Apple Inc. Report

Apple’s revenue and earnings per share growth slowed after 2012 but was still strong at about 15% annually for the past five years. The book value per share level is not at all an important indicator for Apple and it was pulled down by share buy backs. Apple has warned of slower growth in Q1 set to be reported January 29.

Apple Inc. (AAPL, U.S.)
RESEARCH SUMMARY  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold no shares
Based on financials from: Sept. ’18 Y.E.
Last updated: January 23, 2019
Share Price At Date of Last Update:  $                            153.92
Currency: $ U.S.
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Speculative Buy
Has Wonderful Economics? Yes, clearly
Has Excellent and Trustworthy Management? Yes
Likely to grow earnings per share at an attractive rate over the next decade? Slowing
Valuation? Attractive with 13.6 P/E
SUMMARY AND RATING:  The graph of revenues per share (red line) shows strong and steady gains as does the graph of earnings per share growth.  The Value ratios, in isolation, would appear to indicate a (higher) Buy. Management quality appears to be strong. The insider trading signal is moderately negative but is not an important indicator. Executive compensation is very high but not a concern given the size of the company. The outlook is somewhat uncertain as the company has warned that its soon-to-be-reported Q1 will show lower sales in China and generally slower growth. The economics of the business are exceptionally good with high profit margins. It has strong competitive advantages in its large base of customers who generally stay with its products. Overall we would rate this as a Speculative Buy. A reasonable strategy for investors new to this stock would be to wait for the Q1 results or to make a small initial purchase and then re-evaluate after the Q1 earnings are reported.
LONG TERM VALUE CREATION: Apple has clearly created tremendous value for share holders over the longer term.
DESCRIPTION OF BUSINESS: Apple designs, manufactures and markets its well known devices as well as associated software and services. Current products include iPhone, iPad, Mac, Apple Watch, AirPods, Apple TV, and HomePod. Additional services include iCloud and Apple Pay.  Software and services are also sold through its online stores. The company sells directly as well as through (primarily) cell phone network provider partners. As of September, 2018 the company had about 132,000 full-time equivalent employees. In fiscal 2018 its revenue  by product was 63% from iPhones, 10% from Mac, 7% from iPad, 7% from other products (includes AirPods, Apple TV, Apple watch, Beats and others) plus 14% from services which includes iTunes, AppleCare, Apple Pay, licencing and other services). Geographically, the revenue sources were: North & South America 42%, Europe 23%, China including Taiwan and Hong Kong 20%, Japan 8% and Rest of Asia Pacific 7%.
ECONOMICS OF THE BUSINESS: The economics of the business are exceptionally good with a 49% ROE despite its huge holdings of cash and marketable securities. It’s bottom line profit margin is 22% and its gross margin in 2018 was 38%.
RISKS: The annual report lists numerous risks. One o f the most relevant risks would be cheaper competitor products and also the fact that the iPhone replacement cycle could lengthen as the product has matured and there is less need to upgrade frequently.
INSIDER TRADING / INSIDER HOLDING: There have been some large recent insider sales including by the CEO. This is not unusual but overall we would judge the insider trading signal to be somewhat negative.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (pass, given the consumer nature of its products and that its product line is now relatively mature), has favorable long-term economics due to cost advantages or superior brand power (pass due to brand loyalty and high margins), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (pass, the P/E ratio seems modest in relation to growth or fail and why), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)
MOST RECENT EARNINGS AND SALES TREND: Revenue per share growth in the past four quarters beginning with the most recent (Q4 ended September 29, 2018) was 28%, 24%, 20% and 16%. Earnings per share growth in these same quarters was 41%, 40%, 30%, 16%. Revenues per share were up 22% in fiscal 2018 and earnings per share were up 29%. This is very strong growth but indications are that the soon-to-be reported Q1 saw little or no growth.
COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS: In the fiscal year ended September 29, 2018, iPhone unit sales were up 0%, iPad unit sales were also about unchanged and Mac unit sales were down 5%. Indications are that volumes probably declined in the soon-to-be reported Q1 of fiscal 2019.
Earnings Growth Scenario and Justifiable P/E: The P/E of 13 appears to be pricing in relatively modest and lower growth of around 6% annually.
VALUE RATIOS: Analysed at a price of $153.92. The price to book ratio is of little or no relevance for this company but is nominally unattractive at 7.0. The dividend yield is modest at 1.9% and is based one relatively low payout ratio of 24%. The yield is low mostly because the shares trade so far above book value. The P/E ratio is attractive at 12.9. The ROE is very high at 49% and that is despite the fact that 65% of the assets are invested in marketable securities and cash which earn very little. Revenues per share have grown at a strong rate of 15% over the past five years and earnings per share growth has averaged 16%. We calculate an intrinsic value of $151 if earnings grow more slowly at 6% and the P/E drops moderately 10 12 and $241 if earnings per share grow at 12% and the P/E rises moderately to 15. Overall, the value ratios, in isolation would support a (higher) Buy rating.
SUPPORTING RESEARCH AND ANALYSIS  
Symbol and Exchange: Apple
Currency: $ U.S.
