torsdag 6 november 2014

How safe is your Apple investment, really?

... continue to build the Apple model from yesterday


Finish the company model by adding some Balance Sheet items and a Cash Flow analysis. You'll find all these numbers right next to the Profit and Loss statement in the company report.

Just add the most basic measures, like Shareholder's equity (that is what you as a shareholder own a part of, it is the difference betwen all the company's assets and all its liabilities), cash or cash equivalents and debt.

(long term debt usually stands for the interest bearing debt, while other kinds of debt are things like accounts payable to suppliers)

If the company has a lot of debt this affects its valuation, its interest costs as well as its ability to make large acquisitions. So far, none of these factors are large for Apple. However, lately Apple have started to issue debt to finance its dividend and share buybacks.

Add in measures for Equity per share (it is nice to see how much of the share price is actual value on the balance sheet per today. The difference has to be made up by future profits that exceed your annual return requirement) and Return on Equity (earnings/Shareholder's equity). Just note that right now you have no way of forecasting the equity. We'll come to that below.

The cash flow the company generates is more or less its earnings after paid taxes..., albeit with a few adjustments:

Start with earnings = net income. Add non-cash accounting items, like depreciation and amortization (these are just periodization [timing] items, the actual cash outlay is booked under investments [which are not accounted for in the P&L statement and therefore have not affected earnings]), then deduct investments, the difference between booked taxes and actually paid taxes, change in net working capital (payables, receivables, prepaids etc), a.k.a. NWC.

Make various sums and variations of cash flow, such as Operating cash flow (what the company actually creates/receives in cash flow before it makes investments [buying long term machinery] or change its financing [debt issuance, paying or taking bank loans, stock buybacks]) and Cash flow before financing items.


cost of share purchases at current price
Buyback cost as proportion of earnings
Dividends per share DPS
Cost of dividends and equiv.
Shareholder's equity
Cash
Long term debt
Equity per share
Return on Equity = Earnings/equity
Net income
Depreciation and amortization etc
Deferred taxes
Other, net working capital
Total operating Cash Flow
According to Apple
Investments
Financing including stock repurchases
TOTAL CHANGE IN CASH


Fill out the rows for all items.

Make an assumption on likely dividends going forward. Past trend, annual growth, company dividend policy or dividends as a share of profits serve as guidance factors. You'll need the cost of dividends and buybacks later when forecasting Cash Flow and Equity.

You already have net income for all years (if debt were important net income would be affected by the cash flow statement and the reslting level of debt).

Depreciation can be extrapolated from previous trends or from known investment levels or stock of capital (machinery). In a steady state depreciation should be about equal with investments (because that's what being depreciated with a lag), deferred taxes are probably correlated with the total tax level. If it's not a big item the forecasting isn't important anyway.

The same goes for NWC (net working capital; payables, receivables etc, accounting items that explain the difference between booked sales, sent invoices and actually paid in cash from clients and vice versa for suppliers and payables)

Forecast investments from previous level and trend. I chose to forecast investments being 20% bigger than depreciation. That might be too negative. On the other hand I keep deferred taxes a net positive.

Financing: going forward, don't assume anything about bamnk loans, debt issuance etc unless there is a very good reason. In Apple's case at this point you are only interested in how the big items of stock buybacks and dividends are affecting its cash and equity.

Nota Bene: In Apple's case the Balance Sheet and Cash Flow exercise hardly made any difference at all. Other companies are more BS dependent.

When you are done go back to the Shareholder's Equity line, and make forecasts by taking last year's equity and add earnings and deduct dividends and buybacks.



Now you are ready to make your first Discounted Cash Flow valuation (DCF analysis):

Calculate Cash Flow excluding Dividends and Buybacks. In this model it is almost exactly the same thing as net earnings going forward. Repeat annual Shareholder's Equity to keep it handy.

Choose a discount rate, a required return, a factor that states how much return you demand (or think the market demands) annually on an investment in Apple. I put in 7%. I actually think that's way too little, considering Apple's risky business (fickle consumers, high tech) but such are the times (actually you shouldn't care about the current times when making a warranted valuation, but if you don't you'll end up with very divergent valuations. Anyway, it's a way of finding out what the market is assuming)

Then calculate the Present Value of annual cash flows. Next year's cash flow of e.g. 10.7 is worth 10 today (10.7/1.07) and cash flow 2016 is worth X/1.07^2 today and so on so just keep dividing the CF every year by the discount factor. Make line for the Sum Of discounted CF up until that year.

