When it comes to technological lifestyle products, everyone would be familiar with the brand Apple. Be it the iPhone, Mac, iPad or Apple Watch, Apple has become synonymous with IT products.
Besides producing IT products, Apple also provides services to its customers, such as the Apple iCloud, Apple TV+ and Apple Pay, just to name a few.
Given its prominence in the IT space, it is no surprise that Apple has become one of the largest tech companies in the world. If we were to look at its stock price performance over the years, it is nothing to sniff at.
From 2015 till date, Apple’s share price has grown by more than 300%! With its impressive stock market performance thus far, it might be tempting to just invest in Apple without much thought.
However, doing so would be foolhardy as you might not be able to maximise your profit potential. After all, no matter how good a company is to invest in, you definitely do not want to be overpaying for it.
On this backdrop, I thus decided to do an analysis on Apple. Through it, I hope to gain a better picture of whether I should invest in Apple at its current market price or not.
Disclaimer: This post should not be used as a recommendation to buy or sell Apple shares. Rather its intended purpose is to be a source of insight and education. Any decision to buy or sell Apple shares should be made on the personal accord of the reader after doing their own research. As such, I take no responsibility for any future gains or loss amounting from the trading of Apple shares. Lastly, I am also not currently vested in Apple.
Before looking into the fundamentals of Apple Inc, it would be useful to first look at how and where Apple’s revenue comes from.
In its annual reports and financial statements, Apple categorized its total net sales into two broad segments, products and services.
However, for my analysis, I decided to instead categorise Apple’s total net sales into its various products, while still keeping services as a broad revenue segment. Doing so allows more detailed insight into which product/segment is contributing most to Apple’s sales figures.
For the past five financial years, Apple’s iPhone has been the main contributor to its total net sales. However, the percentage net sales contribution of the iPhone has been declining over the years, from 63.4% in FY2016 to 50.2% in FY2020.
With the iPhone’s decline in net sales contribution, both Apple’s wearables and services have increased in total net sales contribution. If you are wondering which products are included in these two segments, the below image explains it all.
The change in contribution trends of wearables and services can also be seen in the net sales growth rate of Apple products and services.
For the past five financial years, with the exception of FY2018, net sale figures for iPhone has been rather stagnant. Conversely, net sales growth for Apple’s wearables and accessories has been on an impressive upward trend. This also holds true for Apple’s services segment.
According to Apple Inc’s FY2020 annual report, the increased net sales growth in wearables was mainly due to the Apple Watch and AirPods. For the Services segment, increased net sales growth was driven by Apple’s Appstore, advertising and cloud services.
Geographical sales segment
In addition to looking at which segment yielded the most sales for Apple, it is also important to know which regions of the world contribute the most sales. This can help us to better predict which country’s market conditions will drive or impede Apple Inc’s growth and earnings.
Unsurprisingly, the region that contributed the most of Apple Inc’s net sales was the Americas. Europe is the next major contributor, contributing to a quarter of Apple’s total net sales in FY2020.
Given that Apple’s definition of Europe includes not just European countries, but also India, Africa and the Middle East, it makes sense that together with the Americas (consisting of North and South America), they contribute to a majority of Apple’s net sales, at slightly more than 70%. That is after all literally half the world that we are talking about!
If we were to further divide Apple’s total net sales into countries, US and China were the only countries that singlehandedly contributed more than 10%.
As seen, China’s contribution to Apple’s total sales has been on a downward trend, while that of the US has been on a steady upward trend.
In the near future, I expect this trend to continue given that individuals would be more inclined to purchase IT products from their own home-grown companies. China after all already has its own technology companies in the form of Huawei and Xiaomi.
Having briefly looked at Apple’s business figures and structure, I will now move on to the nitty-gritty part of the analysis, which is to look at Apple’s financial data and assess its growth prospects.
As like all analysis posts, I will categorize my analysis of this data both into what I liked about it and my potential areas of concern.
What I like about Apple Inc
Positive top and bottom-line results
Over the past five financial years, Apple has delivered good top and bottom-line results.
As seen, over the past five financial years, Apple experienced positive growth in its total net sales, operating and net profit. Much of this growth can be attributed to the stellar growth of Apple’s wearables and services segment, achieving record net sales year after year.
