Why I Took a Bite of Apple Today

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Bloomberg screenshot.

Yes, markets are getting crushed once again and who knows when will it be over. Challenging business times, endless forecasts (such as probable recession, and so on).

Among these events in the financial world, I purchased some Apple (ticker: AAPL) shares lunch time today (1/7/2016).

Early signs that Apple would indeed have difficulties this year was introduced by Morgan Stanley in mid-December 2015.

According to Huberty (Morgan Stanley), rising international prices and smartphone market oversaturation outside China are weighing on Apple’s primary source of revenue (52% of fiscal 2015 sales; Fortune).

In addition to the ongoing China stock market related fears, AAPL went down (along with other bluechips and other shares as well).

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Now, I am not saying that AAPL will not go lower, but the right question (I think) is, do I have the necessary margin of safety at this time of purchase? As of the moment, my intrinsic value calculation of AAPL is somewhere between $110 to $120/share. So with 20% Margin of Safety, the answer is YES.

Next question is will I have the stomach to purchase more shares-such as if AAPL goes down further to $90, $85, $80, and hopefully settles somewhere in the $70 area. The answer is YES.

Using my simplest method (out of 72 valuation models), AAPL is definitely undervalued as of the moment.

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With its current price of $96.45, that gives 13% discount and 27% discount from its $131.40 record high on May 22 of last year (2014).

Further, ‘the skepticism can be summarized as follows: the world worries that Apple will never find another iPhone. Last year, operating profits from the iPhone jumped from $102 billion to $155 billion, a 52% increase. That single product accounted for 66% of total sales, and for the entire increase in revenues; sales from all its other products combined actually declined’ (Fortune).

For some in depth historical numbers (Worrisome, neutral, and speculation):

Worrisome:

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D/E is increasing on a quarterly basis until current.

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Currently, Apple has Long-term debt at 9% of its market cap or $53 Billion from $17 Billion in 2013.

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Debt-coverage has definitely reduced since 2013.

Currently, I do not fret so much about this as Apple’s owner’s earnings can cover the current net debt. Further, I see that Apple is still more reliant on its shareholders and future shareholders for capital rather than debt borrowing.

I noticed that from all of Apple’s acquisition, a massive blunder it made when it acquired Dre’s Beats Music Headset for $3 Billion on May 28, 2014 (http://aaplinvestors.net/stats/acquisitions/)

Another slightly negative thing that I found about Apple is that the company had spent roughly 49% of its earnings on share buybacks just to reduce it by 6% (my calculation).

Revenue, Ebitda, Owner’s earnings, Book value growth had slowed since 2012. One more thing is that 2015’s debt levels was higher than its profits.

Talking about growth, Apple had a dramatic dividend growth in 2013. From 38 cents to $1.63 (329%). Other than that, the company had slowed down.

One more thing to recognize is that, Apple only began tapping to its borrowing capacity in 2013, although I do not doubt its capabilities of repaying its debt, I am looking forward for it (Apple) not to make a mess with it (debt) and bid its D/E ratio up or greater than 0.8 (personal preference; industry average is at 0.4).

Return on equity is high yet facilitated by increased in leverage, but also in its Profit margin (a positive). Asset turnover is not impressive and had been declining since 2011. I hope for a stability in this aspect.

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Neutral/speculative

On the speculative side, I’ve bought Apple at a good value with current P/E ratio of 10.9 and a Forward P/E ratio of 9.89 with a forecasted median growth rate (Wall Street estimates) of 5%. Now, recent reports came out that Iphone sales (70% of revenue) are expected to decline this year. Further evidence was reported by the Wall Street Journal that Apple had reduced its orders from its China producers by 30%–this seems to be another one of threats being a shareholder.

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Executive decision of share repurchasing seems reasonable at recent years.

Dividend seems to be okay with 20-30% payout ratio range in the recent years since it started paying out in 2011. Further, for the past decade, the company has returned roughly about $186 Billion to its shareholders. Not bad for the largest market capitalized company in the U.S. (currently at $538 Billion)

General expenses is declining for the past decade, including 2015’s $14.3 Billion salaries and expenses, which included the following information of compensation to its executives published by the Business Insider.

2015 Executive Salaries:

Tim Cook, CEO: $10.3 Million

Luca Maestri, SVP and CFO: $25.3 million

Angela Ahrendts, SVP of retail and online sales: $73 million

Eddy Cue, SVP of internet software and services: $25 million

Dan Riccio, SVP of hardware engineering: $25 million

Bruce Sewell, SVP general counsel and secretary: $25 million

Other than that, I do not find its current $3.5 Billion Stock-based compensation alarming at all (in relative terms comparing Non-GAAP to EPS).

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Capital expenditures appears to be controlled (for the past decade).

Some additional news:
Wall Street now expects iPhone unit sales to grow by only 2% year over year in the December quarter and to actually fall 5% in the March period. That would be the first time the popular smartphone has notched a sales decline since its launch in 2007. (WSJ)

Apple Inc.’s investors are spooked.
The shares ended the day below $100 for the first time Thursday since October 2014 amid concerns that demand is waning for iPhones, the most critical piece of the company’s business. More than 60 percent of Apple’s revenue comes from the iPhone so any sign of weakness for the product causes concern among investors. (Bloomberg)

Other ratios (Reuters)

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Other References

Fortune http://fortune.com/2015/12/14/morgan-stanley-apple-price/

Fortune http://fortune.com/2016/01/06/apple-wall-street/

If you are interested in this similar approach to investing and would seek updates or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

-End-

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