Stock Market Evaluation For Apple Inc
1. COMPANY DESCRIPTION AND PERFORMANCE OVERVIEW
Apple, Inc. (AAPL) is an American consumer electronics, computer software, and personal computer company that designs and markets products for consumers worldwide. Most notably, Apple, Inc. is known for:
; ? the Macintosh computer line
; ? the iPod
; ? the iPhone
; ? the iPad
; ? iTunes
along with a host of accompanying software and operating systems. These offerings are available at any of Apple, Inc.’s 301 retail stores (in ten countries), in other retail stores
(e.g., Wal-Mart, At & T, Best Buy etc.) and through the company’s online store.
Fiscal year 2010 saw positive gains from Apple, Inc. With 49,400 employees worldwide, the company garnered $65.23 billion in sales and $14.01 billion in profits. Apple, Inc. also increased its total assets to $75.18 billion along with $47.79 billion in total equity. The company’s recent success is largely due to the announcement and launch of the iPad (January/April 2010) and the fourth generation iPhone (June 2010). Sales of the iPad reached 500,000 units in the first week leading to the first time since 1989 that Apple’s market cap exceeded that of its competitor, Microsoft. In October 2010, Apple, Inc.’s stock price reached an unprecedented high, surpassing $300 per share. Apple’s 2010 success is the result of a 2007 shift of company emphasis from personal
computers to mobile electronic devices. Formerly known as Apple Computer, Inc., Apple, Inc. dropped the word “computer” from its name to reflect its new focus and subsequently released the iPhone and Apple TV. The following day, Apple shares reached what was then an all-time high of $97.80. Four months later, the price per share surpassed $100. The steady stock price increase continued with the launch of the App Store and the continued dominance and popularity of the iPhone, netting Apple its best
non-holiday quarter (Q1 2009) with $8.16 billion in sales and $1.21 billion in profits, all amidst a considerable recession. Though Apple, Inc. continues to design and market personal computers, its emphasis on mobile electronics has spurred its recent market success.
2. APPLE COMPUTER SWOT ANALYSIS
Apple is a true pioneer in designing new products that are intuitive, easy to use, fun and exciting.
Apple’s CEO and Founder, Steve Jobs, is a true genius in identifying and designing
sophisticated products that are revered by its customer base.
Apple has a very short lead time to bring innovation to market. The company is large enough and has enough cash that it can bring innovation to market quickly, even if it means, for example, buying a supplier to get the exact material needed. Apple has significant intellectual property that is covered by patents. If the patents are written to truly box out the competition some of their products will not commoditize as quickly.
Apple is on top of the digital media distribution with its iTunes application. iTunes also allows Apple to sell more of its high margin products like iPods.
Apple is positioned to be the top magazine and press distributor of the future through distribution on it’s iPad.
Apple products are easy to use and fun.
Apple products are visually appealing. Apple patents the geometric “ornamentation” of their products.
Apple has a loyal customer base that is willing to pay a higher price for its products. Apple has a strong brand name.
Hewlett Packard, Dell and other manufacturers Apple’s competitors have a tough time in
keeping up with new product introduction pace.
The iPad tablet allows users to buy a less expensive alternative from a laptop in a down economy.
Through strong innovations Apple is increasing its customer base every day. With the introduction of iPhone and iPad, Apple has integrated several customer needs (smart phone, music player, e-book, netbook etc) in one products.
Competition for Apple products is fierce. Patents sometimes do not prevent competition from quickly attempting to commoditize the Apple’s products.
Apple’s smartphone operating system is not as good open as Google’s Android operating
system. Many upcoming tablet makers (Samsung, Archos, Lenovo Creative and others) can compete with iPad because they will use the more popular Android OS which incorporates the Flash software which is used by many websites.
Apple prices are higher than competitors.
Notwithstanding its popularity, a big set of consumers do not like Apple’s “closed” culture, its dictatorial, arbitrary and whimsical decision-making process. Apple has suffered in sticking with AT & T as the primary carrier of its iPhone products whose wireless is not good and widespread as Verizon.
Few companies are so much dependent on one person, as Apple is with Steve Jobs. Thus there is significance nervousness on the future of Apple when Steve Job retires or dies. Apple has limited diversity in their product lines. Competitors offer more choice of options on hardware, software, sizes, and features.
Apple may be a bottleneck to free press in its position as music, magazine and press distributor. The company recently refused to put the latest Esquire magazine in it’s iPad
because the magazine showed a women in her underwear and did not meet Apple’s decency standards.
