The stock that is recommended for the investor is the Apple stock. Apple is an electronic/computer company with high profitability and a great future. A fundamental analysis of the company reveals that it has a healthy balance sheet and massive cash reserves. Apple as company is known for its unparalleled innovation and products. Its products range from mobile phones, computers, online music streaming and recently headphones. These are just some of the products offered by this company. In addition to this, Apple is regarded as the largest company in the world with a market capitalization of $800 billion. The selection of the Apple stock as an option for the investor was based on a wide array of factors starting from its robust management team led by the chief executive officer, Tim Cook. As expected, these factors form only part of the rationale for choosing Apple as viable investment. The company is even more poised for growth with various products set to be launched this year and even better products this year (Rodrick, 2008).
The company’s future growth will be propped by these products and the appetite of the world for premium products with excellent features (Rodrick, 2008). Apple is a great investment because it has a wide base of clientele that is always ready to buy its new products at a premium price. Apple also enhances its products yearly giving the users new experiences and driving the sale of its products (Rodrick, 2008). Besides her great products, the company has also since divested into music streaming services and headphones, areas that are set to grow exponentially in the foreseeable future. To fund any expansion and improvement plans, the company has a great reserve of cash that could be used and are therefore at no risk whatsoever of debt. This makes the company both safe and a guaranteed return on the investment made to the company. But one doesn’t stop there in terms of the value that will be provided to the investors both in the short term and the long term.
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Currently, apple is working on a range of products, some secret, some public and some highly speculated, but all of which are guaranteed to be game changers when launched. Apple has a robust work force comprising of highly skilled workers that innovate and bring its products to market. Its status as the world’s largest company in terms of market capitalization, the company employs very reliable individuals that add to the value provided by the company. The management at Apple is also regarded as the best in the world adding the confidence in the direction the company will be heading to in the future. This means that the company is set for even greater things in the future. One could argue that Apple’s status as the largest company in the world makes it very stagnant as an investment. This would mean that it has little potential for growth, but cannot be really taken as a true state of the company. As proven in historical data for the company (Kahn, 2006), Apple’s constant innovation is set to result in the revamped earnings in the company that is set to drive growth and increase shareholder value (Beneish, Lee, and Tarpley, 2001). This coupled with the management’s strategy of aggressive share buy backs makes it a very safe investment with potential for growth and a small downside.
Why the stock is suitable for the client
The stock fits perfectly for the client’s portfolio because of its proven record of accomplishment, potential for growth and a healthy balance sheet. It fits the client’s preference for a stock that will grow at a reasonable price and a relatively minimal risk due to the perceived low volatility of the stock. Historical data reveals that Apple has consistently managed to return high earnings with the production of its iPhone and Mac computers (Kahn, 2006). For almost ten years running, the company has been known for the high demand of its products even before they are launched into the market. This demand is only set to increase in the future and become the next boost to the company’s already high revenue. Currently, the company continues to increase its sales of the apple watch, a new frontier product that received rave reviews at its launch and whose sales are set to improve in the medium to the long term. To a great degree, the company shows great promise when subjected to the three types of analyses required of investments such as these.
But to better reflect the company’s suitability, it is important that the investor profile be outlined and their objectives run against the company’s prospects for growth.
Client profile.
The client in question is a risk averse investor at the age cohort of 45 to 55 years old. While they have a fairly large amount of cash to invest in the market, they are risk averse at a high degree but still hope to receive some value from their investments. The client realizes that putting their money in a savings account is akin to investing it with slowly diminishing returns due to low interest rates that he is likely to accrue, coupled with the high inflation that is likely to eat into the gains made using this conduit. The client therefore hopes to invest in a company that has some value and is also set to experience modest growth in the future.
Given these characteristics, the client can be described as somewhat an investor that aims at both value investing and a certain level of growth investing. Normally, the term used to describe this type of profile is growth at a reasonable price or GARP. It arises from the desire of the client to receive a certain amount of return on their investments in the short to medium term since they are old and therefore have no time for value investing that would take a long term to realize gains. Conversely, the client also desires to experience a certain amount of growth in their period of investing. The Apple stock is the ideal company for this investor because, first a technical analysis would reveal that the security has recently been trading at low prices due to lukewarm reviews on the sale of the Apple watch in the quarter ended fiscal year 2016 as opposed to the same period in 2015 (Kahn, 2006). Further technical analysis of the company shows that these bleak stock prices are largely temporary and will be corrected with time to reflect the true value of the stock especially with the announcement to launch new products later this year.
