Financial Analysis: Apple Inc - Case Study Example

Financial Research Report Investor’s Profile The investor is a high net worth individual and has a strong penchant for equity investments. She does not want to invest in debts to earn fixed interests on her investments as often it does not beat inflation. She has almost $100,000 as a spare amount that she is contemplating to invest in the stock. She has already built a portfolio of over $500,000 that she has built up in the last couple of years. None of the stock she has divested so far. While a good dividend paying company is fine with her, she does not want to make it a criterion. She prefers growth over regular streams of dividends. She wants to invest in the company that is innovative and occupies one of the first two positions in its field of operations. The company must be growing, on average, at the rate of minimum 6% in the last 10 years. The company must be a part of the S&P 500 if it is not in the Dow Jones. Moreover, she does not look for a short-term return, but wants to retain the stock for at least 4 to 5 years or even longer until the growth prospects are intact. She would prefer a stock that is listed at NASDAQ. The company selected could be in technology or in service sector such as banking or insurance and must be operating in most parts of the world. The investor is looking forward to invest in the company that is highly innovative in its processes and full of innovative ideas. Moreover, the company must show rising cash flows year after year from its operations. The Company Selected: Apple Inc. Based on the above-described investor profile, the Apple Inc. seems to be a good choice for inclusion in investor’s portfolio as it fulfills her listed investment criteria. The Apple is an US based publicly traded company and listed at NASDAQ stock exchange. Its market cap is close to USD 748 billion. Its fiscal year ends in the last week of September. It is a technology company producing a variety of consumer electronic goods and the leader in most of its product offerings. The company is growing at a phenomenal rate for the last several years. The company is highly innovative and known for its revolutionary products across the world. Whether the selected company fits the criteria of the client/investor, it is required that the company’s financials such as­ its revenue, profitability margins, leveraging or liquidity ratios, earnings per share, price-earnings ratio, cash flows are scanned. It would be appropriate to find how the company has fared as far as innovative initiatives are concerned in the last decade or so. It is also necessary to find the risk level involved while investing in this company and the strategies employed to minimize the risk. Financials Apple’s annual report provides all the required numbers for calculating financial ratios (Apple Inc, 2014). Gross profit Margin = (Revenue- Cost of goods Sold)/ Revenue (Fabozzi and Drake, 2009) For three consecutive years, gross profit margin is calculated as per the following. 29 September, 2012 28 September, 2013 27 September, 2014 156,508,000-87,846,000 170,910,000-106,606,000 182,795,000 -112,258,000 156,508,000 170,910,000 182,795,000 43.88 % 37.63% 38.59% Net Profit Margin = Net profit/ Revenue (Fabozzi and Drake, 2009) 41,733,000 37,037,000 39,510,000 156,508,000 170,910,000 182,795,000 26.67 % 21.67 % 21.62% The gross profit and the net profit margins in the last two years have reduced when compared with the year ended 2012; however, the profit margins are still robust when compared with peers. Moreover, revenues have been growing at the rates of around 8-9 percent every year even in the difficult market conditions due to ongoing recession. It is equally important to find how liquid its financials are! if it has employed debt– whether short term or long term, for its operations. Current Ratio = Current Assets/Current Liabilities (Fabozzi and Drake, 2009) 29 September, 2012 28 September, 2013 27 September, 2014 57,653,000 73,286,000 68,531,000 38,542,000 43,658,000 63,448,000 1.495 1.678 1.08 Current ratio of the Apple Inc. has decreased in year 2014 when compared with the two previous financial years; however, it is still above 1.0 suggesting that the company still enjoys sound liquidity. It is equally important to find to find how quickly the company can pay its current liabilities from its current assets and for that quick ratio can provide a good indication. Quick Ratio = (Current Assets-Inventory)/Current Liability (Fabozzi and Drake, 2009) 29 September, 2012 28 September, 2013 27 September, 2014 57,653,000-791,000 73,286,000-1,764,000 68,531,000-2,111,000 38,542,000 43,658,000 63,448,000 1.47 1.64 1.05 It is amply clear that the company is equally sound as far as quick ratio is considered. In the last financial year, it is estimated slightly above 1.0 revealing that the company can quickly meet its current liability. Return on Equity = Net Income/Shareholder’s equity (Fabozzi and Drake, 2009) This is a good measure to know the earnings against shareholder’s equity. 