Project investment model

Introduction

Investment is way of handling money or assets possessed. More importantly, it has many benefit if utilized properly. For example, it gives a chance to grow the value of money because money does not grow by itself unless being invested. In particular, investors find it easier to invest their money into stock market, where stock can be easily traded as owners’ preferences and it stay head with the inflation. This means that the money being invested into the stock market will not decrease in value when inflation occurs. After all, the main goal to invest in stock is to gain profit through trading. In other words, it is always optimal to buy low and sell high for investors to earn the difference between two prices as the profit.

In this paper, I chose to dig into the consumer electronics industry from an investor’s perspective because it is one of the fastest growing industry, and mostly associated with technology, which is highly utilized for education, communication, medical research and national defense. For a better understanding, I picked up two companies from the top tier of the industry: Apple and Huawei. Both of them are public traded company that can be easily accessed by investors through stock trading platform. I will firstly analyze the market and the consumer electronic industry. Then I will analyze the companies that represent the industry in terms of their profitability, risk, growth, and overall trend.

Market Analysis

This paper is mainly focusing on stock market. Unlike real estate market, where requires a lot of capital to be able to have the access, stock market requires relatively less capital. It is also easy to get in and get out. An example would be an investor could easily sell its stock when it starts decreasing in value. Stock can also be easily purchased when a chance of making a profit is spotted. Real estate requires not only a huge start-up fee, but also most often a percentage fee that paid to brokers and agencies. Stock market can be speculated through knowledge and understandings to the company. In comparison, real estate is subjected to economic changes and natural disasters such as flood and hurricane. These are hard to be predicted. Another popular choice is foreign exchange market, however, there are lots of risks correlated to it in my opinion. According to Hanks, it is highly leveraged. This means that investors can multiply their purchasing power through credit extended by their brokers. The increase in purchasing power allows the forex investor to make a substantial profit with very little cash in a brokerage account, but it also carries a corresponding increase in risk (Hanks, 2010). Moreover, foreign exchange market lacks regulation with high risks associated with 24/7 market place. Investors have to pay close attention to the targeted market so that they will not lose money.

Profitability Analysis

	Q3 2017	Q2 2017	Q1 2017	Q4 2016	Q3 2016
Gross Margin	56.89%	58.28%	58.11%	57.13%	30.81%
Net Margin	19.1%	20.84%	36.46%	17.72%	2.41%

[footnoteRef:1] [1: Consumer Electronic Industry Profitability Ratios 2016-2017 https://csimarket.com/Industry/industry_Profitability_Ratios.php?ind=1012]

Table 1 above shows the overall key profitability ratios for the consumer electronic industry between 2016 to 2017. Overall, the industry has a quite static gross margin during the recent 2 years with the highest being 58.78% in Q1 2015 and lowest being 30.81% in Q3 2016. The average of gross margin for consumer electronic industry is 49.35%. This number is higher than industry’s average number. According to Csimarket.com, the average gross margin ratio of consumer electronic industry ranks at fifth place in technology sector, which is considered to be high. On the other hand, retail apparel industry has an average gross margin of 38.08%, with a high variance between 80.99% of the highest and 22.22% of the lowest. Even though it ranks the first place in retail sector, the average gross margin of 38.08% is still approximately 11% lower than that of consumer electronic industry. And this can be seen as an advantage to consumer electronic industry. Moreover, even though the net margin of consumer electronic industry has been decreasing from Q1 2017, the average ratio of this year is still higher than last year of 2.41%, as indicated in table 1. The increased profitability means that it is a good idea to considering investing in consumer electronic industry, as the value of money will be very likely to grow.

Table 2 below are the profitability ratios of two key companies in consumer electronic industries: Apple and Huawei. The reason that I compare these two companies because they are able to represent the industry somehow. And by analyze the difference between two companies’ profitability ratio, I am aiming to provide an idea of how companies in this such performed in terms of profitability. Despite Apple’s financial performance information for year 2017 can be found on Morningstar. Com, Huawei’s financial performance for 2017 is not available yet due to the different fiscal year problem from different countries. To solve this issue, I am only comparing the financial performance of year 2015 and 2016 for the two companies.

