Successful investing should not be a complicated process; it is all about purchasing high-quality companies at a convenient valuation. Statistical data suggest that stocks that have strong quantitative attributes in terms of financial quality and value tend to stand out in the market in the long run. While the market is underestimating Apple Inc. based on its ability to remain consistently profitable and maintain a predictable revenue flow in the long term, the valuation and financial quality of the company show that it is particularly attractive. The Apple Inc. (AAPL) stock seems like a compelling investment when considering the company’s valuation levels and financial quality together. The company went from the verge of bankruptcy and rose to be the ‘most valuable company in the world’ in 2012. Apple’s leadership strategy is mainly built on both innovation and differentiation. However, are these strategies as sustainable as they seem? This paper seeks to get a clear picture of Apple Inc.’s top-down structure and its stock valuation and use this information to determine whether it is worth investing in the company.
Top-Down Analysis of Apple Inc.
The External Environment
The external environment of any firm creates both the opportunities and threats for the company, and it is a very vital part of the top-down structure of any company. The external environment at Apple Inc. can be divided into social, demographic, technological, and macroeconomic factors. The economic factors that may be viewed as opportunities in the industry are the need for affordable products that will satisfy the needs of the customers even in the event of a declining global economy. Socio-cultural trends, on the other hand, are the moves towards more portable and smarter devices that are more user-friendly and have a slick design. As for the technological aspect of the external environment, there is a need for a company to constantly innovate and remain at the forefront of any technological advances ( Alami, 2018) .
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According to Porter, there are five forces that come to play when shaping the industry: bargaining power of suppliers, the bargaining power of buyers, the threat of new entrants, the intensity of rivalry, and the threat of substitute products and services. The bargaining power of buyers in the technology sector is high in the long run due to the availability of a wide range of substitute products. For this reason, it is very crucial for a company to differentiate their products to reduce the buyers’ bargaining power. A differentiated product is less susceptible to loss of sales due to any price premiums because differentiation helps build customer loyalty. Apple has been very serious about this issue of product differentiation, and this is evident in the uniqueness of the products offered by the company.
The bargaining power of suppliers is another very crucial factor that can affect a company’s strategy, and this has affected the manner in which Apple views its suppliers. The strategies that Apple implemented in its operations have been proven to have greatly reduced the suppliers’ bargaining power, and this has helped put a limit in the cost of products in cases of increasingly demanding consumers or an economic turmoil. However, Apple failed to set the necessary barriers to limit the availability of substitutes at a much lower price and eliminate the threat of new entrants, despite the company’s leadership and innovative status. Over the years, Apple has continually varied its strategy towards its competitors. Unless Apple alters its strategy in the next few years, the company will not be able to sustain its strategic group position against other technology giants like HP and Samsung ( Cardenal, 2018) .
Internal Analysis: the Value Chain of Apple Inc.
The key goal that has been driving Apple Inc. since the company was founded is the creation of value. This value is based on a number of key competencies that are integral to the company’s value chain. The main activities that Apple undertakes include marketing and sales, operations, human resources, and R&D. While other Companies might view R&D as a support activity, it is a driving force for Apple, whose support activities include supply chain management (both inbound and outbound logistics), design, and customer service. The supply chain system at Apple is arguably the best designed and most efficient supply chain system in the world. The ability of the system to get a product to the public on time without incurring any unnecessary inventory costs is what has placed the company at a major advantage against its competitors. Besides, Apple has a unique design activities system that is based on technological elegance and ease of use, and it is tailored to suit the needs of the customers, and this is the key reason for the above-average returns that the company has witnessed over the years.
One of the key strength at Apple is the company’s focus on R&D, a step that brought about an era of technological innovations, pushing the company to new markets such as the music industry and communication market. Marketing and sales opportunities have also greatly added value to Apple’s value chain because it does not just sell a product but a ‘way of life.’ The iPhone’s marketing strategy brought about a revolution in the company’s technology, and it is the key driving force behind its massive success. These factors have been key in the development of Apple’s core competencies, and they are based on both resources and capabilities: the design of products from scratch, focus product lines, using simple and unique designs that are very user friendly, a team of skilled product designers and talented engineers, but most important of all, a well-financed and excellent R&D department ( Blandin, 2018) .
