Apple Investment and Financial Analysis

Apple Inc. Investment Analysis and Recommendations

Apple Inc. is an American multinational company specializing in designing and producing mobile telecommunication devices that include iPhone, computer software and hardware, Apple TV, Apple Watch, iPod, and other electronic devices. Apple was incorporated and publicly registered in 1977. Headquartered in California, Apple is one of the most successful American companies in term of revenue with the annual revenue reaching $233.7 billion at the end of 2015 fiscal year. On February 2016, Apple recorded $521.3 billion worth of market capitalization. While Apple designs the bulk of their products in the United States, the company's manufacturing plants are located in China. Apple also operates in Europe, Japan, Canada, and Latin America. (Apple Inc. 2015).

Board of Directors

Apple Inc. Board of Directors is overseeing by the company CEO (Chief Executive Officer) and other competent senior management. The Board oversees the day-to-day operations of the company as well as assuring the shareholder's long-term interests. Moreover, Apple Inc. Boards take the proactive approach to set the ethical standards by maintaining high ethical approach and responsibility. Based on the information in the proxy statement, Apple Inc. Board of Directors consists of 8 members from the information in the 2015 annual report. (Apple, 2015). Annually, the shareholders elect the Board member and select leaders based on their competencies, attributes, and experiences. Thus, the Apple proxy states the biographic data experiences, and attribute of each member of the board. The proxy statement also provides information regarding the Board member selection process, the composition of committee and committee charter. (Apple Inc. 2015).

Monitoring of potential Apple's Board of Directors

Apple's Boards believes in using their current leadership to achieve the company objectives. The board also believes in enhancing the corporate governance by periodically reviewing the leadership structure to meet shareholders' interests. In arriving these obligations, Apple's Board composes of a group of leaders with a diverse background in finances, risk management, and senior leadership. However, Apple set up different committees to monitor the activities of the Board members. (Adjaoud, & Ben-Amar, 2010). The Audit and Finance Committee is responsible for monitoring and overseeing Apple's financial statements as well as other financial information. The committee also oversees that the company financial statements and reporting to comply with legal, ethical, and regulatory requirements. Moreover, the committee oversees the internal control systems and data security. (Mukherji, 2002).

On the other hand, the Compensation Committee is responsible for reviewing and approving Board's compensation and company's executive officers. The Compensation Committee is also responsible for administering equity compensation plan for the Board member and perform other duties as being set forth by the company charter. The Nominating and Corporate committee are also one of the Apple's committees responsible for implementing a periodic reporting on the matter responsible for selection, identification, and qualification of Board members. (Adjaoud, & Ben-Amar, 2010). The committee is also responsible for making recommendations for the selection of competent candidate to the Board. However, Governance committee advises and recommends critical matters to the board. They also recommend a modification of policies to Board as deemed appropriate and assigned by laws. (Kotler, & Keller, 2012).

Strengths and Weaknesses Apple's Board Structure

One of the strengths of the Apple's Board lies in the leadership skills of the board's member. For example, Tim Cook, who is the (CEO Chief Executive Officer) has an accumulation of experience in strategic global operations. Apart from Cook advanced educational background, he has also accumulated a wealth of experience in strategic supply chain, and product inventory. Other members of the Board also have working experiences in their related positions. For example, Luca Maestri, who is Apple Chief Financial Officer has more than 25 years of working experience as a Finance and Corporate Controller. Moreover, he has been a been a global leader building finance teams for different global companies. The working experience and advanced educational qualifications of the Board's members have assisted Apple to record superior performances year by year.

Another strength of the board is the performances and composition of the audit committee. The audit committee assists the board to implement the ethical financial controls that assist the company to abide by the GAAP financial requirements. The audit committee also implements the risk managements process at the enterprises level. Another strength of the Board is by setting appropriate internal control systems to ensure that the organization complies with the findings of internal auditors and independent auditors.

Despite the strength of Apple Board members, the shortcoming of the Board is that Tim Cook has not been able to provide a unique leadership style that Steve Job has left behind. Typically, Steve Job legacy was still the core products and services that continue to drive up revenue for Apple Inc. Apple Watch, which is the post Job release is yet to impress customers Moreover, the iPhone 6 Plus does not require leadership to develop because the design is reciprocal of the previous iPhones that Apple has developed. Apple needs to increase the Board members and include a more visionary member to maintain the company revenue growth.

