My brother recently got a job at the Apple Store. One of the perks of working at the Apple Store – not including the discounts you get on purchasing Apple products – is the employee stock purchase plan. Once you pass your probation, you are allowed to purchase Apple shares at a 15% discount up to 10% of your salary per year. I would absolutely love to purchase Apple shares at a 15% discount. Alas, I am not an Apple employee. However, my brother is. He told me recently about how his co-workers were freaking out about the plummeting share price and were trading insightful stock tips such as panic selling shares now before it falls further. Sigh. This case study is for my brother, to educate him on the wonderfully profitable enterprise he has found himself working for, and to all Apple employees who, I assume, have no idea what their shares represent (hint: it is not merely some piece of paper that gyrates wildly in value second-by-second along a ticker). This is Apple stock 101 for the Apple Store employee.
I’ve been slowly enslaved by Apple since 2005. It all began with one of those white, plastic rectangles called an iPod shuffle. You remember: those commercials with the silhouettes who rocked out with their white, plastic shuffles dangling from their necks on a string.
Dear lord, how could Apple have allowed that to happen? There were so many chocking hazards that I don’t know how Apple didn’t accidentally murder someone with that first gen device.
From that Medusa-like monstrosity, Apple tightened its grip around my tech life by slowly, and seductively, pulling me into iTunes, Macs, and ultimately, the iPhone. The tech in my life currently looks very white, very thin, and very brushed aluminum.
So I do have a starting bias that I personally enjoy the products Apple makes.
I purchase and use Apple products because, in my opinion, they combine the best of aesthetic beauty and functionality. It annoys me when I see an ugly piece of plastic parading as a tech device (hello spouse’s Blackberry from 2010, I’m looking at you). We humans are naturally drawn to beautiful things. And just as we like looking at beautiful human beings, we like looking at beautiful objects. Apple makes beautiful, high tech objects that work smoothly.
This is what Apple is great at: they combine functionality with beauty, deliver a smooth user experience, and have well-paid and well-trained staff to help support the greatest of the clueless (i.e. your parents).
A Look at the Financials
You’ve probably heard that Apple is the largest publicly traded company in the world, with a market capitalization of $534 billion. But why is Apple the largest publicly traded company with the largest market capitalization? Because it is the most profitable company in the world. So what makes Apple a wonderfully profitable enterprise? Let’s dive into 10 years of its financial data – all data was collected from Morningstar, Apple’s Annual Reports, and Raritan Capital.
Revenue, Profit, & Free Cash Flow
Revenue growth has been phenomenal over the past 10 years, going from about $20 billion in 2006 to $233 billion by 2015. This represented a compound annual growth rate in revenue at a 28% clip.
Net Income – the pure profit Apple made – jumped from about $2 billion to $53 billion. Net Income grew even more stupendously at a compound annual rate of 39%.
Free Cash Flow, the cash flow provided by business activity after spending on things needed to sustain and grow the business, grew from $1.6 billion to $69.8 billion, representing a compound annual growth rate of 46%.
Capital expenditure has remained fairly steady at around an average of ~15% of cash flow from operations.
Now onto per share numbers. Essentially, a share entitles you to a fractional proportion of all the profit from a business. If you owned all the shares in Apple, you would be entitled to all the profit that Apple generated in a year. In the case of 2015, you would be entitled to $54.4 billion dollars as the sole owner of the enterprise that is Apple. You could take that $54.4 billion and do as you please with it. Alas, no one owns 100% of the shares in Apple, so you as a shareholder, will have to split the profit pie with every other shareholder. If you only owned 1 share of Apple, you would be entitled to 0.0000000173% of the economic interest in the enterprise.
Said in a simpler way, if you owned 1 share of Apple, you are entitled to the Earnings Per Share figure, which for 2015 was $9.22. Speaking of Earnings Per Share, over the past 10 years it increased from $0.32 per share to $9.22 per share, representing a compound annual growth rate of 40%.