The Future of Apple
During Apple’s early stages, the company was the drive behind most changes witnessed in the technology sector. In 1978, Apple II brought about a revolution that saw to the PC Company becoming a multi-billion dollar industry. Throughout these stages, Apple changed the external environment instead of using it to its advantage. It was only in 2007 when Apple realized this, turned the tables, and started capitalizing on the technology opportunities that this industry presents.
The tech industry is very volatile, and the players in the sector not only need to adapt and become the leader in this environment, but they also need to adjust the external environment to their advantage. This is a step that Apple was able to make. Even when emerging trends in the tech world drove the strategies of other firms, Apple managed to remain the leader of its technology world. Sociocultural factors such as the customers’ need for faster and more flexible products and other economic factors like the financial crisis experienced in 2008 were the market’s key drivers to cheaper and more portable devices. This phenomenon saw the creation and the massive success of the iPad ( Blandin, 2018) . It is a good thing that Apple was able to use its strategies to drive the external environment, and not the opposite. There is, therefore, hope for the company to remain in play even in the future.
This world is increasingly cost sensitive, and this means that Apple needs to make use of its core competencies to be both a differentiation and cost leader for it to stay ahead of the game. For Apple to remain at the top of the competition, there is a need for the company to be able to direct its core competencies towards becoming both a differentiation and cost leader. Also, Apple should come up with new strategies that will block new entrants from getting to the market and hamper the actions of current rivals who are improved on their innovation by the day. While the company’s differentiated and innovative strategy has made it an industry leader, it has not stopped competitors from developing similar products at a lower cost. Similarly, Apple’s differentiation strategy has made the loyal customers remain regardless of the premium prices. However, this will not be a long-lived and sustainable strategy if a competitor manages to outperform it at some point ( Cardenal, 2018) .
DuPont analysis of the Apple Inc. shows that the Return on Equity (ROE) increased from 2016 to 2017, and this can be attributed to the increase in financial leverage. When calculating the annual return on equity, the average total shareholder equity over the financial year and the net income that is attributable to common stockholders over the past year are used. The DuPont analysis between Apple and Samsung Electronics show that Apple Inc. is way ahead of its competition, and proper steps will help the Company maintain its position even in the coming years ( Concepts, 2018) . The DuPont calculation table has been included in the appendix.
Stock Valuation for Apple Inc.
In this section, we will calculate the intrinsic value of Apple (NASDAQ: AAPL) by making an estimation of the future cash flows and then passing over them to their present value. The Discounted Cash Flow (DCF) method is a direct valuation technique that is used to value a company by predicting its cash flows in the future and discounting them to the money there is today. In this case, we use the two-stage model, which is to say that we will be having two different periods for which we need to predict the cash flows. We will begin by getting the estimated cash flows for the next five years ( Blandin, 2018) . For this case, we used the consensus of the analysts, and the sum of the cash flows is then discounted to the current value today.
The quantitative analysis calculations using at least two methods of estimation are included in Appendix 2. The calculations show that the present value for the next five years cash flows amount to $202,646. The second stage is referred to as the Terminal Value, and this is the cash flow to the business upon the completion of the first stage. The Gordon Formula (Perpetuity method) is used to calculate the terminal value using an annual growth rate of 1.8 percent (equal to the government bond rate of a period of 10 years). The present value of the terminal value is $472,206, and this terminal value that has been discounted to today and the sum of the cash flows in the next five years gives the Equity Value, which is $674,852. Finally, we will divide this equity value by the total number of outstanding shares. If the stock is an ADR or a depositary receipt (representing the number of shares within a foreign corporation), then we will use the equivalent number. This calculation gives the value per share as $128.67 and comparing this intrinsic value to the current share price of $115.19, it is evident that there is a 10 percent discount in the share value. This calculation is based on the assumption that the discount rate is part of the cash flows ( Facts, 2018) .
