Are you interested in investing in innovative companies with exceptional management, solid balance sheets and exciting future growth prospects?
In this series, I present companies that you should seriously consider buying and holding for the next decade and beyond.
Here are 5 reasons why you should consider adding Apple to your portfolio.
1 – EXCEPTIONAL FRANCHISE
Apple was founded in 1976 by Steve Jobs, Steve Wozniak and Ronald Wayne. It is an American multinational technology company that designs, develops, and sells consumer electronics, computer software, and online services.
- BRAND STRATEGY
Apple’s main strength and advantage over its competitors is the coherent brand strategy it has enacted over the past 20 years.
At the core of Apple’s business ethos is delivering exceptional customer experience through user-friendly interfaces. From the iPod, iPhone and Apple Watch to iTunes and Apple Pay, the standout features of Apple products are the elegant user interfaces and the simplicity of use.
Further, from 2001 and the launch of the iPod, Apple has enacted a very well thought out strategy of harmonizing its brand and product strategy together. Apple products coexist in a common ecosystem and they are very difficult to use alongside other brands’ products (ex: difficulty to transfer Apple files to Microsoft files).
- THE APPLE IDENTITY
Beyond creating visually appealing user-friendly products, Apple has forged a strong brand identity centered on emotions. The brand’s personality lauds lifestyle, imagination, freedom, innovation, dreams and individual empowerment.
Steve Jobs was very careful to craft an image of simplicity and honesty that spoke directly to consumers. For a long time, the tech industry was dominated by “experts” who dryly enumerated the intricate specifications of their computers and software.
Jobs innovated by implementing a story-telling marketing approach. His mantra was simple yet so powerful: Make a great product, sell dreams and focus on the experience, turn customers into evangelists, master the message, keep it simple, and be the best.
Today, Jobs’ marketing strategy is studied in business schools around the world. One of the best examples of Job’s marketing savvy was his 2007 introduction of the iPhone.
- CUSTOMER EXPERIENCE
Steve Jobs understood that a revolutionary company needs to deliver on its promises: If the product is beautiful, so should the customer experience. It’s not enough to seduce the customer until checkout, it’s equally important to make him fall in love with you and remain loyal for his entire life.
In recent years, Apple has increased its reach by expanding its distribution capabilities by opening its own retail stores in strategic locations around the world. The namesake Apple Stores located in up-market venues increases the accessibility of its products and further reinforced its price-premium position on the tech market.
The driving idea behind the launch of the stores was for the ecosystem experience to begin in the store. To drive sales, Jobs argued, the customer needs to feel the environment in the store. Despite initially receiving criticism, the Apple Stores were a resounding financial success, reaching over a billion dollars in sales within the first three years.
Today, the Apple Stores are lauded for providing an incomparable customer experience. The stores are beautifully designed and stimulate the curiosity of learning more about the products. Customers can receive training and practical help at the Genius Bars. Further, Apple staff is exceptionally well trained to foster a sense of inclusiveness that not only showcases quality technology but also how it should fit in people’s lives.
Lastly, Apple is pushing its marketing even further by removing the word “store” altogether: On its website, “Apple Store, Valley Fair” became simply “Apple Valley Fair”, so did “Apple The Grove” and “Apple Union Square”. This fits into Apple’s larger strategy of transforming its stores into “town squares“.
- BRAND HALO EFFECT
The “Halo Effect” refers to “a consumer’s favoritism toward a line of products due to positive experiences with other products by this maker.” If you enjoy a company’s product, the theory says, your chances of purchasing another one of their products increases.
One of Apple’s motives behind pushing the iPhone and iTunes was to attract customers to its somewhat forgotten laptops. Although this is hard to imagine today, Apple laptops were not a big success in the early 2000s. Back then, Dell, IBM, HP, Lenovo and Packard Bell dominated the market. Apple only entered the top five personal computer brands by market share in 2015.
20 years later, it is undeniable that the halo effect has worked for Apple. Customers who bought iPods and iPhones now buy Apple laptops and other accessories because the initial products provided satisfaction. This reinforces the brand loyalty and ultimately creates a wide economic moat because no other company provides this type of integrated ecosystem and brand identity.