Contact: (408) 974-3123
Web-site: www.apple.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS  
Latest four quarters annual sales $ millions: $265,595.0
Latest four quarters annual earnings $ millions: $59,531.0
P/E ratio based on latest four quarters earnings: 12.9
Latest four quarters annual earnings, adjusted, $ millions: $59,531.0
BASIS OR SOURCE OF ADJUSTED EARNINGS: No adjustments were made. There were likely some unusual gains and losses but we have not researched those.
Quality of Earnings Measurement and Persistence: Earnings per share growth has been persistent but is expected to slow
P/E ratio based on latest four quarters earnings, adjusted 12.9
Latest fiscal year annual earnings: $59,531.0
P/E ratio based on latest fiscal year earnings: 12.9
Fiscal earnings adjusted: $59,531.0
P/E ratio for fiscal earnings adjusted: 12.9
Latest four quarters profit as percent of sales 22.4%
Dividend Yield: 1.9%
Price / Sales Ratio 2.90
BALANCE SHEET ITEMS  
Price to (diluted) book value ratio:                                         6.96
Balance Sheet: As of fiscal 2018 year end, September 29, 2018 the book assets are comprised as follows: 58% are marketable securities, 7% cash, 13% accounts receivables and vendor non-trade receivables, 11% property plant and equipment, 9% other assets which includes derivatives and just 1% inventories. What is notable here is the huge 65% in cash and marketable securities. Also there appears to little in the way of capitalized product development costs which could indicate conservative accounting. Apple’s true value is largely unrepresented in this balance sheet. There is very little inventory which may reflect that out-sourced vendors carry the inventory. On the other side of the balance sheet, these assets are supported as follows: 29% common equity, 31% debt, 15% accounts payable, 21% other liabilities (much of which is long-term taxes payable – which may represent the deemed repatriation tax that is payable over time). 3% deferred revenue. This is a very strong balance sheet.
Quality of Net Assets (Book Equity Value): This is not really relevant for a company selling at a recent 7 times book value.
Number of Diluted common shares in millions:                              4,847.6
Controlling Shareholder: We were unable to find information on this in the proxy circular. We believe that there is no controlling shareholder as such.
Market Equity Capitalization (Value) $ millions: $746,134.9
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 29.3%
Interest-bearing debt as a percentage of common equity 107%
Current assets / current liabilities: 1.1
Liquidity and capital structure: Apple has vastly more cash and marketable securities and therefor liquidity than needed.
RETURN ON EQUITY AND ON MARKET VALUE  
Latest four quarters adjusted (if applicable) net income return on average equity: 49.4%
Latest fiscal year adjusted (if applicable) net income return on average equity: 49.4%
Adjusted (if applicable) latest four quarters return on market capitalization: 8.0%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE  
5 years compounded growth in sales/share 15.2%
Volatility of sales growth per share:  $                                  –  
5 Years compounded growth in earnings/share 16.0%
5 years compounded growth in adjusted earnings per share 16.0%
Volatility of earnings growth:  $                                  –  
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 37.6%
More conservative estimate of compounded growth in earnings per share over the forecast period: 6.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 12.0%
OUTLOOK FOR BUSINESS: Analysts appear to be forecasting a 12% increase in earnings per share for 2019. But that could be optimistic given declining unit sales of the iPhone.
LONG TERM PREDICTABILITY: It seems likely that Apple will continue to grow but at a much more modest rate. It is possible that the installed base of iPhones will continue to grow slowly but that unit sales will be lower due to a longer replacement cycle.
Estimated present value per share: We calculate  $151 if adjusted earnings per share grow for 5 years at the more conservative rate of 6% and the shares can then be sold at a P/E of 12 and $241 if adjusted earnings per share grow at the more optimistic rate of 12% for 5 years and the shares can then be sold at a P/E of 12. Both estimates use a 7.0% required rate of return.
ADDITIONAL COMMENTS  
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (pass). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass), No potential for substitute products (pass No tendency to compete ruinously on price (pass). Overall this industry appears to be very attractive for Apple as an established incumbent.
COMPETITIVE ADVANTAGE: Apple’s competitive advantage at this lies in it dominant brand position and huge installed base of customers that are loyal to the brand because they like the products and/or because it is very inconvenient to switch brands.
COMPETITIVE POSITION: Apple has a dominant position in the cell phone market North America
RECENT EVENTS: Apple has “warned” that its sales in its soon-to-be-reported Q1 will be lower than originally anticipated and that sales in China were particularly weak.
ACCOUNTING AND DISCLOSURE ISSUES: We have not identified any concerns.
COMMON SHARE STRUCTURE USED: Normal, 1 vote per share
MANAGEMENT QUALITY: Management quality appears to be good although they may still be coasting on the vision of Steve Jobs to some extent.
Capital Allocation Skills: The core business has not required massive amounts of capital. The company has probably retained more cash than it needed to but. The wisdom of the most recent share buy backs at prices higher than the current share price remains to be seen.
EXECUTIVE COMPENSATION: Executive compensation can be described as obese with four of the named officers compensated at about $26 million for 2018 largely in the form of stock options. It may paint a picture of a Board that (erroneously) believes that stock options are not a real expense.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. The small, eight member Board here is composed mostly of current or former CEOs of very large companies (including Disney and Boeing). It also includes representation from investment managers. And it includes Al Gore. Overall, it is probably a good Board, one that would not be beholden to the CEO.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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