Apple has been the most-sued technology company since 2008, the year after the iPhone was introduced, topping Microsoft, Hewlett-Packard and Dell, according to LegalMetric, a compiler of litigation data based in St. Louis.
Apple has recently relaxed restrictions on developers and now allows them to use third-party software, such as Flash to make applications run on their portable devices. User satisfaction will be higher because many of the popular applications use Flash. Apple used to require that any software used to create applications for its portable devices must be written to run directly on their operating system.
Rumor has it that Apple will introduce Verizon iPhone in near future that will expand its popular product to a new customer base.
Apple’s share of the worldwide computer market is small, at about 4.2%. But the
company’s market share in traditional computing is growing rapidly, thanks to a powerful
“halo effect” from iPhone and iPad users that are increasingly switching from Windows PC to Macs.
Apple has stepped up its war with Google who dominates global mobile ads with the launch of its iAd mobile phone advertising in Europe. iAd, allows software developers to display advertisements within mobile applications. Two dozen commercial partners, including L'Oréal, Louis Vuitton, Absolute Radio and Perrier, have already signed up for iAd. More than half of the US top 25 advertisers have signed up since it launched in June, Apple claims.
Within the next 3 to 5 years, Apple can most likely squeeze netbooks out of the market with tablets and lower-priced laptops if Apple continues to develop better web capabilities, a wider array of features, and better operating systems. Apple Inc. appointed former Northrop Grumman Corp. Chief Executive Ronald D. Sugar to its board who in his past experience managed websites and protected computer systems against hackers. Sugar may make a huge impact on Apples ability to convince consumers its ability to thwart off hackers.
Apple’s biggest threat is the sustainability of its growth as competitors catch up with innovations and provide alternative products. It constantly needs innovations and new product introductions that will be harder to do as market gets saturated with smartphones, MP3 players and tablets.
If Apple wants to operate in China it has to follow the rules of the Communist government, which does not want its citizens accessing politically sensitive information. Political care must be exercised if Apple wants to tap into the huge Chinese market.
Many times application developers choose not to list on the Chinese online store because they don't want to create their program in Chinese, said Si Shen, CEO of PapayaMobile, an Android-based gaming platform. Apple must incentivize developers to create the applications in Chinese.
There have been a number of vulnerabilities detected in Apple’s iOS software and Safari browser that render the firm’s latest handheld devices susceptible to cyber attack. In fact,
the security bugs, more and more common in the mobile world, could enable hackers to take total control of an inexperienced user’s iPhone or iPad, and wreak havoc by listening
in on phone calls, intercepting e-mails, and/or appropriating sensitive information.
3. ESTIMATING THE INTRINSIC VALUE OF APPLE INC.
Based on our SWOT analysis, we will now describe the assumptions that we have made in evaluating the value line projections for Apple Inc. as produced in the spreadsheet.
Estimated Growth Rate and Growth Forecast:
Apple is having amazing growth in recent years. During the last five years, revenue grew some 35%, income grew by 57%, EPS grew from 2.5 in 2005 to an amazing 16 (chart 2) in the last quarter. The ROIC value grew from 20 to around 30 today (chart 1). Accordingly, there stock value also jumped from $70 to more than $300 today. In the last 10 years Apple's stock value jumped by an astonishing 3000% (from around $10 to $300 today).
The future growth rate of a company is a function of Return On Invested Capital (ROIC), retention rate and other factors like economy and the competitions.
ROIC = NOPAT/Invested Capital
ROIC = (Net Income + Interest)/(Debt + equity) .
Apple’s interest and debt are zero.
ROIC = Net income/Equity = 14013/47791 = 29.32
High ROIC value of 29.32 for 2010 is justified because the company has established a price premium. Its MacBook brand of laptops cost significantly more than other brands of laptop computers. Its MP3 and MP4 players (i.e. iPod Classic, iPod Touch, iPhone, iPad, etc.) also cost significantly more than other brands of MP3 and MP4 players. However, Apple cannot sustain these advantages over time as other competitors like Samsung, Sony, Google etc. have already started to make inroads into its markets. Therefore, we will project progressively lower ROICs during the forecast periods.
Apple’s retention ratio is 1.00 since it does not provide any dividend after 12/15/1995.
