Thursday, 23 October 2014

Apple Inc. 2014 Results: A Great Company With A Share Price to More Than Match It

A few days ago, Apple Inc. (NASDAQ:AAPLreported the results for fiscal year ending September 2014. It's been more than two years since I last wrote a short piece on Apple's results and equity valuation. At the time, 10 September 2012, the Apple share was trading below $95 (just under $663 at the time, there was a 7-for-1 stock split in June 2014). Back then I wrote (bold added),
But for a great company it does not automatically follow that its shares are a great investment. The shares currently trade at a forward P/E of 15.1 (based on forecasted EPS of 44.21 for this year), a P/E of 24.1 based on 2011 earnings with a current P/B of 5.6. Based purely on the trailing P/E of 15.6 reported above the shares are not expensive. Based on average earnings for 2008 to 2011 however, the shares currently trade at a P/E of 46.0. Herein lies the fundamental risk of investing in the Apple share: The last five years have been extraordinarily strong operationally for Apple, but the market is pricing in a significantly better future than that delivered hereto. History shows, and economics teach us, that over the long term, very few companies manage to earn a return on equity significantly higher than its cost of capital as the high returns attracts ever increasing competition until the returns are brought down towards costs of capital. And significantly fewer (none?) manage to deliver a 85% return on equity on a sustainable basis, certainly not when having reached the size Apple now has.
 and concluded,
In conclusion, the probability of the Apple share price dropping seems significantly higher than it increasing, which is why I would not recommend the prudent investor to buy Apple shares at this price level. But look to buy the share if it drops below USD 480 [$68.6 following the share split] if the fundamentals remain strong, a price that implies no future growth from the 2012 expected earnings. The excess cash of USD 80 [$11.4 following the share split] a share is your margin of safety.
Since this report was written, the Apple share price has increased just under 6% to $102.99 as of 22 October 2014. During the same period, the S&P 500 increased more than 34% while the NASDAQ increased close to 40%.

Apple has continued to deliver some staggering accounting numbers during the last two years as well. Total revenue for 2014 was the highest ever reported, having expanded from $37.491 bn in 2008 to $182.795 bn this year. This equates to an annual growth rate just north of 30% during the last six years. Return on equity (ROE) for 2014 came in at 35.4%, the highest ever reported based on data since 2008 and up from the 30.0% reported for 2013. Cash earnings remain significantly higher than net income indicating high quality earnings. The balance sheet remains strong and with equity making up 48% of total assets and almost $72 bn in excess working capital (calculated as the working capital position plus long term marketable securities that exceeds 2.0x current liabilities) the company can survive an economic downturn or two.

A few key measures are however revealing the enormous company Apple has become. Total revenue for the year increased "only" 7.0%, down from 9.2% in 2013 and 44.6% in 2012. Gross profit increased 9.7%, up from the 6.3% decline in 2013, but significantly below the 35.0% average growth rate during the last six years. The gross profit margin is keeping up quite well, but at 38.6% it was lower than the 39.4% average for the 2008 to 2013 period. Though earnings for the year was up 6.7% on last year, they dropped 5.3% compared to 2012 and the record ROE discussed above was driven solely by increased leverage as both profit margin and asset turnover declined during the year. This is also evident by the declining return on assets (ROA), which fell to 22.6%, the lowest reported for the 2008 to 2014 period and 3.1 percentage points lower than the average during the period. 

Compared to two years ago, my back-of-the-envelope analysis and conclusion about Apple's results and the share price therefore remains large unchanged: it is a great company with a share price to more than match it. The biggest risk of investing in the Apple share also remains largely unchanged in my opinion, namely that the company's results and profitability are so impressive even expecting them not to deteriorate seems like a tall order. The stock market is however pricing in further growth. If you do too, you might just have to settle for poor returns during the next few years as well which I suspect any U.S. stock market investor with a long position will have to settle for anyway.

Soure: EcPoFi, Apple Inc.

Disclaimer: I have no position in the Apple Inc. share and do not intend to enter into any position in the near future. I have a short position in U.S. mid-caps. Read additional disclaimer here.


The Short Version of the "Austrian" True Money Supply (TMS), as of 6 October 2014