Riding on the bump in stock prices after announcement of new products or revelations on the range of secret projects of the company, the investor will have a quick way out given their scope of investing is within the short term to the medium term. The company is set to celebrate ten years after unveiling the iPhone brand and is expected to launch new products to celebrate the event. While the reports are at this point based on speculation and guesses on what Apple will launch next, there are strong factors pointing to the probability that they might be in line to produce iPhone 7 with enhanced user experience and never seen before features. While this is just one spectrum of the potential returns of the investment, it already presents a great opportunity for the investor to generate value from their investment in the company.
The dividend yield of the company is fairly low when compared to the cash reserves of the company. But this would not dampen the investor interest in the investment. It is publicly known that the Apple management’s primary obligations are to constantly generate value for them using an aggressive share buyback strategy. In fact, the company is publicly known to set aside a sizeable amount of money, approximately $200 million for share buy backs. This means that its growth, of rather growth of value is set to be multifaceted such that it is determined by several factors which means better security of the investment due to diversified avenues for growth generation on the company (Beneish, Lee, and Tarpley, 2001). The final aspect of this company that makes it a solid investment is the nature of management at the helm of the company. The company’s management team comprises of experienced and highly skilled personnel with a well laid out vision for the company both in the short term and the long term. This is manifested in the massive amounts of cash invested in future project research drives and improvement of existing products hence both short term and long term prospects of growth for the company (Beneish, Lee, and Tarpley, 2001). This coupled with shareholder value generation makes the company very ideal as an investment and therefore suitable for the investor.
Five financial ratios for the past three years, current ratio, price to earnings ratio, earnings per share, quick ratio, profit margin
Following a fundamental analysis, there needs to be a technical analysis which involves the analysis of the company’s performance and books to determine its financial health and ability to generate profits in the future (Beneish, Lee, and Tarpley, 2001). This is done by undertaking a financial ratio analysis of the company. Different ratios as will be explained reveal different aspects of the company. The focus on this particular analysis will be on the liquidity and the profitability of the company for the short to medium term (Ou, 1989). The financial ratios present the company’s performance for the past three years which reflect recent results with the goal of predicting future results of the company.
Current ratio.
This is a liquidity ratio that is aimed at determining the company’s ability to cover its debt obligations using its assets. The current ratio has the scope that could be estimated to be both short term and the long term. It can therefore be described as the ability of the company to pay off its short term to long term liabilities (Ou, 1989). It is worked out by dividing the current total assets by the current total liabilities of the company as will be shown below for the fiscal years 2014, 2015 and 2016.
Fiscal year 2014
Current ratio= current total assets/current total liabilities
=68531/63448
= 1.08
Fiscal year 2015
89378/80610
= 1.108
Fiscal year 2016
106869/79006
= 1.352
The current ratio of the company for the three years amount to a figure higher than 1. This means that for three years running the company has been in great financial shape with its assets comfortably surpassing its liabilities hence the ability of the company to pay off its short term and long term obligations using its assets. Notably, the current ratio of the company has been growing progressively over the years representing a robust cash allocation from management and the ability of the company to consistently generate revenue giving it enough cash and assets to cover its obligations.
Earnings per share.
This financial ratio is categorized as a profitability ratio and refers to the income of the company allocated to the outstanding shares in the company. In effect, this ratio represents the amount of income gained by the company on account of the equity owned by the shareholders in the company (Ou, 1989). it is worked out by dividing the company’s net income less dividends by the total number of outstanding shares in the company. It therefore represents the amount of income expected to be generated by one unit of stock in the company.
Calculations
Number of outstanding shares = 5.21 billion
2014
Net income/shares outstanding
39510/5100 = 7.747
2015
53394/5100
= 10.469
2016
45687/5100
= 8.958
The earnings per share made by the company could be categorized as modest to impressive. For the year 2014, for each share, the company generated a return of $7.75 dollars which by industry standards is very high. This means that for each share owned by investors such high gains will be expected. The years following this period the earnings per share increased to just over $10 and slightly reduced to $8.98 in the fiscal year 2016. Regardless of the small fluctuations the company presents a comfortable amount of return that would be ideal for the investor. And this is despite the fact that the calculations are made using the current number of outstanding shares without taking into account any changes that could have been undertaken in terms of outstanding shares in the company.