Ethical Concerns

Apple's Board has tried to implement the ethical standards in all the countries they operate by encouraging all its employees to implement appropriate ethical conducts. Apple main principles are based on respect, honesty, integrity, compliance, and confidentiality, which have been the code of business for the company for more than two decades both in the United States and outside the United States. Apple Audit Committee has also assisted in enhancing the ethical standards by ensuring that Apple provides the ethical financial reports free of frauds. Moreover, the Board also performs the factory audit and adhere to "Supplier Code of Conduct, which is one of the strictest in the industry.."(Apple, 2015 p 1). Typically, Apple provides support for the suppliers to assist them operating effectively. Apple set standards for their supplier, and all suppliers are to meet these standards, hence, holds their suppliers accountable for the product supplied. The company may refuse to do business with suppliers that do not abide by the code of conduct.

Despite the company ethical standards, Apple has still faced some ethical issues that have affected the company's reputations. For example, some iPhone users have lodged a complaint that their iPhones collect the user locations, which has been identified as an infringement on consumer's privacy. Although, Apple announced that users can disable this feature, nevertheless, some phones still collect user location information after the feature has been disabled.

Analysis of Apple Income statements and Balance Sheets and Microsoft

Apple operates in highly competitive business environments, and the top competitors are Samsung, Microsoft, Hewlett-Packard, Dell, and Nokia. The study selects Microsoft as the top competitor of the Apple Inc. and to carry out the competitive analysis. Microsoft Corporation is an American multinational company specializing in manufacturing and marketing of the smart phones, computer, software and computing devices. Both Apple and Microsoft are listed in the major U.S. stock exchanges and raise funds by selling shares to the public. (Microsoft Corporation, 2015). Table 1 compares the financial statements of both companies between 2013 and 2015.

Table 1: Apple and Microsoft Financial Statements for 2015, 2014, and 2013 ($ millions)

DuPont Identity

The report compares the Dupont Identity of both Apple and Microsoft between 2013 and 2015. The Dupont identity is the financial information that provides a firm ROE (return on equity) that is represented by the profit margin, equity multiplier, and total asset turnover. The Dupont calculation assists in determining firms' potential values based on their financial performances. Table 2 presents the Dupont Identity of both Apple and Microsoft between 2013 and 2015.

Table 2: Dupont Identity of Apple and Microsoft between 2013 and 2015

Differences and Trends

As being revealed in table 1, Apple Inc. performs better than Microsoft in term financial performances between 2013 and 2015. Apple net income increased from $37.0 Billion to $53.3 Billion between 2013 and 2015. However, Microsoft net income decreased from $21.8 Billion to $12.1 Billion between 2013 and 2015. Although, both companies increase the values of the total assets during the period, however, Apple recorded more revenue than Microsoft between 2013 and 2015. As being revealed in Table 2, Apple performed excellently in the ROE than Microsoft. The ROE of Apple Inc. increased from 30.64% to 47.86% between 2013 and 2015. Contrarily, the ROE of Microsoft declines from 30.09% to 14.36% between 2013 and 2015. The factor responsible for a decline in the ROE of Microsoft is that the company recorded a decline in the net income during the period. Although, both Apple and Microsoft recorded positive net income and revenue between 2013 and 2015, however, Apple recorded an increase in the profit margin from 21.67% to 22.85% between 2013 and 2015, however, Microsoft recorded a decline in the profit margin during the same period.

On the other hand, "Apple exhibited improved financial stability during the review year. It generated revenues of U.S.$233,715 million in FY2015 as compared to U.S.$182,795 million in FY2104, representing an annual growth of 27.9%. This was primarily due to 52% higher retail sales recorded by iPhone, 6% by Mac, 10% by services and 20% by other products. The Higher revenue of the iPhone division could be attributed to strong demand for iPhone 6 and 6 Plus. iPhone's unit sale increased by 37% over FY2014. The Mac's revenue increased due to strong demand for Mac portables." (Globaldata, 2016, p 3).

Apple's Dividend Growth Rate

A dividend growth model is a financial analysis that analyzes how firms pay their dividends under the following conditions:

• Zero growth, • differential growth, and • constant growth. (Ross, Westerfield, & Jaffe, 2013).

As being revealed in Table 3, Apple dividends growth for 2015 fiscal year is 30.20% using the H. model with the calculation using the following formula:

Dividend growth rate: Retention rate x Asset turnover x Profit margin x Financial leverage

Dividend growth rate = 0.86 x 50.86 x 23.04 x 1.79 = 30.20%.

