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Published on the Money Magazine - March 2013 edition
Apple's share price has made whopping gains, but its stock value has plummeted. What is shaking the tree?
Last year, Apple Inc. surpassed ExxonMobil Corporation to become the world's largest company by market capitalisation. Its share price increased from $400 in January 2012 to $700 in September 2012, a whopping gain of 75% over 9 months. The stock’s value however plummeted from its peak in September to $500 in December, reducing the overall gain for 2012 to 25%. This sudden drop attracted our attention and in this article we will assess the possible causes of this drop.
Many cited the anticipation of higher US tax rates on capital gains as the primary reason that started the sell-off last September. Those who argued on this basis claimed that the gain registered by Apple during 2012 was much larger than that of other stocks, and so it follows that the selling pressures should likewise be large. This argument is not water-tight because an investor who does not want to part from this stock could still have been tax efficient by selling the stock and buying it again soon after. With hindsight we confirm that the fiscal issues were not the cause of the sell-off because the share price did not recover between 1 January 2013 and the time of writing. Conversely, its direction continued moving in negative territory.
The decline in interest in Apple therefore must be linked to its outlook. Indeed Apple’s future is grey with the increased presence Samsung now has and the lack of innovation inherent in the products that were recently launched (the iPad mini and the iPhone 5 seem to have been merely recycled from older models). Apple seems to have been more focused on fending off competition by suing Samsung on a number of patent issues rather than focusing on innovation. In addition, key people are not with the company any longer. The company fell apart when Steve Jobs was asked to leave by Apple’s board of directors in 1985 – will the same happen again? Other key innovators have left Apple too. Scott Forstall, a software engineer with 166 pending patent applications (more than anyone else at Apple) and the architect of the iOS resigned recently. This makes him available to Apple’s competitors – and that cannot be good for Apple. The market sentiment seems to express the worry that Apple may become the next Research In Motion (best known for the Blackberry smartphone).
Naturally Apple enthusiasts shrug off these issues. They claim that Android and Samsung are actually filling a market which Apple itself engineered in the first place, that the demand for Apple products is still strong (Apple’s high-end PCs and software are considered industry standard in the film, design and music industries) and the Apple’s products enjoy an exceptional brand loyalty. Above all, Apple’s strength lies in its design – Apple products are cool and they will continue to be in high demand until their aesthetics stop standing from the crowd.
In the next part of this article we will analyse the financial health of the company and will try to assess the challenges that the future holds for Apple.
Apple's financial position is strong. It does not have long term borrowings on its balance sheet and its business generates tremendous cash flows, estimated at $40 billion annually. Its gross margin and return on equity increased almost every year during the last 10 years (refer to Table 1 below). Strong growth in these ratios was also registered over the last 4 years shrugging off the effects of the financial crisis. What is more important is that profitability levels were not adversely affected by increased competition – on the contrary, Apple performed even better financially.
|Gross Profit %||28%||28%||27%||
|Inventory as a % of WC||1%||2%||2%||2%||3%||2%||2%||5%||5%||4%|
|Debt / Equity||0.54 x||0.61 x||0.59 x||0.55 x||0.74 x||0.88 x||0.50 x||0.57 x||0.52 x||0.49 x|
|Acid Test Ratio||3.22 x||2.47 x||2.62 x||2.91 x||2.33 x||2.43 x||2.70 x||1.96 x||1.58 x||1.48 x|
Apple accumulated a stockpile of cash to the tune of $121 billion, which as Tim Cook (Apple's CEO) himself said in an interview to Bloomberg Business weekly, is invested in "the most conservative instruments known to man". This puts the company in a solid position not only from a balance sheet point of view but it also reassures its shareholders that the company has enough resources to finance future growth and research.
The finances of the company are solid so the next step is analysing whether the stock is expensive. The share price is selling at a price/earnings ratio of around 11.5 at the time of writing, meaning that an investor pays $11.5 for every $1 that Apple is currently earning. To put this in perspective, buying property as a rental investment typically involves paying €20 for every €1 of rent the property yields (or in other words earns a 5% return). Stocks that hold huge potential have very high price/earnings ratios whereas companies that are not positioned to grow sell at price/earnings ratios close to the range that Apple is currently trading.
This is a key point that we believe many people overlook. The price/earnings ratio of Apple is already fair, possibly factoring into consideration the challenges mentioned above. In principle, an investor who does not buy the Apple stock because he worries about its future would be double counting the Apple’s risk profile since its risks emanating from increased competition or reduced innovation arguably are factored in already.
Apple is not only a ‘cash cow’ but may hold potential for growth. After all, Apple's strengths lies in taking an existing product and makes it wanted by market. Apple did not create the mp3 player, the smartphone or the tablet pc but it definitely transformed the products available on the market and made them both desirable and must-have.
Looking forward, according to market intelligence the TV set (not the Apple TV) is in Apple’s pipeline. It will not be surprising if Apple transforms a low-margin product (and dominated by Apple’s arch-rival, Samsung) into a must-have revolutionary product. The demise of Steve Jobs is the factor that raises doubts on whether this trend can be sustained however - is it possible that the largest company in the world depended on one man's work alone? Apple has a strong management team (most of whom were recruited by Steve Jobs himself) and it is hoped that they are able to carry on Steve's ideology.
Probably, the market overreacted to the challenge that Apple is facing but on the other hand, the vicissitudes of the technology industry makes this sector a tricky one – a company typically either does very well or not well at all (think of Blackberry again). At the current price/earnings ratio, the acquisition of Apple stock makes a good addition to one’s portfolio, but the investor should keeping the afore-mentioned opposing forces clearly in mind and mitigate his risk position accordingly (by for example, but not only, ensuring that he holds a well-diversified investment portfolio and manages his exposure to Apple Inc.).
The views and opinions expressed in this article are solely of the authors and do not reflect the views of the users of the website, its affiliates or of any financial institution. This article is published solely for informational purposes and is not to be construed as a personal recommendation, a solicitation or an offer to buy or sell any securities or related financial instruments.
Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. The authors do not accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
Chris (6 years ago)
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