The overall market for MP3/MP4/tablet players is still in its nascent stage which explains the extremely high growth percentage of Apple as compared to U.S. GDP. As this market matures and more competitors introduce rival products, Apple’s growth rate will diminish in the years to come. It is a mathematical/economical certainty that high growth rates of all companies decay very quickly and large companies struggle to continue growing. However, in the short term we believe they have still some room to grow. Rivals are just starting to catch up in some of its lucrative market like smart phones and digital players. But still, nobody seems to have an answer for its lucrative iTunes music store.
Therefore, in our model, we have reduced the value of this ratio from 29% in 2010 to 6% in 2021 in a progressive fashion.
Operating margin is computed as EBIT/Sales. For the year 2010, it is 29% or 0.29. It is dependent on historical patterns as well as changes in market conditions. We believe that operating margin will remain relatively stable during the forecast period as sales increase so is the earnings and vice versa keeping the OE constant.
From Apple Computer’s Income Statement of 2010, we get the effective actual tax rate as 24%. We will continue to use this tax rate for the entire forecast period.
Estimated Capital Growth Rate:
Capital growth reflects the increase in value of any capital assets that are current part of the financial portfolio. Most Apple products are produced by FoxConn, a contract manufacturer based in China. A high estimated capital growth rate is not a prerequisite for the company to grow and produce more quantity of products. Therefore, we adjust the estimated growth rate by a small margin to arrive at the figures for estimated capital growth rate. We expect this growth rate to be stable as increasing efficiencies in the manufacturing process counter increasing depreciation of the capital equipment.
Free Cash Flow Growth:
The growth in this category has been astonishing again for Apple in the last few years. Free Cash Flow has grown from 2.6 in 2005 to 17.0 now (chart 2). Its capital spending grew by 49% in the last 5 years. But the ratio of capital spending over Equity ratio is declining for the last three years (chart 3). We believe this is due to the outsourcing of most of their manufacturing to FoxConn. However, as Apple ventures into new product lines, it needs to invest in R & D. It’s spending on Research and Development grew by 27% in last 5 years and 34% in the last three years. This tells us that Apple’s R&D spending is accelerating. However, since the revenue and income grew bigger than the R&D spending, their revenue and income per employee is increasing (chart 4) even with the addition of more employees. All these are leading to the growth in their Free Cash Flow. In the long term, however we believe their Free Cash Flow growth will stabilize and perhaps even slow down as rivals catch up with them.
Risk Free Rate:
Per convention from the text book, we have used 10 years Treasury bill rate as risk free rate. That value as of 11/19/10 is 2.88%. The corresponding 20 year Treasury bill rate on the same date is 3.91% and 30 year rate is 4.25%. We thought that using 20 years rate is a good balance keeping in mind the current uncertain economic conditions.
Market Risk Premium:
Market Risk Premium is calculated by deducting risk free rate from the market index. Historically that rate is around 7.1% per Morningstar. Since the market is coming out of recession we expect the market index to be higher than the average historical value. However, we are not overly optimistic at this point about the robust growth, as the recovery looks quite anemic so far. Also, market has already priced in some of the growth. Nevertheless, since the risk free rate is pretty low, we believe having 8% risk premium is pretty reasonable.
Long Term Growth Rate:
The U.S. and most of the world markets are just coming out of a recession. The U.S. economy, as indicated by GDP, is bound to grow slowly but steadily for the next 2-5 years. The GDP growth in the last quarter was only around 2%. However, we believe growth is going to pick up soon and give us around 4% growth over the long term. However, Apple’s competitors here in the U.S. as well as abroad are also poised for growth as well. Apple’s brand is highly dependent on the personality of just one person, namely its CEO, Steve Jobs, as opposed to its competitors.
4. VIEWS ON APPLE STOCK
Apple had an amazing run for the last few years and we believe that is unsustainable in the long term. As we have shown in our spreadsheet we are reducing Apple’s growth progressively for the next 10 years. Thus, based on our analysis we will rate the stock as “buy” for the short term (next 3-5 years) and “outperform” for the long term. If somebody already owns the Apple stock
and had been owning for the last few years our advice would be to take some profit here now (say selling 25% of the Apple holding).
I am on the fence about buying the stock. I definitely believe that we should Not sell the stock but at such a high price and a forecast of continued but slow growth due to competition, am just not sure it is a wise investment. Will it truly continue to increase its worth? By how much? And would we get a large return or just breakeven. For a short term investment it might be worth it but for a long term investment is the risk worth it? I would prefer to have everyone’s opinion before I write my section.
Chart 1 (Source ADVFN)
Chart 2 (Source ADVFN)
Chart 3 (Source ADVFN)
Chart 4 (Source ADVFN)
Chart 5 (Source ADVFN)