Table 3; Apple Inc. Dividend Growth

Issues Relating to Growth Model

A growth model calculation requires a speculation to forecast the future dividends. However, Apple Inc. has been paying their shareholders the dividends yearly, which are steady since 2013. The future payout depends on the company net income growth rate. However, Apple has been constant in paying out the quarterly dividends to shareholders since 1995, and two payouts occurred in 2012. Despite the company superior performances, Apple needs to record a growth rate in revenue and net income to ensure that the company maintains the increase in dividends payouts. (Foerster, & Sapp, 2005).

Apple Reasonable Constant Growth

By using the H. model, Apple may record a decline in the dividends growth rate in the next five years based on the growth of the Android smartphone. Apple will face stiff competitions with other phone makers making company record a decline in the dividends growth. Table 4 provides the forecast of the Apple Dividends growth rate in the next 5 years. (Morning Star, 2015).

Table 4: Apple Dividend growth rate Forecast

Analysis of Apple's Annual Report

An increase in the Apple growth rate has been attributed to the integration of innovation in the company business model. Apple Inc.is one of the top companies in the United States that believe in delivering quality products to the consumer. Over the years, the company has spent billions of dollars in R&D. For example, the company spent over $8 billion on R&D at the end of 2015 fiscal year. Moreover, Apple believes in using the marketing and advertising tools to promote their product and services. Although Apple has not practiced the merger and acquisition strategy in the last 5 years, however, the company targets educational institutions, government agencies, individuals' enterprises and businesses in the United States and outside the United States as the potential markets. Apple marketing strategy is unique in the industry because the company uses the modern technology to design its product to meet the taste of the consumer. The company also uses consumer loyalty, product innovation, and brand awareness to maintain a leadership position in the industry. Despite Apple superior performances, the company ability to maintain a leadership position depends on their capability to produce quality and innovative products for the consumer. By applying sophisticated technological innovation to design and produce their products, Apple will be able to maintain an increase in financial performances.

Beta

Beta measures the volatility of a stock traded on the stock exchange. (Faulkender, M, Milbourn, & Thakor, 2006). Moreover, beta measures the extent the stock returns responds to market returns. The higher the beta, the more volatile a stock. A beta of 1.0 is deemed to be average, however, a beta greater than 1.0 makes the stock price to rise or decline at a faster rate. In 2015, the Apple beta is 1.38 higher than the average of 1.0 showing that Apple stock price is more volatile than average.

Expected Return -- CAPM

The CAMP (Capital asset pricing model) is the expected returns realized from the security in relation to a firm beta. The CAPM is used to calculate the return on a risky asset where the rate of return of a risk asset can increase or decrease. (Department of the Treasury, 2015).

CAPM is calculated using the following formula:

Where

Rs is the expected return;

Rf is the investor rate if investing in money risk-free;

β is the beta; and Rm and Rf are the expected market return - the risk-free rate.

An investor is expected to invest if the potential rate of return is greater than a firm required a rate of return. However, it is not advisable to invest if the potential rate of return is lower. Apple expected rate of return in 2015 is calculated as follows:

CAPM versus Dividend Growth Model

The CAPM and DDM (dividend growth model) are the effective financial models to calculate financial investments. CAPM evaluates the relationship between asset risks and market averages. However, DDM provides a financial projection to measure a future growth rate of dividends. In 2015, the CAPM of Apple Inc. is 13.13% however, Apple dividend growth rate is 30.20%. While CAPM considers the risks tool in the calculation, DDM fails to consider the asset risks in the calculation. The benefit of CAPM over DDM is that it considers several factors to determine the rate of returns. However, neither CAPM nor DDM is a perfect investment tool.

Debt and Equity

The debt, WACC and equity assist in calculating the stock return that shareholder should expect when investing for a long period. A firm equity and debts assist in enhancing a greater understanding a breakeven point of an investment. However, the WACC is used to determine the cost of capital to maximize shareholders' wealth. (Agca,. & Mozumdar, 2004). A difference between the book value and equity is that the market value considers firm growth values. The market value equity is calculated by multiplying the stock price by the outstanding shares. Apple market value in 2015 fiscal year is $594.04 based on the calculation below:

Debt

Apple relies on debts to run its business. The company short-term debts are over $63.4 Billion at the end of the 2015 fiscal year, however, the long-term debts are $56.8 billion. The total debts for the 2015 fiscal year are $120.2 billion. Apple obtains debts from bonds, loans, and selling shares.

Based on the value of the debt and equity value, Apple market value at the end 2015 fiscal year is $622,077.2 million. Thus, the formula to calculate the WACC is as follows:

The calculation reveals that Apple pays Apple pays 6.01% on every dollar investment it finances. Thus, the company stands to generate a positive return in the future.