Free Cash Flow Per Share, grew from $0.21 to $11.83, an eye-popping 50% compound annual growth rate.
And Shares Outstanding has fallen from 6.143 billion in 2006 to 5.793 billion in 2015. This is a good thing as it means there are less owners to spread the profit around with. As long as you continue to hold the shares, as shares outstanding drops, you are entitled to more and more of the profit pie.
Margins, Profitability, & Ratios
What do you notice? Apple has been able to lower its Cost of Goods Sold expenses and Sales, General, and Administrative expenses since 2006. These are the expenses necessary to run the factories, buy the equipment, pay the bills, and pay employees. As these expenses drop, it means more drops to the bottom line in profit.
This increase in profit margins is also correlated with growing profitability ratios.
Return on Assets, Return on Equity, and Return on Invested Capital are all important profitability ratios you need to take into consideration when looking to take ownership in a company. The higher these ratios, relative to their industry, the better profit can be generated by the enterprise.
Return on Equity measures profits per dollar of the capital shareholders have invested in the company.
Return on Assets measures the same thing, but over the entire asset base, not just equity.
Return on Invested Capital is the best way to determine whether or not a company has a moat. It looks into how efficiently a company is using its capital, and whether or not a its competitive positioning allows it to generate solid returns from that capital.
None of these three ratios on their own truly provides any smoking gun signs of the attractiveness of a business, but each provides a clue on the profitability and attractiveness of the enterprise. The higher these figures, the more likely that the business has a sustainable competitive advantage, or moat, to protect and grow its profits into the future from rivals and competitors.
A general rule of thumb suggests that if a company can sustain and grow Return on Asset ratios in excess of 10%, Return on Equity ratios in excess of 15%, and Return on Invested Capital ratios in excess of 15%, there is a good indication that a competitive advantage exists, which is a good thing.
Balance Sheet, Cash Flow, & Efficiency
Some things that caught my eye looking over the balance sheet items include: inventory falling as a percentage of assets over time, lower current assets over time, higher long-term assets over time, and lower current liabilities over time.
If you’re wondering why Long-Term Debt suddenly appeared in 2013 and has grown to represent 18.41% of total liabilities by 2015, it has to do with Apple’s tremendous horde of cash held overseas, the US repatriation tax, and returning money to shareholders.
In a nutshell, Apple doesn’t want to bring its ~$100 billion in cash that it earned and holds outside of the US because bringing it back into the US would make all that money eligible for a 35% tax hit. So instead, Apple decided to issue bonds – at incredibly low rates – to raise cash to give back to its shareholders. It’s a bit more complicated than that, so if you wanted to read more on it, The Economist and Bloomberg Business had articles to get you started.
Moving on, we have fairly strong Current and Quick ratios. The reason the ratios have dropped over the years is because Apple doesn’t carry as much pure cash on its balance sheet like it did back in the day. Some of it is related to the whole avoidance of repatriation tax and bond issue described above.
Apple is a fairly efficient machine. It’s known for its ruthlessly efficient supply chain management, the area Tim Cook innovated and cut his teeth at Apple before becoming the CEO.
Connected to their highly efficient supply chain, Apple has a negative cash conversion cycle. The cash conversion cycle measures how long it takes for outgoing cash (to purchase the items to make products) to be converted into incoming cash. The less time it takes for a company to convert outgoing cash to incoming cash, the better. In Apple’s case, it possess the enviable position of collecting cash on its products sold well before it pays what it owes to vendors along its supply chain. Essentially, Apple can get its customers to pay them for their iPhones, iPads, and Macs well before they have to actually pay the companies along its supply chain that supply Apple with the various components, raw materials, and pieces that go into making those iPhones, iPads, and Macs.
A look at some of the cash flow ratios. Nothing too out of the ordinary here.