Moving forth, I expect this growth trend to at least continue for FY2021. This is mainly due to Apple releasing new products that provide upgrades across its entire existing product line. Some of these products and innovations include the M1 chip for the 5th gen iPad Pro and new iMac, and also 5G-enabled iPhones.
Already we have seen the effects of some of these new products in Apple’s recently released H1 FY2021 financial results.
Based on Apple’s Q2 FY2021 financial statements, net sales across all its segments were significantly higher as compared to FY2020 over the same period. Furthermore, net sales from all geographical regions also increased as compared to the same period in FY2020.
Given that H1 FY2021 total net sales already amounted to US$201 billion, I am quite confident that FY2021 financial results will comfortably build upon FY2020’s results.
Good R&D balance
As a provider of IT products and services, its is important that Apple continually keeps up with research and development (R&D) efforts to stay ahead of its competitors. In the technology space, a company can easily lose its competitive edge if it fails to innovate and progress, we just need to look at Nokia for an example.
On that note, I am glad that Apple has been able to successfully balance its R&D efforts with its bottom line.
As seen, despite the year-on-year increase in R&D costs, Apple has been able to contain it to a small portion of its total net sales. Furthermore, with growth in both its operating and net profit, R&D efforts have also not negatively hampered Apple’s profitability.
Besides positive growth in earnings and profits, Apple is also on a very strong footing in terms of financial health.
As seen, Apple’s debt as a portion of its assets is at an acceptable percentage of 34.7% in FY2020. While this percentage has been slowly creeping up over the years, it is mostly down to Apple’s share repurchase program. I will touch more on Apple’s shares buyback in later parts of the post.
In addition to a healthy debt level, Apple’s current assets also exceed its current liabilities by 1.36 times. This means that Apple would not have issues fulfilling all of its near-term debt obligations and payments. Coupled with an increasing amount of free cash flow, I would say that Apple’s financial health is rather impeccable.
Lastly, in terms of its dividends, Apple is also not overstretching itself. Based on the past five financial years, Apple’s dividends paid out has never exceeded its operational free cash flow. While the payout percentage might seem high for FY2020, it is mostly down to Apple’s 4-for-1 stock split that it conducted in August 2020, resulting in an enlarged number of shares.
Overall, based on Apple’s current debt and cash generated, I do not foresee any near-term financial concerns with Apple.
Positive returns to shareholders
Continuing on from its good financial performance, Apple has also positively rewarded its shareholders over the years.
From the above, we can see that Apple has an insanely high return on equity of 113.1% in FY2020. This means that each dollar of shareholder’s equity is entitled to $1.13 of Apple’s net profit. This unusually high ROE is due to Apple’s share repurchase program.
In addition to a high ROE, Apple’s NAV and dividend per share are also on an upward trend. The decrease in both metrics in FY2020 was due to Apple’s 4-for-1 stock split. If not for the stock split, Apple’s NAV would have had a CAGR of +19.5% and +9.5% for its dividend per share, over the past five financial years.
The rise in NAV is even more impressive when you consider that Apple uses a significant portion of its free cash flow to buyback its shares.
Apple stock repurchase programme
When it comes to considering Apple’s returns to its shareholders, you just cannot overlook its massive shares repurchases.
In FY2020 alone, Apple spent a total of $72.4 billion to repurchase around 917 million common shares. This is not the first time that Apple has done this as it has consistently repurchased its shares since 2013.
By repurchasing its own shares over the years, Apple effectively shrunk the number of outstanding shares available to shareholders. The main benefit of this is that the intrinsic value of Apple’s shares thus rises as each share is now entitled to a larger portion of Apple’s earnings and book value.
With Apple’s massive share repurchase programme, there might be concerns that Apple is not reinvesting back into its business for growth. I however feel such fears are unfounded.
If we were to look at Apple’s R&D costs over the years it is actually increasing at quite a high rate.
Over the past five financial years, Apple’s R&D costs have increased at a CAGR of +16.9%. If we were to consider FY2020 R&D costs, it has increased by around 88%. This shows that although Apple has repurchased its shares over the years, this is not done at the expense of maintaining the company’s competitiveness.
The main reason for Apple to repurchase its shares is due to its massive free cash outlay every financial year. Due to Apple’s capital expenditure light business model, it does not need to spend a bulk of its free cash flow generated. Thus, to prevent additional tax incurred on this massive cash pile, Apple decides to repurchase its shares to both better utilize its cash and return value to its shareholders.