Investment Recommendation
It does not make sense to make an investment in this portfolio in the long term. Without a doubt, the AAPL stock is driven by the sale of the iPhone. If the company is able to penetrate into new markets, especially China, successfully, this will be a great determinant of whether the company will sustain a strong year-after-year growth. There is also hope that the company will explore other areas such as wearables, game consoles, and set-top boxes. While these new ventures are set to produce new avenues for future growth, they will not drive the near-term earnings (the next two years) as much as the demand for the iPhone will. As discussed earlier, the company announced a massive capital return program through dividend increases and share repurchases to reward shareholders in 2014. A similar announcement was made in 2015, and the impact was felt in 2016. The trailing price-earnings ratio at Apple Inc. is 17.1x current value per share at AAPL is $128.67 (which is just slightly above the valuation by Standard & Poor), and there is an expected growth that will outpace the market to make it an attractive valuation. Besides, Apple’s balance sheet has been cited as a key catalyst for growth and a reason for the continued repurchase of shares ( Khan & Alam, 2018).
However, investment at Apple Inc. does not come without risk. The focus and reliance on the iPhone for near-term growth is a risk. In a situation where the penetration and growth are the smartphone market slowed down, the Apple would suffer an exponentially painful period because more than half of the company’s revenues are sourced from the iPhone products. For this reason, a slowdown in any of the following sectors would result in a material decline in Apple’s stock and multiple prices: penetration into China, the overall growth of the smartphone market, and the growth of iPhone’s market share. The future growth of the AAPL stock depends on a new product that will redefine a current category or the emergence of new product categories. One might wonder why the company is too focused on returning its cash through dividends and share repurchases rather than re-investing into R&D or making acquisitions.
All in all, Apple Inc. has been known for growth and innovation, and it has managed to capture its consumers with its smartphone (iPhone), tablet (iPad), and personal computing (MAC) products. The company has managed to get away with raising the costs of their products to high levels. There is a risk in the ability of the company to maintain these customers in the future while attracting new ones in diverse markets. New technology makes buyers indecisive because they are always seeking the best and newest products, and brand loyalty will be easily sacrificed when a new gadget appears. The risk of investing in Apple Inc. is that the company will not be able to keep up when the new wave is experienced ( Kristina, 2018) .
References
Alami, D. (2018). Industry and Company Analysis of Apple. Retrieved from https://www.financialanalystwarrior.com/apple/
Blandin, H. (2018). AAPL Analysis & News - Apple Inc. Retrieved from https://seekingalpha.com/symbol/AAPL
Cardenal, A. (2018). The Market Does Not Understand Apple. Retrieved from https://seekingalpha.com/article/4185715-market-understand-apple?page=2?article_roadblock?referrer=https://seekingalpha.com/article/4185715-market-understand-apple?page=2
Concepts, F. (2018). Industry and Company Analysis of Apple. Retrieved from https://www.financialanalystwarrior.com/apple/
Facts, A. (2018). Topic: Apple. Retrieved from https://www.statista.com/topics/847/apple/
Khan, U., & Alam, M. (2018). Retrieved from http://ijecm.co.uk/wp-content/uploads/2015/06/3660.pdf
Kristina Zucchi, C. (2018). Investing In Apple: The Risks & Rewards. Retrieved from https://www.investopedia.com/stock-analysis/021815/investing-apple-risks-rewards-aapl.aspx
Appendix One: DuPont Analysis of Apple and Competitor (Samsung Electronics)
| ROE= | Net Profit Margin x | Asset Turnover x | Leverage | ||
| Apple | Sep 30, 2017 | 36.07% | 21.09% | 0.61 | 2.80 |
| Sep 24, 2016 | 35.62% | 21.19% | 0.67 | 2.51 | |
| Sep 26, 2015 | 44.74% | 22.85% | 0.80 | 2.43 | |
| Samsung Electronics | Sep 2017 | 21.88% | 16.5% | 0.733 | 1.4296 |
Appendix Two: Quantitative Analysis Calculations