Year over Year Growth
Year over Year growth in Revenue, Operating Income, Net Income, and EPS has slowed down since the heydays of explosive growth in the early-to-mid 2000s.
As you can see, the huge growth experienced with the release of the original iPhone, and than the iPhone 4 in 2010, slowed down in 2013 and 2014, only to revamp with the release of the iPhone 6 and 6+ which finally brought bigger screens to the iPhones, releasing a lot of pent up demand for bigger screens on the iPhone.
Revenue by Region
Apple didn’t break out China as its own separate region until 2011. I imagine they used to clump it together with Asia Pacific before 2011. They also got rid of Retail starting in the 2013 annual report.
As China has grown to represent the second most important region for sales outside the United States, there are concerns on how much growth in sales is left for China.
Revenue by Product
The iPhone is without a doubt the most important product Apple possess. It has single handedly propelled Apple to the top as the largest publicly traded company and also the most valuable.
The Mac has been a steady and growing revenue source.
The drop in revenue collected by the iPad has been concerning for investors.
This is speculation as Apple has not released any official numbers on the Apple Watch, but if you look under “Other” you will see a $1.688 billion jump from 2014 to 2015. The Apple Watch sales figures are buried in here, along with iPods (they still make those?), Apple TVs, and Beats accessories. It is in all likelihood that Apple Watch sales figures make up a good chunk of this $1.688 billion increase in the “Other” segment.
While the phenomenal success of the iPhone has been a huge blessing for the company, it is also a potential curse. There is a lot of fear on what happens to Apple if the iPhone goes the way of Blackberry. A concentration in investing can reap enormous benefits if correct, but can spell disaster if incorrect.
You can see that even in 2010, Apple had a fairly balanced and diversified stream of products generating revenue. That is no longer the case in 2016. The iPhone makes up a whopping 66% of all revenue generated by the company. The continued growth of the company relies more and more heavily on the continued success of the iPhone.
Units Sold by Product
These figures show how many units are sold per product line. In the latest annual report, Apple has finally axed the iPod as a unit they report on and only display data for the iPhone, iPad, and Mac.
This graph reveals what some investors are afraid of with the concentration of revenue coming from the iPhone. Once upon a time, the iPod was the most important product at Apple, driving its growth and profits. Apple successfully transitioned to the iPhone, which has steadily replaced the iPod in importance as a source of growth and profit. The anxiety surrounds what comes next after the iPhone? Can Apple transition so successfully again like it did from iPod to iPhone? It seems unlikely that Apple can hit a home run like the iPhone again.
I think the cold, hard reality is that it is insanely difficult for any business to even come up with something as wildly successful as the iPhone: to think they can do it 2 times is a bit of a stretch. While I’m sure Apple has the experience, talent, and creativity to make successful future products, to think that they can replicate the iPhone’s success is more wishful thinking than thinking clearly.
Unit Price by Product
It’s interesting to note that the iPhone has been able to maintain its pricing power, which is a good thing as it is such an important source of revenue for the company.
Meanwhile, the iPad has not only been slowing down in units sold, the pricing power has decreased with time.
The Mac truly is the slow and steady workhorse in Apple’s product line up. Not only has it grown revenue and units moved year over year, they have also increased and maintained pricing power of the product line. Too bad it doesn’t generate anywhere near the revenue the iPhone does.
As long as Apple can maintain the pricing power of the iPhone, it should continue to enjoy nice margins and overall profitability of the enterprise.
Now that we’re all through with the basic data on the financials of the company, lets dive into what some of it means.
As you can probably tell, Apple is currently a very, very profitable enterprise. It generated $54.4 billion in pure profit last year. To put that in perspective, Apple could buy the entire American Express company with one year’s worth of profits. With 2 year’s worth of profits, Apple could outright purchase McDonalds. You get the picture: Apple is a money printing machine.