	Apple	Huawei
	2016	2015	2016	2015
Gross Margin	39.08%	40.06%	54.19%	46.50%
Operating Margin	27.84%	30.48%	41.43%	21.29%
Net Margin	21.19%	22.85%	20.38%	37.30%
ROE	36.90%	46.25%	12.49%	11.17%
ROA	14.93%	20.45%	9.70%	6.00%

[footnoteRef:2] [2: Morningstar financials.com]

Clearly, both companies have pretty much the same gross margin in 2015. However, in 2016, Huawei was able to retain more money out of revenue generated, as explained by higher gross margin of 54.19%. Operating margin gives an idea of how much the company is making on each dollar of sales. As we can see from the table, Apple has higher operating margin in 2015 and Huawei has higher operating margin in 2016. This indicates that Apple’s variable costs are relatively lower than those of Huawei in 2015, however, Huawei managed to reduce its variable cost significantly in 2016. And this leads to a 20% increase in operating margin for Huawei in 2016. Net margin is one of the most important indicators of a company’s financial health, and it does not only consider the costs associated with selling the products, but also advertising, administrative and salary expenses that in order to keep the business running. In 2015, Huawei’s net margin exceeded Apple’s by approximately 15%, therefore, Huawei did a superior job than Apple in 2015. In 2016, Huawei’s net margin has decreased dramatically from 37.30% to 20.38%. in the meantime, Apple remained an unchanged net margin which ended up being higher than Huawei’s. and this indicates that Apple did much better than Huawei in terms of generating profit from sales.

ROE measure a company’s ability to generate profit with the money that shareholders have invested, and this is particular important when comparing two companies’ profitability in the same industry. As we can see from table 2, Apple is able to generate more revenue using its equity than Huawei in 2015 and 2016, even though its ROE decreased slightly by from 2015 to 2016. This indicates that Apple is better at managing its equity and utilizing shareholder’s investment, and this is a good news to investors simply because their money is unlikely to be wasted in terms of use. In addition, ROA measures how efficiently a company is using its assets to generate revenue. The higher the ratio, the more efficiently the company is using its assets. Apple has higher ROA than Huawei in the past two years. However, Apple’s ROA has decreased in 2016, and this is due to the decreased net income and increased total asset from 2015 to 2016. Investors will need to reevaluate this if they want to consider Apple. However, in year 2017, Apple’s net income did increase by $2.7 billion, which is a good sign to the investors.

What we can conclude from Apple and Huawei’s profitability ratios is that every company has their own focus and particular aspect that they are good at. For example, Huawei has relatively lower variable cost than Apple because of the lower operating margin. However, Apple is better at utilizing the money that shareholders invested than Huawei. Therefore, when consider investing in such a consumer electronic industry, we need to consider various aspects. It also depends on investor’s personal preference, such as high return associated with high risk versus low return associated with moderate risk.

Risk Analysis

Every investment opportunity is associated with a particular level of risk. The higher the risk, the higher the return that is being expected by investors. Same as other industries, there are many risks existing in consumer electronic industry. In the following paragraph, I will take Apple as an example, and describe its risks that are representable to the whole industry.

Firstly, Apple is originated in America, where a lot of loyal customers are willing to purchase their products. However, it may not be the case in other countries such as China. While Apple’s computer remains the top selling brand in America, it is not that popular in China. People in China are not familiar with the iOS operating system and certainly they did not like the price. Some domestic brand in China had some pretty good sales in recent years such as Lenovo. Therefore, a company that has good performance in its hone country may not be as popular in other countries, especially when considering different cultures and lifestyle. Therefore, such companies that expanded internationally will always face many domestic competitors. And plus, the local government policy that supports the local business, it is even harder to companies like Apple to gain additional market shares under these circumstances.

Secondly, the more successful the company, the greater chance that it will be expose to risks. As we know, Apple outsourced many parts and raw materials used in the manufacture of their products. For example, a majority of the parts were imported from China and many iPhones were assembled in China as well. In such case, it could lead to a risk exposure to apple because once there is an economic downturn in the countries or regions where Apple chose to outsource, Apple’s whole production line is going to be down. Since the demand for Apple’s product is quite high, apple will suffer a big loss and customer dissatisfaction if such risks go out of control. Thirdly, Apple’s weighted average cost of capital (WACC) was 9.88%[footnoteRef:3] as of Dec 2017, which is 2.76% higher than the 7.12%[footnoteRef:4] of Samsung. Apple’s higher WACC indicates a higher risk associated with the company’s operations. In order word, if people is to invest in Apple, they tend to require higher returns to compensate the higher risks undertaken. Same, people will not expect Samsung’s return as high as Apple because of its lower risks as can be seen by its lower WACC comparing to Apple. Therefore, WACC is another factor that investors would have to consider before making investments. In this case, Apple should have higher expected returns than Samsung because of its higher expected costs for all financing sources. [3: https://www.gurufocus.com/term/wacc/AAPL/WACC/Apple%2BInc] [4: https://www.gurufocus.com/term/wacc/SSNLF/Weighted%252BAverage%252BCost%252BOf%252BCapital%252B%252528WACC%252529/Samsung+Electronics+Co+Ltd]