29 September, 2012 28 September, 2013 27 September, 2014 41,733,000 37,037,000 39,510,000 118,210,000 123,549,000 111,547,000 35.31% 29.98% 35.42% Return on shareholder’s equity is important in the sense that it finally reflects in the stock price of the company. In the recent fiscal year completed, the company has been able to notch higher returns on shareholder’s equity when compared with its results in the previous year. This shows the company’s efficiency in utilizing shareholder’s fund – an important barometer for judging the stock price of any company. In a way, this can also be reflected in the earnings per share. Earnings per share for three years are as per the following. Cash Flow Analysis Cash flow is an important part of any financial analysis of the company that reveals the soundness of company’s operations. The company’s cash flows for the last three years are as per follows (Apple Inc, 2014). (All numbers in thousands) 29 September, 2012 28 September, 2013 27 September, 2014 Operating Cash Flows 50,856,000 53,666,000 59,713,000 The cash flows from the operations are consistently showing a rising trend. That sounds well for Apple. Stock Price Analysis Earnings per share (EPS) = Net Income/ No. of Outstanding Shares (Fabozzi and Drake, 2009) 29 September, 2012 28 September, 2013 27 September, 2014 6.31 5.68 6.45 The current price of $128.46 per share (Yahoo.com, 2015) can provide the P/E multiple of the company based on the last year’s EPS. P/E multiple = Market Price/ EPS = 128.46/6.45 = 19.91 Expected EPS in the current fiscal year 2015 is likely to be between 8 and 10 (Lange, 2015; Jones, 2015). Based on the lowest estimate of forward EPS, the P/E multiple can be calculated taking into account the current price for investment. P/E= 128/8 =16 However, if the EPS touches to 10 for current fiscal then the P/E multiple will be at the current price: P/E= 128/10 =12.8 Financial Review On profitability and liquidity criteria, the company shows extremely strong financials that are hard to find. The company’s current market capitalization is close to $750 billion (Yahoo.com, 2015) far ahead of the nearest rivals. At current price, the company commands P/E multiple close to 20 based on the EPS of the full fiscal year ended in September 2014. However, on forward EPS of 8, estimated as minimum in the fiscal 2015, the P/E multiple comes close to 16. The company is consistently paying dividend for the last several years; its payout ratio is almost 25% year after year. The company has paid dividends of $10.5 and $11.0 during 2013 and 2014 respectively (Apple Inc, 2014). The company also expects to pay quarterly dividends of $0.47 per share each quarter in 2015 (Apple Inc, 2014). It is important to note that the company has split the stock in ratio of 7:1. Thus, expected annual dividend is likely to be $13 when computed for equity before split. Based on the current market price of $128.46, the dividend yield comes out to be almost 1.5% that is certainly good when compared with the fixed-income US Treasury bonds. Medium-term (3-5 years) Treasury bonds currently provide nearly 1.5% yields on an annual basis (Fidelity, 2015). Does the Company Meet Other Investor Requirements? Apart from the financial review it is important to scan Apple Inc. from other angles that the investor is looking for while investing in the company. It is important to know whether the Apple leads or occupies at least the second spot in its most offerings. Apple leads in majority of its product offerings such as iPad, iPod, iTunes, iPhones. The Company’s products such as iMac, iPod, iPhone, iPad, iTunes command premiums when compared with its nearest rivals. In most of its products the company does not compete directly with many other giants such as Microsoft, HP, and IBM due to a different market niche that the company has carved for itself. Moreover, the company markets its products through the company-owned over 425 retail stores across the world. That is an added strength of the company. Apple has been always in forefront in capturing and deploying right technologies to develop new products in a short period of time. It is important to note that Apple could develop iPod in eight months straight; it shows its conception and execution capabilities (Fischer, 2010). Most of its rivals follow and try to copy Apples products. Samsungs smart phone is not much different than Apples in many of its features and that is why Samsung has faced several patent-violation suits from Apple. The companies working in technology fields are most prone to risks due to rapid obsolescence involved in technologies that they adopt. So innovation is the key to outsmart the rivals. Apple – the Company Known for Radical Innovations Most firms restrict themselves to incremental innovation year after year; however, Apple belongs to a different league. Radical innovation as opposed to incremental innovation is need of the time as it helps carve a definite niche for the organization in the market place. Innovative approach ascertains a competitive edge over competitors. Usually, radical innovative initiatives come through a visionary leadership style and Apple is a glaring example of it (McDermott & OConnor, 2002). The past history of Apple very well establishes this fact. Steve Jobs visionary thinking and approach was just not restricted to only product designs but he went much beyond. He took initiative and established ‘Apple University’. Guynn (2011) argues, "Steve was looking to his legacy. The idea was to take what is unique about Apple and create a forum that can impart that DNA to future generations of Apple employees". The key objective behind establishing this training institute has been to develop young executives in the footsteps of Steve Jobs so that when he is no more, the company’s growth is not strangulated. It is a fact that Apple has continued to grow with new innovative ideas even after three years of Steve Jobs’ death in 2011. The Apple Inc. is launching a new product smart watch, another innovative product in the month of March, 2015. It is more than a simple watch; it is said to be a fitness monitoring device constantly motivating its user to remain a fitness freak. It is likely to be a unique personal product that will keep its user more efficient, productive and organized. It will tell its users how many calories she or he has burned. Even it detects heart rate while doing a workout (Apple Watch, 2015). Next in the line is a smart autonomous car that will be running on batteries. The point is that the company has been launching totally new and radical products with regular intervals so that its growth story can remain intact. The potential investor is pressing hard to invest in the company that does not stagnate due to market saturation or dearth of innovative ideas and