IN SUM: These elements have contributed to the creation of an intimate link between Apple and its customers, to the point of creating a almost “cult-like” following.
2 – FINANCIAL SUCCESS
Apple’s strong franchise, innovative products and effective marketing have resulted in an extremely successful and profitable business model. It is arguably one of if not the most successful franchise of the 21st Century.
- STRONG REVENUE GROWTH
Apple generates gigantic revenues, with 2019 revenues exceeding $260 billion dollars.
Despite reaching phenomenal heights, the company is still growing: The company’s 2016-2019 Revenues grew 20%; 2016-2019 Net Income is up 20% and 2016-2019 EBITDA is up 11% from 2016.
- HIGH MARGINS & PROFITABILITY
While Apple’s 5YA Gross margin of 38% is inferior to its industry 5YA of 44%, its 5YA Pretax margin of 27.95% and Net Profit margin of 21.49% are superior to its industry average. This means that Apple’s management is very effective at controlling costs to maximize profits.
What makes Apple so profitable? Two words: Scale and efficiency.
Apple is very efficient at controlling costs: Despite its sheer size, Selling General & Administrative costs (SG&A) are only $18.2 billion. Compare that to Samsung, for example, whose 2019 revenues are $230 billion and SG&A $27 billion. Apple generates an extra $30 billion per year in revenues while spending $9 billion a year less on administrative expenses. Further, Apple’s 2019 Net margin of 21% eclipses Samsung’s of 9%. That’s efficiency.
How can Apple be so efficient? By generating economies of scale. This is achieved in several ways. First, most Apple products (iphone, ipad) share roughly the same components so the company can purchase these parts in bulk at discount prices. Second, Apple’s marketing power is such that advertising one product basically advertises all of its other products. This results in lower marketing costs compared to smaller firms who have to advertise all of their products separately. Third, Apple’s dominant market position gives it pricing power over its competitors. If a competitor enters the market, Apple is able to lower the price of their products to levels the competitor cannot match.
Lastly, consider this: Apple’s has a roughly 60% profit share of the entire smartphone market! While this ratio fluctuates between 60%-80% at any given time, this represents incredible market dominance. This status as market leader ensures that Apple generates sufficient revenues to continue investing in R&D and marketing to further enhance its status of being the undisputed market leader.
3 – LOW DEBT & MASSIVE CASH
With Total Assets of $338.5 billion, Apple is one of the richest companies in the world. Its Current Assets of $162.8 billion and Current Ratio of 0.64 mean that the company is very unlikely to encounter short term liquidity problems. (Current Assets are assets that can be readily converted into cash within a year.)
- MASSIVE DEBT?
At first glance, we are shocked to see that Apple is carrying $91.8 billion of long term debt. Also, from 2016-2019, its Debt to Equity Ratio has almost doubled, going from 1.5 in 2016 to 2.7 in 2019. This suggests that the company is highly leveraged.
Why would such a profitable company be carrying so much debt?
The fact of the matter is that Apple took advantage of the fed’s Zero Interest Rate Policy (ZIRP). In 2013, Apple started issuing bond notes for a total of $64.46 billion worth of debt. It did this not because it needed the money but because zero interest rate loans are essentially free money.
Thus, Apple funded part of its growth through cheap debt because the returns far outweighed the cost. As a result, the company’s balance sheet appears highly leveraged. This can be problematic in cases where companies don’t generate sufficient cash but as we will see, Apple is in no danger of insolvency anytime soon.
In order to provide stimulus to the coronavirus-hit economy, the Federal Reserve recently announced that it would once again slash interest rates to zero. Will Apple dip its toes in the cheap debt market again? It’s entirely possible. In 2018, Apple issued $7 billion in bonds in order to raise liquidity for buybacks, dividends and corporate purposes.
Given that the coronavirus will impact Apple’s Q1 and Q2 earnings, the company may decide to take on more cheap debt to finance its short term activities rather than spend its war chest. Personally, I would prefer it if they spent their own cash rather than load up their Balance Sheet with more debt; However, I trust Tim Cook to act in the company’s best interest.
