Is the Apple’s Stock Cheap?
On Jan. 31, Buffett’s Berkshire Hathaway added almost 76 million Apple shares to its holdings and doubled its position. Warren Buffet said to CNBC: “Apple strikes me as having quite a sticky product, and an enormously useful product to people that use it,”
Current Market Value of Apple’s Stock:
The Stock has the current price of 141 USD with market capitalisation of 736.11B which makes Apple the biggest company in the world (by revenue, the company occupies the 10th rank). Apple owns the highest market capitalisation, despite of the current trailing Price/Earnings ratio (PE) of 16,9. In the last 5 years, PE has oscillated between 9,50 and 18,10. Aapl’s average annual return from 5 years was 12,36%, slightly above of SP500’s average return of 11.11%. But in the last 5 years, the PE ratio of SP500 has increased from 15,50 to current level of 25,10. All that information indicates that the market doesn’t consider Aapl as a growth stock despite of the overperformance since 2011.
Fig. 1: Average annual return vs. volatility from last 5 years
In average, the company generated double digit growth in Revenue (28,4%) and in Net Income (33,18%) since 2010 (see table 1). Apple was a very successful growth company.
Table 1: Growth, Profitability and Financial Ratios for Apple
On April 2016, the company was very harshly punished by wall street, stock tumbled nearly 8 percent in a single day because of first quarterly revenue fall in 13 years. A Drexel analyst, Brian White, said: “As the iPhone 6-Series nears the end of this two-year cycle and the macro backdrop remains challenging, volatility in Apple’s results is to be expected,”. His view reflects very good how Wall Street “values” the stocks.
From Table 1, we can recognize that Apple has very high Gross margin of 40% and income margin of 22,80%. The high margins indicate strong economic moat of the company which has also affected the company’s financial ratios:
Debt/Equity = 0,59
Financial Leverage = 2,51
Current Ratio = 1,35
This ratios are impressive and also not correct. The company’s balance sheet from 2016 shows total cash of $67 Billion but in reality, Apple’s cash reserve is more than $240 Billion ( ~32% of Market Cap.). The big part of cash is supposedly trapped in offshore accounts. The truth is that the cash is onshore and used by company to indirectly buy back own shares which can be seen on table 1. For more information about this issue, read the post “The Truth Behind the Tax Holiday and Apple’s Cash Reserves in Overseas”.
Table 2: Apple’s Net Sales
Scepticism about the Future of Apple:
Trouble in China:
As we can see on Table 2, Apple’s net sales in China has dropped 17% in 2016. Before 2016, China’s market provided Apple most growth. To addition to that, China suspended iBooks Store and iTunes Movies services on April 2016.
Apple’s iPhone Over Reliance
Table 2 indicates that iphone sales make the biggest part of revenue, 63% in 2016, 67% in 2015 and 56% in 2014. But the products iphone, ipad and mac have short product life cycle and once every 2 -3 years, the company must come out with new innovation or with a new hit product which have to be as successful as iphone.
Because of reasons mentioned above, the investors are worried about future growth prospects of the company, especially in China market, and they severely punish the stock when the company slightly disappoints them.
Apple’s Long Term Strategy:
Of course the problems mentioned above are known to the company and Apple has strategies to free itself from dependence on hit products with short product life cycles.
If we look at the table 2 we see the growing revenue from services which includes (from 10-K 2016):
The iTunes Store allows customers to purchase and download music and TV shows, rent or purchase movies and download free podcasts.
The App Store, available for iOS devices, allows customers to download apps and purchase in-app content.
The Mac App Store, available for Mac computers, allows customers to discover, download and install Mac applications.
The TV App Store allows customers access to apps and games.
The iBooks Store, available for iOS devices and Mac computers, features e-books.
Apple Music offers users a curated listening experience with on-demand radio stations that evolve based on a user’s play or download activity and a subscription-based internet streaming service
iCloud is the Company’s cloud service which stores music, photos, contacts, calendars, mail, documents. iCloud services include iCloud Drive®, iCloud Photo Library, Family Sharing, Find My iPhone, iPad or Mac, Find My Friends, Notes, iCloud Keychain® and iCloud Backup for iOS devices.
AppleCare® offers assistance that is built into software products, printed and electronic product manuals, online support including comprehensive product information as well as technical assistance.
Apple Pay is the Company’s mobile payment service.
The majority of services are operating in IOS Ecosystem. This is very important because:
1- each product, like iphone, and each service, like icloud, would promote other apple services and products,
2- the customers would be “trapped” in the ecosystem and they would not easily leave it.
According to Asymco analyst Horace Dediu:
In its first 10 years, the iPhone will have sold at least 1.2 billion units, making it the most successful product of all time. The iPhone also enabled the iOS empire which includes the iPod touch, the iPad, the Apple Watch and Apple TV whose combined total unit sales will reach 1.75 billion units over 10 years. This total is likely to top 2 billion units by the end of 2018.
Apple’s IOS Ecosystem is already huge and continuously growing with a double digit growth rate (see table 2). And additionally, Apple’s products are premium which means the customers in ecosystem have high income. For example, in Q1 2016, iOS download from Apple’s App Store generated four times the revenue for developers compared to Google Play, according to App Annie.
The Company continuously develops strategies to expand the IOS Ecosystem:
“The Apple Watch, the AirPods, Pencil and possible new wearables point toward a future where the iPhone is a hub to a mesh of personal devices. The seamless integration of such devices is what has always set Apple apart,” Horace Dediu
More important than wearables is the company’s project to produce electric vehicle, under the codename ‘Project Titan’. The Apple Car with Carplay will be part of the IOS Ecosystem and eventually, the vehicle will be controlled by iphone.
The IOS Ecosystem with several digital services can provide a revenue with high profit margins and sustainable growth which would be reflected in higher PE ratio.
No Investment or Financial Advice.