Quick ratio.
The difference between the quick ratio and the current ratio is that the quick ratio denotes the ability of the company to pay off its short-term obligations using short term assets (Ou, 1989). It is calculated by dividing the current assets less inventory by the current liabilities. The subtraction of inventory arises from the fact that the period required for the settling of the inventory could be longer and that this would make these assets non-current hence unable to be used to cover the short-term liabilities of the company. However, just like the current ratio, the quick ratio is a liquidity ratio that is also referred to the company’s acid test and therefore a strong indicator of the financial health of the company.
Calculations
Current assets-inventory/ current liabilities
2014
68531-2111/63448
= 1.047
2015
89378-2349/80610
= 1.079
2016
106869-2132/79006
= 1.325
The company’s quick ratio is having been above 1 for the past three years meaning that it has been able to pay off its short-term liabilities using its short-term assets. This also means that the company assets are highly liquid and higher than their liabilities meaning that the company is not at risk of default on its debt obligations. Over the years there has been a progressive increase in the quick ratio from 1.047 in 2014 to 1.079 in 2015 and finally growing to 1.325 in the year 2016.
Price earnings ratio.
This ratio denotes the earnings made by the share in a designated period of time. There are two ways in which this can be worked out. The first is by using historical data on the earnings on the share price which refers to the trailing price earnings ratio. The trailing price earnings while not directly related to the future price trends of the company stock provide a crucial insight into the company’s past performance and therefore could by extension be used to predict future price trends. Then there exist the forward price earnings ratio that is calculated using the estimates for future stock prices by experts and analysts. This analysis will be based on past prices of the stock, hence the trailing price earnings ratio. It will be worked out by dividing the current Apple stock price by the earnings per share of the stock. The currency of the price will be determined with reference to the fiscal year under review and the earnings will be determined from the previous year’s gain estimates.
The trailing price earnings ratio for the fiscal years’ calculations are as follows.
Calculations
2014
109.33/32.05
= 3.41
2015
96.96/-12.27
= -7.90
2016
117.91/20.95
= 5.63
The calculation for the earnings per share were conducted by subtracting the share price at the beginning of the year from the share price at the end of the year to determine the earnings realized by the stock price. The current price of the stock (price at the end of the fiscal year) was then divided by these earnings. In 2014, the trailing p/e ratio amounted to 3.41 which means that an investor needed to invest $3.41 dollars in order to receive a share price gain of $1. This number has since improved to $5.63 given a more competitive environment but it still represents an attractive investment.
Profit margin.
This is a profitability ratio that will determine the company’s profitability for the three years that will be reviewed. This ratio will provide insight into how consistent the company has been in the generation of revenue. This will be worked out by dividing the company’s net income by the company’s total revenue. The profit margin is calculated as a percentage and shows how much a company keeps in earnings out of every dollar of revenue gained from the business.
Calculations
Net income/total revenue
2014
39510/182795
= 0.216*100
= 21.6%
2015
53394/233715
= 0.2284*100
= 22.84%
2016
45687/215639
= 0.2118*100
= 21.18%
As previously stated, the profit margin presents the company’s profitability. For the three fiscal years under review, the company’s profit margin has remained above 20% showing that the company retains just over 20% of its revenue as income. Given the company has a sound and comprehensible business model, this provides evidence of the company’s ability to generate consistent profits in the short term to medium term. This points to the fact that the company will be able to generate comfortable returns to make the investment worthwhile for the investor.
Using the ratio analysis determine the risk profile of the investment from the investor’s point of view and include measures that could be put in place to mitigate this risk/minimize perceived risk
From the investor’s point of view and with regard to the financial ratio analysis, the stock is medium to low risk for the investor. This doesn’t mean that the stock is essentially completely free of risk and that it is thus, a sure investment. As can be seen, most especially from the annual earnings per share, the company is susceptible to fluctuations in stock prices arising from the performance of the company and in some instances news and speculation on the company. Given the unpredictability of this risk, it poses a threat to the investor’s capital especially given the predominantly short term outlook of the investment. The competitive nature of the electronic, computer and mobile phone business can also be regarded as a risk to the company. Any glitches in terms of the technology of their products might have a damaging effect on the image of the company. This might take a long time to repair and recover the losses in stock price, time that the investor might not have in their hands.