An ecosystem of products and services
As a producer of multiple IT products, Apple is able to create an ecosystem whereby all its devices work seamlessly with one another. This enables Apple to then better retain its customers and even encourage them to purchase more of Apple’s products in the future.
For example, let’s say a particular iPhone user is looking to get a smartwatch to pair with his/her iPhone. There is a high chance that this individual would look to purchase the Apple Watch due to its seamless compatibility with the iPhone. With the pairing of the iPhone and Apple Watch, this user is now able to answer calls using the Apple Watch, conveniently look at the Apple Watch for any phone notifications or even switch songs via the Apple Watch, amongst the many other features of the Apple Watch. Let’s not get me started on whether he/she would purchase the Apple Airpods in the future…
With this interconnectivity between Apple products, purchasing more Apple products just ‘makes sense’ due to how well they work with each other and the convenience of shared data across multiple devices.
Effectively, Apple is trying to build up a wall encircling its customers and keeping them within the ecosystem. The more Apple products you use, the more entrenched you would become in this ecosystem, making it harder to break away. This also perhaps explains why Apple has such staunch customers and supporters.
From a financial standpoint, Apple’s ecosystem is great for its business as each customer provides multiple potential revenue streams. On the other hand, there is much to be debated on the ethics front. However, I would not be going to that extent for this post.
Favourable growth prospects
As mentioned earlier, Apple is pushing out upgrades for a few of its products with the release of the M1 chip and 5G phones. Thus, sales figure for the iPhone, iMac and Ipad should remain high at least for the next year or so.
Moving past that, Apple has also conducted multiple mergers and acquisitions over the years. Recently, Apple’s CEO, Tim Cook revealed that Apple acquired a total of 100 companies over 6 years. That averages out to one company every three to four weeks…let that sink in a moment.
While Apple does not publicise its various M&As, there are claims that Apple has been acquiring firms specializing in AI technology in recent years. If true, it is not really surprising since the two segments of services and wearables, home and accessories remain Apple’s fastest-growing segments. Thus, investing in AI technology could definitely provide Apple with an advantage over its competitors in these markets.
Furthermore, as we transit into an era of smart devices, I expect more growth opportunities for Apple, especially in its wearables, home and accessories segment.
Areas of concern
Personally for me, despite there being much to like about Apple, there were still some slight notable concerns.
Slight decline in profit margins
While Apple recorded positive financial results over the years, its profit margins are actually declining.
If we were to look at both operating and net profit margins, we can see that it has slightly declined over the years. This was due to increasing cost of sales and operating expenses.
Apple attributed the rise in cost of sales to foreign currency weakness relative to the US Dollar. On the bright side, Apple reported higher material cost savings for its products line in FY2020.
For the rise in operating expenses, Apple attributed it to higher headcount-related expenses on R&D, marketing and advertising services. More cash was also spent on the advertising and marketing of Apple products and services.
Moving forth, Apple also highlighted in its FY2020 annual report a highly possible downward pressure on its margin figures in the near future. Nevertheless, given that the decline in profitability margins are not that huge, I feel that investors should not jump the gun and instead observe Apple’s results over a longer period of time.
How ‘essential’ are Apple products?
By and large, Apple products are generally not considered to be cheap. Given that what drives Apple’s total sales is the demand for its products, how sustainable is such a business model if prices continue to rise?
With the Covid-19 pandemic still hampering the recovery of the global economy, consumers might become more prudent in their spending. This would mean limiting purchases of big-ticket items or not spending on their ‘wants’.
In this vein, I doubt that many individuals would be willing to fork out cash just to get a slight upgrade on their Apple products. This is even more true if such products were bought not too long ago.
However, judging by the figures of 1H FY2021, perhaps there is not much to worry about as Apple reported improved sales as compared to last year. Furthermore, with its massive amount of cash generated per year, there is still considerable leeway for Apple to absorb potential negative impact to its sales.
Nevertheless, in light of the current pandemic, investors might not want to assign too positive a growth metric to Apple in the short term.
Taking in both the positives of Apple and my own personal concerns, I do feel that Apple is a stellar company fundamentally. The more important aspect to consider would definitely be its current market valuation.
