin, ROCE, and ROE are three most important indicators of profitability (Bajkowski, 1999, p.5). The above profitability graph reveals that profitability of Apple was 0.45, 0.47, and 0.40 in 2011, 2012, and 2013 respectively. The industry average profitability for 2011, 2012, and 2013 were 0.35, 0.27, and 0.26 respectively. Market Ratios - The market ratios helps to analyse the attractiveness of investment opportunity for a particular stock. The most widely used indicator of market ratios are Earnings per Share (EPS), Dividends per Share (DPS), and Price-to-Earnings ratios. Generally, the higher the EPS the more would be the earnings available to investors and the same is also true for DPS. On the other hand higher P/E multiple indicates that investors are willing to pay more for each share of the company and thus it could imply that company is overvalued. Industry Market Ratios AAPL Average EPS (Net Profit/Outstanding Shares) 40.23 10.895 DPS (Cash Dividends/Outstanding Shares) 2.30% 2.80% P/E (Market Price per Share/EPS) 13.2 21.2445 The EPS, DPS, and P/E ratios of Apple are 40.23, 2.30%, and 13.2 respectively. The industry average of EPS, DPS, and P/E ratios are 20.67, 0.03, and 18.56 respectively. b. ROA and ROE Analysis In order to analyse the productivity of assets and equity of the company it is important to compute the ROA and ROE. However, the ROA or ROE for any given year has little meaning unless it is compared with other competitor companies operating in same industry. The increase or decrease in ROA and ROE is equally important to understand the current trend and forecasting future trends in asset productivity. Thus, it is very appropriate to conduct a time series trend analysis from 2010 to 2013 and a peer group comparison. The ROA is an indicator that determines the profitability of company relative to its total assets. The ratio gives an idea as to how the economically the assets of the company are managed and employed to generate earnings. The ratio of firm’s “Net Income” to “Total Assets” is the most widely used formula for determining the ROA of the firm. The ROA thus generates what portion of company’s net earnings constitutes investment of capital in assets. As the standard value of ROA varies from one industry to another, it is important to determine the “Industry Average” of the ratio. The assets of the company might comprise of both equity and debt as the company may use either debt capital or equity to finance its assets. The value of ROA gives an idea to the investors regarding how efficiently the company is converting shareholders’ investment into net income. Generally, across all industries it is accepted that the higher the ROA the better is the utilization of asset and the more efficiently the assets of the company are utilized. The company under consideration is Apple Inc whose key competitors are Microsoft Corp. and Google Inc. A peer group and time series trend analysis will reveal the market competitiveness and efficiency of the firm in the industry over time. The ROA of AAPL increased from 0.87 in 2010 to 0.93 in 2011 whereas in comparison the same for industry experienced a very distinct declining trend. The recession in developed economies after the financial crisis has impacted asset utilization of these companies. However, Apple also experienced declining trends in ROA from 2011 to 2013 when its ROA declined from 0.93 to 0.83. A similar declining trend was also observed in case of industry average where the asset utilization declined from 0.57 in 2011 to 0.54 in 2013. The Return on Equity (ROE) helps to determine the amount of net of net income that is available to the shareholders. this ratio is an indicator of company’s profitability that analyses how much profit is generated by the company by utilizing the money invested by shareholders. The ROE is calculated as the ratio of “Net Income” to “Shareholders’ Equity” and is often expressed as percentage. The net income is the net profit of the full year but before distribution of dividends to common stock holders and after distribution of dividends to preferred shareholders. The identity is very useful for comparing the profitability of the firm with peer groups. Generally, the higher the ratio, the higher would be the efficiency of utilization of shareholders’ capital. The ROE of AAPL increased from 1.36 in 2010 to 1.41 in 2011 whereas in comparison the same for industry experienced a very uniform trend. Apple experienced declining trends in ROE from 2011 to 2013 when its ROE declined from 1.41 to 1.38 respectively. But a linear or stable trend was also observed in case of industry average whose ROE marginally changed from 0.91 in 2012 to 0.84 in 2013. The most recent annual report of Apple reveal that at the end of current fiscal the company had cash and equivalents worth $14,259 million. This asset is considered to be the most liquid current asset irrespective of currency of operation. While cash includes cash in hand, bank, and demand deposits the equivalents are investments made by company that can be readily converted into cash within small time interval. Such cash equivalents include investment like treasury bills, commercial papers, money market securities having maturities less than 3 months. It also includes accounts receivables that are generally available on demand. These financial resources help the company to meet urgent liabilities without relying on external financing or long-term assets. c. Du Pont Identity The purpose of this research is to conduct a DuPont analysis as a useful tool to provide an overview of strength and weakness of financial statements. The DuPont analysis can be used to analyse the inherent strengths and weakness of any firm as reflected from its publish financial statements (Soliman, 2008, p.849). Basically, the analysis involves determination of three types of key ratios namely profitability, efficiency, and equity multiplier that estimates operating efficiency, asset utilization and financial leverage respectively (Bhattacharyya, 2011, p.73). The Du Pont analysis of AAPL and its key competitors are calculated as follows: APPLE INC. (AAPL) DuPont Analysis 2010 2011 2012 2013 Profit Margin (Profit/Sales) 0.28 0.31 0.35 0.29 Total Asset Turnover (Sales/Assets) 0.87 0.93 0.89 0.83 Equity Multiplier (Assets/Equity) 1.57 1.52 1.49 1.68 ROE 0.38 0.44 0.47 0.40 Industry Average