Of course, this money printing machine is built almost entirely off the back of the iPhone. The iPhone is Apple’s cash cow. The iPod was Apple’s cash cow before the iPhone. Off the back of these two products, Apple has seen its share price soar over the past decade:
This is taken from Valueline’s most recent report on Apple. Since the release of the iPhone, the share price has gone from a low of $7.20 (adjusted for the 7:1 split in June 2014) in 2006 to $101.42 where it sits as of market close on January 22, 2016. That represents a 14 fold increase in the stock price. That correlates with the 12 fold increase in revenue. However, it doesn’t correlate as much with the 28 fold increase in net profit. What gives?
My opinion is that because Apple leans so hard on the iPhone to generate the vast majority of its revenue and profit, the collective opinion of all of Apple’s investors is one of general caution: while placing all your eggs in one basket can lead to tremendous success when you are right, it can lead to disaster if you are not properly diversified and wrong.
This is why the shares are only priced at 11 times trailing twelve month net earnings. The market is spooked of what may happen to Apple’s growth and profitability if the iPhone hits a bump or starts to decline. And seeing as there is no product currently that could supplement the amount of money the iPhone brings in, it is understandable why the market would feel apprehensive of applying a higher valuation multiple on the share price.
I think this general fear was pretty evident in the volatility that the stock price experienced over 2015:
At certain points in 2015, the market was willing to trade shares as high as $130 per share,while it sank in the latter half the year and the market was only willing to pay around a hundred dollars or so. This is the nature of the equity market. In the short term, investors are selling back and forth amongst each other and what the stock price does is more akin to a popularity contest than a rational measurement of the true value of the underlying enterprise.
With that said, Apple is a much tougher business to value correctly than something like an established candy company. With the candy company, you can be fairly certain that your products will remain timeless – as long as you maintain and grow the brand – and purchases will be fairly consistent over long stretches of time. With a high tech company like Apple, technology changes so quickly that yesterday’s winner can end up todays loser. Look no further than Blackberry. I think this anxiety builds itself into the valuation of Apple.
However, I think Ben Thompson over at Stratechery has it more correct than not that Apple and the iPhone are much stickier than people presume. Making future predictions is all a bit bullshitting with some facts and historical data to back you up, so I’ll offer my opinion but I highly suggest you look into the company and come to your own conclusions on what the future for Apple may look like.
I do think the most probably outcome for Apple is to continue enjoying revenue growth, mainly through the iPhone, for the next few years, albeit not at the same clip that it experienced in the past. There will be continued growth, but don’t look at the growth from 2006 to 2015 and expect that to occur again.
It is most likely that history will not repeat itself for Apple, in the sense of its mind blowing growth over the past 10 years. But that doesn’t mean doom. Rather, I expect Apple to hum along as it starts reaching saturation with iPhone sales, continuing to generate steady growth in revenue, net profits, and free cash flow. Shareholders should see rising earnings per share and rising dividend payouts, as Apple continues to commit to returning capital to shareholders through share buybacks and dividends.
All of these factors should lead to a fairly satisfactory outcome for Apple employees, and shareholders, buying stock at these prices. No, you will in all probability not experience a 14 fold increase in the stock price again. This is because I don’t believe Apple will be able to replicate the success that was the iPhone. The stock experienced a 14 fold appreciation because the business that is Apple experienced a similar level of revenue growth over that time period.
Hopefully, it’s all starting to click now: a stock represents a fractional interest in a business. In the case of Apple, the stock represents a piece of ownership in Apple. The stock has performed exceptionally well over the past 10 years because Apple has created and released highly successful products, which have increased revenue and profits for the company. Your shares represent a fractional interest in those revenues and profits.
If you are an Apple employee, like my brother is, the outcome of consistent stock purchases through the employee share purchase plan and holding those shares for 5+ years should lead to a satisfactory outcome. If I were an Apple employee, I would commit the 10% maximum of annual salary towards the stock purchase plan, get the 15% discount on stock purchases, turn on dividend reinvestment, and forget about the account. Don’t look in there. Don’t look at what the stock price is doing – it is irrelevant. When you do check in 5, 10 years time, you should most likely enjoy a satisfactory outcome with your investment having appreciated at a good clip through the growth of the business enterprise that is Apple.