there cannot be a better company than Apple. On cash flow from operations, the company is consistently showing higher cash flows in the last three fiscal years meeting client’s other essential requirement. Risks Involved While the company stock may be a superb candidate for investment, still certain risks are always involved. There is always a systemic risk involved while investing in the equity market. The financial crisis that the US faced in 2008 (subsequently, the whole world) is a glaring example of the systemic risk. Any systemic risk will get the whole market down regardless of the inherent strength of the stock (Schwarcz, 2008). Any investment done just before the onset of systemic risk occurs may depreciate investment value. However, it has been seen that those who invest from a long-term perspective usually recover losses in the days to come. Over and above systemic risk, the company specific risk is also involved. While Apple’s operations are spread across the world and the company runs manufacturing units in the countries other than the US, the company faces foreign exchange risks, risks due to labor unrest, political risks, market failures of its newly launched products and so on. Risk Reduction Strategies Usually, the company management does take into account such risks and take remedial measures. For example, the company mitigates foreign exchange risk by entering into hedging contracts for a portion of its foreign exchange exposures for a full year. The company employs a value-at-risk (VAR) model to calculate the optimum risk involved in such exposures (Annual Inc., 2014). Avoiding Operational Risks The company outsources its component procurement from the several sources to mitigate the suppliers’ risk. While the company designs its products in California, the US, its manufacturing facilities are spread across various locations such as China, Korea, Taiwan, Mongolia. This is how the company mitigates risks associated with a single plant (Kabin, 2013). Similarly, Apple outsources components supply from numerous suppliers the world over so as to have a steady supply to keep its manufacturing plants fully operational. Nevertheless, the investor risks still persist due to uncertainties that exist in the market. Usually, investments in financially strong companies do not get stuck up at lower value for a long time. During uncertainties or difficult market conditions, the investor can hedge her investments by selling a futures contract in the derivatives market so that any losses on her investment will be offset by the profit earned in the derivatives. Other option is to put a stop loss at certain percentage point below the cost price so that losses can be restricted. While buying the Apple stock at $120, stop loss can be put at $108 (10% below the cost price). Recommendation It is amply clear that Apple Inc is a perfect company for investment meeting the investor’s investment profile. While financials can suggest the investment in Apple, the timing of investment is equally important. As such macro economics are better than what has been experienced in the last few years. So there is a least risk as far as significant downward movement is concerned. NASDAQ and Apple both are on the rising trend. Apple stock has already touched $132 a few days back and retreating from there. Apple’s beta is 0.96 that shows volatility with respect to the stock index NASDAQ (Yahoo.com, 2015). It means the shares of Apple move in the direction of the NASDAQ Composite Index by 96 points for every 100 point change in the index. Technically, the market may correct at least by 6-7 percentage points from its top any time within the next few months; at that time, Apple stock will also correct by almost the same percentage from its top; that will be the most opportune time for investment in Apple. Expected correction will bring Apple stock close to $120-$121. The investor is recommended to make investment in Apple around this price. However, a lot will depend upon how Apple’s new launch Smart Watch gets customers’ response in the market place. References Apple Inc (2014). Form 10-K. Retrieved March 1, 2015 from http://investor.apple.com/secfiling.cfm?filingid=1193125-14-383437&cik= Apple Watch (2015). Health and Fitness. Retrieved March 1, 2015 from https://www.apple.com/in/watch/health-and-fitness/ Fidelity (2015). Fixed Income & Bonds. Retrieved March 1, 2015 from https://fixedincome.fidelity.com/ftgw/fi/FILanding?bar=p Fischer, B. (2010). Innovation lessons from Apple. Retrieved March 1, 2015 from http://www.management-issues.com/opinion/6037/innovation-lessons-from-apple/ Guynn, J. (2011). Steve Jobs virtual DNA to be fostered in Apple University. latimes.com. Retrieved March 1, 2015 from http://articles.latimes.com/2011/oct/06/business/la-fi-apple- university-20111006 Fabozzi, F. J. and Drake, P. P. (2009). Finance: Capital Markets, Financial Management, and Investment Management. Wiley. Jones, C. (2015). UBS Apple Analyst EPS Projection Has Room For Upside. Retrieved March 1, 2015 from http://www.forbes.com/sites/chuckjones/2015/01/23/ubs-apple-analyst-eps-projection-has-room-for-upside/ Kabin, B. (2013). Apples iPhone: Designed in California But Manufactured Fast All Around the World. Retrieved March 1, 2015 from http://www.entrepreneur.com/article/228315 Lange, C. (2015). Apples First Analyst Price Target Hike of 2015. Retrieved March 2, 2015 from http://247wallst.com/technology-3/2015/01/02/apple-gets-first-analyst-price-target-hike-of-2015/ McDermott, C. M. & OConnor, G. C. (2002). Managing radical innovation: an overview of emergent strategy issues. Journal of Product Innovation Management. Elsevier. 19 (6). 424- 438. Schwarcz, S. L. (2008). Systemic Risk. The Georgetown Law Journal. 97:193. Also Available at http://georgetownlawjournal.org/files/pdf/97-1/Schwarcz.PDF Yahoo.com (2015). Apple Inc. Retrieved March 1, 2015 from https://in.finance.yahoo.com/q/hp?s=AAPL Read More