- MASSIVE CASH FLOW
Until recently, Apple was the richest company in the world. Despite being overtaken by Alphabet, Google’s parent company, Apple is still sitting on a hoard of cash: Its 2019 Sales/Maturities of Investments made the company $98.7 billion and its Free Cash Flow of $58.8 billion is astounding. In total, the company has $210 billion in cash on hand.
As a result, in 2019, Apple paid $14 billion in dividends to its shareholders and, more importantly, bought back $66.8 billion worth of stock. Apple’s recent stock buy backs are dizzying: $72 billion in 2018, $66 billion in 2019, TTM $78.8 billion.
4 – THE DIVIDEND
Another perk of investing in Apple is the dividend. Although the dividend yield of 1.15% is low, consider it icing on the cake.
A low yield can suggest that the stock is overpriced. I don’t believe this is the case for the simple reason that Apple has only recently started paying dividends.
The 5-year dividend growth rate of 10.49% is good. Apple’s management is visibly committed to rewarding its shareholders. Considering how profitable Apple is, I expect this trend to continue in the coming years.
5 – STOCK PERFORMANCE
- HISTORICAL RETURNS
Apple is a stock that has rewarded the patient investors. From December 1980 to December 2000, the stock’s total average annual return was a modest 6.96%. When you factor in inflation (average 2.5% per year), the total return is less than 4.5%, which is worse then the S&P 500.
While the first 20 years were underwhelming, the next 20 years proved to be the jackpot: Apple’s stock price surged from $1.22 per share on December 1st, 2000 to $264.16 on December 2nd, 2020. This represents a total 20 year return of 21,552% (average annualized return of 1077%)!
In February 2020, the stock price peaked at $327.20. However, the coronavirus caused the stock to crash to $224.37 in March, before bouncing back to the $268 level.
Obviously, the chances of Apple delivering similar returns over the next 20 years are low. Apple is a much more mature company now than it was in 2000 so its growth will not be as spectacular.
That being said, Apple’s franchise strength, market dominance, innovative spirit and profitability is such that investors can expect attractive capital gains in the coming years.
- CURRENT VALUATION
With a P/E ratio of 21.20, Apple is potentially overvalued compared to previous years. In fact, 2010 was the last time its P/E ratio was this high.
I don’t believe this is the case.
Apple’s P/E ratio is lower than other FAANGs and major tech stocks: It is significantly lower than Netflix’s (102.57), Amazon’s (93.58) and Nvidia’s (59.64) and slightly lower than Microsoft’s (28.39), Facebook’s (26.93), and Alphabet’s (24.62). It’s P/E ratio is actually the lowest of all the major tech stocks.
With a Diluted EPS of 11.89, Cash/share of 24.44 and Cash Flow/share of 15.21, Apple’s current valuation is reasonable. I say this because the company’s recent success has placed a significant premium on the stock price. Nevertheless, the future growth prospects are such that any price under $280 is a good opportunity to open a long-term position.
At writing, Apple’s Enterprise Value is $1.1 trillion dollars. The Enterprise Value is “the theoretical takeover price […] It is calculated as the market cap plus debt and minority interest and preferred shares, minus total cash, cash equivalents, and marketable securities“. It is one of the few companies in the world to boast such a mind-boggling valuation.
It is undeniable that Apple is an exceptionally well managed company with a very solid business model. The franchise is strong, its brand recognition unparalleled, profit margins high, cash reserves enormous, and potential growth prospects promising.
Also consider this: As soon as the stock priced dived because of the coronavirus outbreak, Apple bought back tens of millions of its own shares. Indeed, just months earlier, the company had established that in normal conditions the stock is worth at least $325. I take this as a signal that the current stock price is below fair value.
Further, there is no question that the company will remain a market leader for the next decade at least. Investors interested in purchasing Apple stock should spread out their investment over the next few months to take advantage of any dips in price that may come as a result of the coronavirus crisis.
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DISCLAIMER: This is not financial advice. Conduct your own research before investing in any asset.