Growth Analysis

	Q3 2017	Q2 2017	Q1 2017	Q4 2016	Q3 2016
Revenue Quarterly Growth	3.4%	-2.66%	2.38%	25.78%	32.46%
Net Income	16.82%	U/A	174.07%	34.25%	-96.86%
Earnings Per Share	12.68%	U/A	341.99%	36.81%	U/A
Free Cash Flow	-42.01%	U/A	-6.6%	54.12%	U/A
Capital Expenditure	54.23%	3.76%	63.18%	72.67%	189.2%

[footnoteRef:5] [5: Consumer electronic industry growth rates https://csimarket.com/Industry/industry_growth_rates.php?capx&ind=1012]

The statistics from the table above is gathered from csimarket.com, and it shows the growth rate from the 5 latest quarter in consumer electronic industry. As we can see, the growth of revenue for the whole industry has been slow down. The highest growth rate was 32.46% at Q3 2016, and the lowest growth rate was -2.66% at Q2 2017. In this particular quarter, the consumer electronic industry as a whole decreased in revenue comparing to previous quarters. Apple’s revenue was $45,408 million in Q2 2017, which is also lower than $52,896 in Q1 2017. Therefore, during this particular quarter, it was not a good decision to make an investment. However, investors who invested at that time could still wait until the performance of the whole industry or a particular company gets better in order to sell high. moreover, the lowest point of growth rate for net income in the industry was at Q3 2016, when a majority of companies in the industry suffered a loss. In the beginning of this year, the industry did exceptionally well with a 174.07% growth rate of net income. By just looking at this growth rate, it was attractive to investors because companies in such industry are making huge profits. The earning per share (EPS) ratio is experiencing a decreasing trend over the latest 5 quarters. And this is not a good news to shareholders, because the earning rate per share is decreasing meaning that for each share, there are less earnings generated. However, this does not indicate any losses for shareholders as the growth rate is still negative. In terms of free cash flow (FCF), we have the lowest growth rate at current quarter being -42.01%. This could result from two factors. Firstly, the industry did not generate enough cash after considering the maintenance and expansion of assets. Secondly, the industry invests more cash than generated into its capital for future use. For the second factor, we would need to look at the growth rate of capital expenditure. There can be seen a growth in capital expenditure from 3.76% in Q2 2017 to 54.23 in Q3 2017. Therefore, the decreased free cash flow previously mentioned could a reason of the increased capital expenditure. the increased capital expenditure in the industry indicates that companies are spending their funds on upgrading, innovating and maintain their capital resources. This could be seen as a good sign because these companies are aiming for long-term earnings and this is why they sacrifice short-term profits to upgrade their facilities. Investors need to consider putting their money into this industry because if there is any company about to closing down, they would not invest on their capital resources anymore.

CAPM Model

As we can see above, Apple’s expected return is 10.12% which is above the market average return, therefore it is a good idea to invest in Apple

Conclusion

Overall, investment is still a subjective decision that depends on personal preference. Some individuals may prefer a more aggressive approach by considering growth potential first, profitability second, and risk lastly. On the other hand, some individuals will be more conservative on investment decisions. They will consider risks first, followed by profitability and growth potentials. Generally speaking, each approach has its own advantages over disadvantages. It is wise for people to make investment decisions based on their current situations, capital resources and risk tolerance.

In my opinion, consumer electronic industry has high growth potential but also with high risks. Some particular companies’ stock price may vary daily. In any given seconds, there are possibilities to lose and earn money in stock market. Investors are very likely to generate profit by properly utilizing knowledge and personal experience.

Bibliography Hanks, G. (2010, May 10). The Disadvantages of Foreign Exchange. Retrieved from Sapling.com: https://www.sapling.com/6499817/disadvantages-foreign-exchange Gurufocus https://www.gurufocus.com/term/wacc/AAPL/WACC/Apple%2BInc https://www.gurufocus.com/term/wacc/SSNLF/Weighted%252BAverage%252BCost%252BOf%252BCapital%252B%252528WACC%252529/Samsung+Electronics+Co+Ltd Consumer electronic industry growth rates https://csimarket.com/Industry/industry_growth_rates.php?capx&ind=1012 Consumer Electronic Industry Profitability Ratios 2016-2017 https://csimarket.com/Industry/industry_Profitability_Ratios.php?ind=1012 Morningstar Financials http://www.morningstar.com/stocks/XNAS/AAPL/quote.html Yahoo Finance https://finance.yahoo.com/quote/AAPL?p=AAPL

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