DuPont Analysis 2010 2011 2012 2013 Profit Margin (Profit/Sales) 0.37 0.21 0.32 0.29 Total Asset Turnover (Sales/Assets) 0.62 0.58 0.57 0.54 Equity Multiplier (Assets/Equity) 1.56 1.58 1.57 1.54 ROE 0.37 0.25 0.30 0.25 d. Analysis of Company’s Overall Performance Profitability- This ratio is a comprehensive measure of profitability that gives the rate at which the sales are being transformed into corporate profits at different levels of business operations. The profitability of AAPL was higher than that of industry average from 2010 to Asset Utilization- Asset turnover ratio signify how efficiently the assets of a firm were utilized for generating sales or cash. The asset utilization of AAPL was highest from 2010 to 2013 compared to industry average, showing signs of recovery in global demand after financial crisis and recession. Leverage- Equity multiplier, the ratio of Assets to Equity, is computed in order to ascertain the extent of debt financing in the capital structure of the company. The ratio signifies that debt financing is decreasing for AAPL and the assets are more financed by the Shareholders’ equity. This will automatically increase the equity multiplier of the company. The equity multiplier or leverage of Apple increased from 0.38 in 2010 to 0.40 in 2013. There is a reverse trend for industry whose equity multiplier has declined from 1.56 in 2010 to 1.54 in 2013 due to increased use of borrowed money during this period. 3. Computation of Internal Growth Rate and Sustainable Growth Rate based on Company’s Dividend Payout Ratio The ROE and ROA of a firm is also used to calculate two additional important numbers, namely IGR and SGR, both of which are mainly concerned at determining the ability of the firm to grow. In order to calculate these two growth rates two basic ratios has to be calculated which are the “Dividend Payout Ratio” and “Earnings Retention Ratio”. The retention ratio is the leftover of cash available to the company after it has distributed dividends to the shareholders. Dividends are frequently distributed by matured firms compared to firms that are in growth phase. Thus, high growth companies such as Google, Facebook, etc. generally do not distribute dividends as these companies re-invest their net earnings in profitable opportunities. Companies not distributing dividends will have 100 percent earnings retention ratio. Based on the available financial information regarding the companies under observation, the IGR and SGR can be calculated as follows: Internal Growth Rate (IGR) IGR = (ROA x b)/[1-(ROA x b)] Where, b= Retention Ratio ROA= Return on Asset Sustainable Growth Rate (SGR) SGR= ROE x (1-d) ROE= Return on Equity d= Dividend-payout Ratio Industry PARTICULARS FORMULAS AAPL Average Dividend-payout Ratio   0.028 0.017 Retention Ratio   0.972 0.983 Return on Asset   0.000 0.150 Return on Equity   0.000 0.242 IGR (ROA x b)/[1-(ROA x b)] 0.000 0.173 SGR ROE x (1-d) 0.000 0.237 The internal growth rate of a firm is the highest achievable by the firm without utilizing external financing. The sustainable growth rate is the maximum growth rate achievable and sustainable by the company with including additional financial leverage in the company’s capital structure. The SGR employs the dividend-payout ratio and is calculated by multiplying the ROE with retention ratio (that is, Retention Ratio = 1-Dividend payout Ratio). Thus, this ratio is important to identify the sustainable growth rate of the company with its own funds and by borrowing money from external parties. The significance of SGR is that the firm should employ borrowed funds only after it has crossed SGR. 4. Summary The strength of the company lies in its cash position. Apple has reported around $14.259 billion of cash and cash equivalent for the year ending 2013 which approximately 38.53 percent of its net earnings for the year. This means that the company will be able to finance its long term strategies for investing in R&D and marketing activities in emerging economies without external borrowings. The strong and the weak points of AAPL can be summarized as follows: Strong Points From the above discussion regarding cash position of the company, it can be said that the company’s potential to repay shareholders is positive. Very high IGR and SGR of over 21 and 29 percent respectively The company has no long term obligation to third party which means that in order to expand geographically it has ample chance to leverage its balance sheet. High profitability, activity and liquidity of assets whereas relatively negligible financial risks. Weak Points Growing competition in market may force the company to adapt aggressive pricing strategy which will narrow its margins. The stocks of Apple are experiencing an uptrend in the recent months due to intense market competition The company has huge cash reserves but it does not pay comparative dividends to shareholder. Overall it can be said that the “Apple” brand is known for delivering high quality and reliable products to customers and that its future growth of the company will mostly depend on the Consumer spending and international diversification into emerging economies. References Bajkowski, J. (1999). Financial Ratio Analysis: Putting The Numbers To Work. Retrieved from http://www.aaii.com/journal/article/financial-ratio-analysis-putting-the-numbers-to-work. Bhattacharyya, D. (2011). Financial Statement Analysis: For University of Calcutta. New Delhi: Pearson Education India. Bragg, S. M. (2012). Business Ratios and Formulas: A Comprehensive Guide. John Wiley & Sons, Inc., 2012. Drake, P. (2008). Financial Ratio Analysis. Retrieved from http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf. Soliman, M. T. (2008). The Use of DuPont Analysis by Market Participants. Retrieved from http://faculty.haas.berkeley.edu/kli/papers/Soliman-2008TAR.pdf. Yahoo Finance. (2014). Apple Inc. (AAPL): Balance Sheet. Retrieved from http://finance.yahoo.com/q/bs?s=AAPL+Balance+Sheet&annual. Yahoo Finance. (2014). Google Inc. (GOOG): Summary. Retrieved from http://finance.yahoo.com/q?s=GOOG. Yahoo Finance. (2014). Microsoft Corporations (MSFT): Income Statement. Retrieved from http://finance.yahoo.com/q/is?s=MSFT+Income+Statement&annual. Appendix Table 1 – Financial Ratios Table 2 – ROA and ROE analysis Table 3 – Du Pont Identity Table 4 – Computation of IGR and SGR Read More