Capital Budgeting Assumptions

The study assumes that equity is measured using the market value rather than the book value. Moreover, the project is funded using the debt level, however, the company may exhaust the debts thereby unable to record high ROE. Thus, the capital budgeting is the strategy of making the assumption about the value of the project. Using the result of the capital budgeting, investors may base their decision on risks. Despite this assumption, the results WACC have shown, the investor will gain high returns despite the risks. Thus, the risks associated with the project is low.

Competitive Analysis of Debt and Equity Mix

This section provides the competitive review of Apple and Microsoft. At the end of 2015 fiscal, Microsoft records a beta of 1.08 which is higher than the average beta of 1.0. However, the expected market return is 0.0722 with the U.S. Treasury week of 0.022. Moreover, average equity premium of 0.07. Thus, the CAPM is as follows:

As being revealed in the table above, Apple CAPM is 6.25% higher than the CAPM of Microsoft. Moreover, Apple borrowing rate is lower than the Microsoft borrowing rate. Moreover, Apple has higher market values than the Microsoft market value.

Capital Structure Theory

The capital structure theory assists in determining method to select the most optimal organization for an investment based on the market value and costs of capital. Typically, the capital structure theory assumes that the company that is able to maximize the market value and minimize the cost of finance will be the best company to invest. At the end of 2015 fiscal year, Apple recorded a long-term debt of $28.98 billion, however, the company net income was $53.39 billion. The data show that the company has an excess fund to finance their both short-term and long-term obligations. Compared with Microsoft that recorded net income of $12.19 Billion and $27.80 billion of long-term debt.

Summary

The results of the analysis make this study to recommends Apple Inc. for the prospective investors as the best company to invest because the company has recorded an increase in the net income in the past three years. Moreover, the company net profit margin is constant in the last three years coupled with ROE which continues to increase. (See Appendix 1). The company also records an increase in the return of asset within the last three years. Between 2013 and 2015, the net margin ratio increased from 21.67% to 22.85%. The ROE also increased from 30.64% to 46.25% between 2013 and 2015. The net income also increased from $37.03 Billion to $53.39 Billion between 2013 and 2015. The results of the analysis reveal that the company has a potential for a superior growth. The competitive analysis with one of the top Apple's competitors reveals that the company performs better than the competitor in term of profitability.

Reference

Adjaoud, F., & Ben-Amar, W. (2010). Corporate governance and dividend policy: Shareholders' protection or expropriation? Journal of Business Finance & Accounting, 37(5/6), 648 -- 667. doi:10.1111/j.1468-5957.2010.02192.x

Agca, S., and Mozumdar, A. (2004). Firm size, debt capacity, and corporate financing choices. doi:10.2139/ssrn.687369

Apple Inc. (2015). Apple Inc. Investor Relations - Dividend History. USA.

Apple, (2015). The Apple Supplier Code of Conduct. Apple Inc. USA.

Faulkender, M, Milbourn, T. and Thakor, A. (2006). Does corporate performance determine the capital structure and dividend policy? doi:10.2139/ssrn.686865

Foerster, S., & Sapp, S. (2005). The dividend discount model in the long-run: A clinical study. Journal of Applied Finance, 5(2), 55 -- 75.

GlobalData (2016). Apple Inc. - Financial and Strategic Analysis Review.

Kotler, P., & Keller, K. (2012). Marketing management (14 ed.). Upper Saddle River, New Jersey: Pearson Prentice Hall.

Microsoft Corporation. (2015). 2015 annual report. USA.

Morning Star (2015). Apple Inc. AAPL. USA.

Mukherji, A. (2002). The evolution of information systems: Their impact on organizations and structures. Management Decision, 40(5/6). doi:10.1108/00251740210430498

Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate finance (10th ed.). New York: Mcgraw-Hill Irwin.

Department of the Treasury. (2015). Daily treasury yield curve rates. USA.

Appendices

Appendix 1

Appendix 1: Apple's Profitability Ratios

Margins % of Sales

2015

2011

2013

Revenue

COGS

59.94

61.41

62.38

Gross Margin

40.06

38.59

37.62

SG&A

6.13

6.56

6.34

R&D

3.45

3.30

2.62

Other

Operating Margin

30.48

28.72

28.67

Net Int & Other

0.55

0.54

0.68

EBT Margin

31.03

29.26

29.35

Profitability

2015-09

2014-09

2013-09

Tax Rate %

26.37

26.13

26.15

Net Margin %

22.85

21.61

21.67

Asset Turnover (Average)