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Financial Analysis of Apple

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Introduction

The death of Steve Jobs in 2012 put Apple in a spotlight even more than the technology company is used to being. Job was the brain and the spine of Apple; few companies are built so centrally around one person. With his passing, it makes sense that investors and other stakeholders are concerned about Apple’s business performance under new leadership. CEO Tim Cook, handpicked by Jobs as his replacement, has worked hard to stabilize the company and reassure investors that Apple will continue to be the same profit-generating monster it was under the leadership of Steve Jobs. Words and anecdotes are often enough to soothe the feelings of employees and some investors, but more forward thinking stakeholders will want quantitative evidence that Apple continues to be a strong company. This paper will provide a quantitative financial analysis of Apple comparing 2013 to 2012; in addition, the paper will discuss 2 corrective options Apple could take in order to generate a greater profit.

Horizontal Analysis

One of the best ways to evaluate a company objectively is to perform a horizontal analysis. This allows the analyst to compare the performance of a company in the immediate moment with another moment in time. Doing so allows for a comparison of trends; for example, if the total revenue of a company has decreased sharply over the past 3 years it is clear that there is a problem and something needs to be done. A cornerstone of any horizontal analysis is the total revenue earned by the company. In 2013, Apple earned 170 billion dollars compared to 155 billion dollars in 2012. (NASDAQ, 2014) This represents an increase of 9.68% from 2012-2013. In an age where technology companies are notoriously vulnerable to massive swings in revenue, a steady 9.68% growth in revenue is a positive thing for investors, employees, and creditors to see the company earning.

There are many other elements that go into a horizontal analysis. For the purposes of brevity, they will be included in a chart form shown below.

Apple Horizontal Analysis Figure	2012	2013	% Change
Cost of Goods Sold	87.92 B	107.24B	21.97
Gross Income	68.06B	63.63B	-6.96
R&D	3.38B	4.48B	29.59
Other SG&A	10.04B	10.83B	7.87
Pretax Income	55.76B	50.16B	-10.04
Net Income	41.73B	37.04B	-11.24

Source: NASDAQ

Strengths and Weaknesses

There are a number of strengths and weaknesses that were identified using the horizontal analysis of Apple. One readily apparent strength was that the company has dedicated an increasing percentage of its budget space to research and development of new products. This is very important given that one of the main criticisms of the company following the death of Steve Jobs was that Apple would be unable to come up with new and innovative products that Jobs would churn out on a yearly basis. (Lashinsky, 2012) Whether or not Apple is able to do so remain a question that no one can answer; however, the fact that the company has recognized its weakness and has dedicated a R&D budget that is 29 percent higher than in 2012 demonstrates that Apple is willing to invest heavily in the process necessary to create new products.

Unfortunately for Apple, the horizontal analysis indicates that there are plenty of weaknesses to focus on. One area that is particularly disturbing is the cost of goods sold. Between 2012 and 2013 the cost of goods sold increased from 87.92 billion dollars to 107.24 billion dollars. On the surface, this might make sense; after all, Apple sold more products in 2013 compared to 2012, so the total cost of selling those products must go up. However, it is important to look at the percentage change and compare it to the total revenue. In 2012, Apple had total revenues of 155 billion dollars, with the cost of goods sold being 87.92. This means that the cost of goods sold was 56% of the total revenue in 2012. In 2013, the cost of goods sold reached 62% of the total revenue generated by Apple. A these mean that, as a percentage, Apple’s cost of goods sold increased 6% from 2012-2013, which makes the increase of the revenue at 9.68% look much more unimpressive.

A second weakness that is apparent after evaluating the horizontal analysis for Apple is the net income of the company. The net income for Apple declined 11.24% from 2012 to 2013, a sign that not everything is right for Apple. A decreasing net income is indicative of a wide range of issues with a company, and it is clear that Apple has faced numerous challenges. Some of the challenges that have resulted in Apple seeing a decline in its net income include stiff competition from challengers like Google, the inability for Apple products to work on different operating systems, new product defects, tax increases, and rapid technology change that quickly makes Apple products obsolete (even to its own products, at times). The decline in net profit is a major warning sign for Apple that changes need to be made in order to help the company continue its path of growth.

Ratios Relevant to Stockholders

A stockholder will look at Apple in a way that is slightly different from an employee, manager, or even creditor. A stockholder only wants to know how much potential profit their investment can generate at Apple. In order to evaluate this from a stockholder’s perspective, it is necessary to look at a number of rations.

Ratio	2012	2013	% Change
Earnings Per Share	44.15	39.75	-9.97
Return on Equity	35.3	29.98	-15.07
Return on Assets	23.7	17.89	-24.51

Source: NASDAQ

Strengths/Weaknesses

There are two main ways to look at these ratios, internally and externally. The strengths of the ratios can be drawn from looking at them with an external perspective. Apple shareholders enjoyed earnings per share in 2013 of 39.75 per share, which is much higher than many other technology companies (and all companies in general). (Lashinsky, 2012) This indicates that compared to other Fortune 500 companies, Apple is still performing competitively. Similarly, return on equity of 29.98 and return on assets of 17.89 are competitive, and the kind of numbers that would make the average investor strongly consider purchasing Apple. When evaluating a company it is important not to lose focus on the bigger picture, which can often be generated through comparison to other companies. In this sense, Apple is still a very strong choice for investors looking to purchase shares.