An investor I highly respect once noted that he does not invest in Apple, even though he has used and enjoyed their products for a very long time, because it is too difficult for him to project with any accuracy what the future cash flows, income statement, and balance sheet will look like. There is a high concentration of revenue being generated from one product: the iPhone. It really comes down to how confident you feel the iPhone will continue generating and growing revenue into the future. And then after that, how confident you feel that a new product will step in to take its place once the tech epoch changes yet again.
While I share the opinion that it is very difficult to see with any clarity where Apple is headed in the future, it is my opinion that the shares are priced low enough that Apple shares should still lead to a satisfactory, but not a spectacular, investment outcome.
Looking through the finances of the company, it is too difficult to ignore just how clean the numbers are and how much money they currently print selling iPhones, iPads, Macs, Apple Watches, and the plethora of other Apple products and services.
For the Apple employee, that 15% discount on the stock price builds in a further margin of safety into the shares, which should provide an extra bump in return as Apple continues to bring in torrents of money from its business operations.
And for those employees at my brother’s store who were freaking out in the lunch room about the recent dip in Apple’s share price down to the low 90s – the fall in the share price should make you giddy, not depressed. If a manager at your store walked up to you and told you that he would sell you a fully tricked out 27 inch 5K retina iMac for 30% off, would you be giddy or depressed? Would you be begging that manager to let you pay full price, or even an inflated price on that product?
Don’t panic when the shares of Apple tumble. You are at the front line of the business. You get to see the customers come in and buy the products. You get to see where senior management is headed with the company before the general population does. As long as the business is humming along, products are being sold, customers are content, and revenue and profit keeps growing, you will be fine in the long run.
*Right as I finished up this post, Apple released its 2016 Q1 earnings. Apple pulled in another record quarter by bringing in revenue of $75.9 billion and profit of $18.4 billion. However, Apple “only” sold 74.8 million iPhones compared to 2015 Q1, which saw 74.5 million iPhones sold. Luca Maestri, the Chief Financial Officer, stated that iPhone unit sales would decline in the next quarter, wouldn’t project anything beyond the next 3 months, and said that it has been a very difficult macroeconomic environment to operate in currently.
Interestingly, the strong US dollar made revenues $5 billion lower. Revenue would actually be up ~8% from the previous year’s record Q1 in constant dollars.
With iPhone sales projected to remain flat, continued concerns about the Chinese market, and the strong US dollar, Apple’s shares will most likely experience further volatility in 2016.
However, I stick by my conclusions that the long term Apple shareholder will most probably expect a satisfactory return from their investment; even more so for the diligent Apple employee who continuously purchases shares at a 15% discount year after year after year.
I am also of the opinion that the macro-ecosystem Apple has created is very sticky. Even if iPhone sales began to taper and remain flat, unless there is a drastic change in how Apple operates or how the product and experience is delivered to the end user, people will continue upgrading and buying within the Apple ecosystem. The amount of money being generated even in a stagnant state of iPhone growth would still literally translate into torrents of cash showing up at Cupertino every single day for shareholders.
Luca Maestri said during the earnings call, “The stock price doesn’t reflect the true value of our company.” I agree with him.
For a more bearish perspective, here is Whitney Tilson and Doug Kass’s take on Apple.
For even more colorful graphs based on quarterly data, check them out here.
**I feel compelled to state this even though I think it is asinine: none of this is a recommendation for you to go buy Apple shares. This is just my opinion of Apple based on the financial data and real life experience I have with the company. If you want to become an owner in Apple via purchases of its common shares, please do your homework, do your due diligence, and research the shit out of the company.