Rating Apple as an investment
Having determined that Apple is indeed a good company to invest in, the next question would be is now the right time to invest? For that, I would rate Apple as an investment based on its growth prospects, stability and valuation.
When it comes to the growth prospects of Apple, I would give it a solid rating of 4 stars. Apple’s line-up of 5G iPhones and M1 chip products should propel its sales figures in the near future. Furthermore, more product sales could also potentially lead to more positive growth momentum for Apple’s services segment.
The reason why I did not give it a full 5-star rating was due to the possibility of an uptick in near-term inflation. With the record fiscal stimulus deployed to combat the Covid-19 pandemic combined with low to zero interest rates, the market is flushed with plenty of cash and liquidity. This broadly devalues the value of currency which could lead to inflation hitting sooner than expected.
Furthermore with massive debt, be it government or corporate, floating around, there comes a point in time when it has to be paid. While there are many ways to deal with the debt, I fear whatever method used would hit the consumer market hard. This could then result in tightened consumer expenditure, which will hurt Apple’s total net sales.
When it comes to financial stability, I think there is nothing much to worry about Apple. However, in terms of earnings stability, it is slightly more uncertain.
With declining profit margins, it could ultimately affect Apple’s bottom if the downward trend continues. Furthermore, with the aforementioned reasons, such as inflation, Apple’s short term earnings is not that predictable.
Hence, I feel that given the circumstances, a 4-star rating is appropriate. After all, Apple does have a sizeable annual generated cash pile to weather some financial headwinds.
For Apple’s current valuation, I give it a 2-star rating. This was due to my personal feeling that the current market price is quite overvalued. To derive Apple’s intrinsic value, I looked at its PE ratio, PEG ratio and discounted cash flow.
Using Apple’s PE ratio as a valuation method is simple, we just have to compare it to the historical PE ratio.
As seen, Apple’s 5-year average PE ratio stands at 20.43.
Based on Apple’s current market price of $124.97 and an annualised earnings per share for FY2021 (based on 1H FY2021 results), Apple’s current PE ratio would be 20.28. This is not wide off the 20.43 mark.
Thus, looking purely at PE ratio, it can be said that Apple’s current share price is rather fairly valued.
Besides looking at the PE ratio, we can also consider using the PEG ratio to determine Apple’s valuation. The difference between PE and PEG ratio is that the PEG ratio considers a company’s future earnings growth rate.
Finding the PEG ratio is simple, we just divide the PE ratio with Apple’s expected growth rate over the next 5 years. To get Apple’s expected 5-year growth rate, we can look to analyst reports. For my calculation, I plucked Apple’s growth rate off Yahoo Finance, which was 17.93%.
Based on this growth rate, Apple’s PEG ratio would be around 1.13. From this value, we can say that Apple’s current market price is slightly overvalued as its PE ratio exceeds its expected growth rate. A fair PEG ratio value would be exactly 1.
Discounted cash flow
When using the discounted cash flow analysis, we are effectively discounting the future cash flows of the company to its present value. For Apple, I used a 5-year period and a free cash flow growth of 11% to calculate its discounted cash flow.
For the simplicity of this post (and also its word length), I will not be covering the full DCF analysis calculation.
Believe it or not, based on my DCF calculation, the intrinsic value of each Apple share is around $54.90. Do note that this is based on a few conservative assumptions I made.
Firstly, I assumed the terminal growth rate to be 2.2%, which is the average GDP growth of the United States. Secondly, I also assumed that Apple would experience a constant compounded free cash flow growth for the next 5 years.
Hence, it can be said that an intrinsic value of $54.90 for Apple is steering on the safe side.
Looking at all three valuation methods, Apple’s fair share price would range from $54.90 to $110.45. The median value of this range would be around $82.68. That I feel would be a good price to buy Apple at too.
Final rating and conclusion
Taking all three ratings into consideration, my final rating for Apple would be 3/5 stars.
Personally, I feel that Apple is a solid company to invest in, based on its financial results and numbers. Apple’s strong branding also adds another feather to its cap and makes it stand out from its competitors. However, like other tech stocks on the market, there is a case to be made that it is currently overvalued.
For now, I will be keeping Apple on my watchlist and patiently wait for its price to drop before investing.
What do you think of Apple as an investment? Do let me know in the comments!