The second way to evaluate a company from the eye of a stockholder is internally, or compared to past years. This makes a certain degree of sense; each company is unique, which means that there is a good argument to be made that the only way to effectively see trends in that company is by comparing it to itself. Through this lens, Apple did not perform well from 2012 to 2013. Each of the 3 ratios declined significantly. Earnings per share, return on equity, and return on assets decreased 9.97%, 15.07%, and 24.51%, respectively. This across the board reduction in these ratios is troubling for a company that is attempting to reassure investors in the wake of the death of Steve Jobs that Apple is as strong as it ever was. Of course, these ratios fluctuate on a year by year basis, and taking any single year by year comparison too seriously is likely folly. However, Apple will not be able to escape comparisons (even with an extremely small sample size) of the company before and after Steve Jobs. These disappointing ratios show that, so far, Apple has not lived up to the task.

Ratios/Metrics Relevant to Creditors

There are other ratios that will be especially relevant to Apple’s creditors. Creditors are mainly concerned with how well Apple will be able to pay its bills and keep functioning in both the short term and the long term. This compares differently to shareholders, who are only really concerned about how much money they can make off of Apple, either in the short term or long term. (Lashinsky, 2012) After all, shareholders can always dump their stocks; creditors are bound to Apple for the long haul. The ratios provided below are some of the most common ones that creditors are interested in.

Ratio/Metric	2012	2013	% Change
Working Capital (millions)	-240	-88	63
Current Ratio	1.58	1.78	12.66
Accounts Receivable Turnover	9.14	13.67	49.56
Inventory Turnover	62.93	88.71	40.07
Times Interest Earned	17.5	15.28	12.96
Debt/Equity	0	0.14	14

Source: NASDAQ

From a creditor standpoint, Apple has many strengths. The current ratio of Apple is 1.78, indicating that the company has nearly double the assets as it does the liabilities. Even more exciting, from the creditor standpoint, is the fact that they current ratio increased from 2012-2013 by a percentage of 12.66. This means that Apple is paying off debts and acquiring more assets in the years that were evaluated. Such a positive increase indicates to a creditor that Apple should be in a strong fiscal position to meet its obligations in the short and long term. A second strength that the company demonstrates to creditors is the percentage increase in working capital. Apple moved from a -240 million in working capital figure to -88 million, a percentage increase of 63%. While the working capital is still in the negatives (something that will be discussed in the next section), the fact that Apple was able to bring it up 63% in one year is a very good sign for creditors. The ability to increase working capital by that many millions and that large of a percentage shows that Apple is working hard to get bolster fiscal measurements that might worry both creditors and shareholders. Indeed, both accounts receivable and inventory turnover also increased in the same period, which means that, from a creditor standpoint, Apple as a company has a great deal of strength.

There are 2 main weaknesses that can be seen from analyzing the ratios relevant to creditors. The first weakness, as mentioned before, is the fact that Apple has a negative working capital. While that negative working capital has decreased by over 60 percent from 2012 to 2013, a negative working capital is still a reason for concern for any company. In the case of Apple, many of the other financial measurements are strong, so the negative working capital can safely be overlooked until other measures indicate weakness. The second weakness observed in the creditor ratios was the increase of the debt to equity ratio from 0 to 0.14. Generally speaking a debt to equity ratio of greater than 2 is worrisome for a company, and Apple’s 0/14 falls far below a 2. However, in 2012 Apple did have a debt to equity ratio of 0. The increase in the debt that Apple has compared to its assets is something that creditors should keep an eye on, but should only worry about it if it continues to increase in subsequent years. After all, many companies would be very pleased with a 0.14 debt to equity ratio.

Business Opportunity: Launch New Product to Reduce Cost of Goods Sold

Based on the horizontal analysis performed in the first section of this report, there are several business opportunities that would appear ripe for Apple. The first opportunity is the launch of a new product, such as the Apple TV. (Lashinksy, 2012) The cost of goods sold increased in 2013, which indicated that Apple had to pay more and work harder to sell the same products. The Apple TV should be able to sell itself and allow for Apple to spend less money selling the goods which will increase the profit of the company (while increasing revenue at the same time). Reducing the percentage of cost of goods sold to the amount of total revenue earned by the company should be a major goal for Apple in 2014, and effectively launching a new product like the Apple TV will help meet that goal.

Corrective Action: Increase Research and Development

Launching the Apple TV is a short term solution to many of the weaknesses noted in Apple in this analysis. The Apple TV was conceived under Steve Jobs and simply had not been launched yet. Apple needs to continue to generate new product ideas instead of coming out with yet another version of the iPhone. (Lashinksy, 2012) Without new products, Apple will continue to see massive revenues but will likely see their total profit decline as it did between 2012 and 2013. The best corrective action to take in order to rectify this issue is to move forward with a more robust research and development budget. Apple increased that budget by 25% in 2013 compared to 2012, and it makes sense for Apple to budget for the same increase in 2014 and beyond. Allocating more dollars to allow researchers to find the next iPhone or iPad will help Apple create the new products that will keep the company strong in the long term.

Conclusion

In conclusion, there are a few chinks in Apple’s armor that can be seen following the death of Steve Jobs. The increase of cost of goods sold, the debt to equity ratio increase, and some other metrics have Apple stakeholders getting a bit nervous. While these are genuine causes for concern, Apple is still in a great position to succeed. By effectively launching the Apple TV while increasing the research and development budget, Apple should be able to ease stakeholder concerns and continue to be the unquestioned technology leader.

References

Nasdaq-Apple. (2014). Retrieved from http://www.nasdaq.com/symbol/aapl

Lashinsky, A. (2012). How Tim Cook Is Changing Apple. FORTUNE, 165(8), 110-