This risk can be mitigated by the investor undertaking a dollar cost averaging method in purchasing the stock. This would require the careful buying of the stock while monitoring its price movements to protect against any fluctuations that might arise. Conversely, the investor can divide their can into different types of companies to hedge against sector related risk by diversification and divesting into different sectors with the same prospects of growth (Solnik, 1995). In case there are losses in one sector, they will be offset by the profits realized from another sector. If however, all sectors do well, the investor is set to get phenomenal gains from their investment.
Provide recommendations of this stock as an investment opportunity providing the rationale using evidence from peer reviewed articles
With the current competitive nature of industries especially in the technological front, there needs to be a very meticulous method of stock picking (Solnik, 1995). Various methods have been in use and still recommended following the investment style of an investor and their profile. It is however, better to use a combination of different stock and company analysis methods so as to have a deeper insight into the state of the company one is looking to invest in. It is following this strategy that the stock recommended to the investor was picked. The rationale for picking this stock can be directly attributed to the CANSLIM method of stock analysis (Deboeck and Ultsch, 2000) . This method encompasses a wide range of factors about the company. The factors include the company’s current earnings per share, annual earnings, new products, and management, supply and demand, leaders, institutional sponsorship and market direction (Deboeck and Ultsch, 2000) . Analysis of these factors provide enough information about the company to determine its viability as an investment.
The company’s status as an investment opportunity can be further determined by the technical analysis of the stock by identifying trends in the stock prices and the making informed predictions on the price movements in the future (Kahn, 2006). Even after ascertaining the suitability of the investment, the investor is required to take measures to hedge their investment against perceived risks. This is especially because the stock prices are unpredictable and could go either with the potential for losses both in the short term and in the long term. A recommended strategy for hedging this investment is by diversifying the portfolio preferably investing in companies in different sectors (Solnik, 1995). With this, the risk of the investment is set to reduce considerably while increasing the upside of the investment.
References
Beneish, MD, Lee CMC, and Tarpley RL. (2001). Contextual Fundamental Analysis Through the Prediction of Extreme Returns. Review of Accounting studies , Vol 6, issue 2, pp 165-189
Deboeck, GJ and Ultsch A. (2000). Picking Stocks with Emergent Self-Organizing Value maps. Neural Network World . Retrieved from http://www.cgfunding.com/stockpicking.pdf .
Kahn, M. (2006). Technical analysis plain and simple: charting the markets in your language . Second edition. FT press.
Ou, JA. (1989). Financial statement analysis and the prediction of stock returns. Journal of accounting and economics , Vol 11, issue 4, pp. 295-329
Rodrik, D. (2009). Industrial Policy: Don't Ask Why, Ask How. Middle East Development Journal , Vol 1, Issue 1
Solnik, BH. (1995). Why Not Diversify Internationally Rather Than Domestically? Financial analysts journal , Vol 51, Issue 1, pp. 89-95
Appendices
Appendix A
Sources of market information.
The data on the company’s financial statements were obtained from Yahoo finance and included the income statements, balance sheets and summary for the day of the 27 th May 2017. The company information can be obtained from this link https://finance.yahoo.com/quote/AAPL/key-statistics?p=AAPL .
The data on the earnings per share were however obtained from google finance and the consolidated charts on the historical market information on Apple Inc. The information can be obtained from this link https://www.google.com/finance?cid=22144 .
All the relevant graphs and tables can be viewed following these links.
Appendix B.
Treatment of the financial ratios and vital information on the calculations
Outstanding shares: the number of outstanding shares used in all the calculations are 5.1 billion which the current number of outstanding shares is. This means that the figures have not been adjusted for the respective years but still provide vital information on the earnings per share.
Price earnings ratio: were worked out commencing with the end of the fiscal year 2014 to the end of the fiscal year 2016. The change in stock price was obtained by subtracting the price of the stock at the beginning of the year from the price at the end of the year. This figure was then used to divide the price of the stock at the end of the period under review.