Calculate the end value of the business for every year and discount that to the present day. You can value the business any way you like and then discount it, just as you can value it anyway you like today. Either you make cash flow forecasts for decades and decades or you assume something about the level of value creation going forward from your last cash flow forecast.

Don't worry if this sounds complicated the first time, the steps in my book about this are much easier to follow.


Free cash flow excluding dividends and Buybacks
End of year equity
Discount rate, required return7%
Discount factor
Present value of cash flow
Sum of present value of cash flow (Net Present Value)
End value of business after last cash flowCF yield requirement6%
CF multiple
End valueNext year's CF times warranted end multiple
Discounted end value (End value divided by discount factor)
Sum of NPV (disc CF stream + disc end value)
Discounted cash flow value per share (end of 2014); sum of NPV divided by nr shares today (eof 2014)

One way is to assume a cash flow yield requirement for the cash flow stream from year N and forward. That means you assign a multiple to the final cash flow in your forecast. E.g., a required yield of 6% is the same thing as saying the eternal stream of cash flows from year N and forward is worth 16.6x the first of those annual cash flows. Then discount that value to present day with the appropriate number of years. Sum it all up and divide by today's number of shares and there you are.



Free cash flow excluding dividends and Buybacks41,74143,82846,02048,32150,73753274
End of year equity114,678120,298128,431139,105152,356
Discount rate, required return7%7%7%7%7%7%
Discount factor107%114%123%131%140%
Present value of cash flow39,01138,28137,56636,86436,175
Sum of present value of cash flow (Net Present Value)39,01177,292114,858151,721187,896
End value of business after last cash flowCF yield requirement6%6%6%6%6%6%
CF multiple16.6716.6716.6716.6716.67
End valueNext year's CF times warranted end multiple730,472766,996805,346845,613887,894
Discounted end value (End value divided by discount factor)682,684669,924657,402645,114633,056
Sum of NPV (disc CF stream + disc end value)721,695747,216772259.7476796,836820,952
Discounted cash flow value per share (end of 2014); sum of NPV divided by nr shares today (eof 2014)118122126130134

Another approach is using Return on Equity as the deciding valuation factor. If an asset returns twice your requirement you can pay twice as much and then get exactly your requirement. Hence an Equity of 100 that returns 14% is actually worth 200 to you if your requirement is 7%: 100x14/7=200.

Other approaches
Required return on equity7%7%7%7%7%
RoE next year38.1%38.1%37.5%36.3%
Warranted equity multiple544%544%535%519%
Equity114,678120,298128,431139,105
Warranted value623,722654,908687,654722,036
Discounted warranted value582,918572,022561,330550,838
per share (today's number of shares)95.293.491.790.0


  • Not surprisingly, Apple is valued as a triangulation of several common methods (very typical and professional... and boring and conventional)
  • There is nothing special about the valuation, no recessions, product misses or great inventions
  • It's like a bond or a country, an oil tanker that slowly and steadily moves along a predictable path
  • ...which I think is weird because that is almost the only thing that certainly NOT will happen



Share price11/4/2014109109109109109109
2010201120122013201420152016201720182019
Sales65,070108,600155,970170,910182,795193,763203,451213,623224,305235,520
Cost of sales106,606112,258137,572144,450151,673159,256167,219
Opex15,30518,034
Operating profit18,54034,21055,76050,15553,48356,19159,00161,95165,04868,301
Income tax(13,118)(13,973)(14,610)(15,340)(16,107)(16,913)(17,758)
Earnings14,01025,92041,73037,03739,51041,58143,66145,84448,13650,543
Diluted nr of shares6,521,6346,122,6635,877,7565,642,6465,416,9405,200,2634,992,252
Earnings Per Share5.686.457.077.748.469.2610.12
Revenue per share26.229.933.036.139.443.147.2
2013201420152016201720182019
P/E19.216.915.414.112.911.810.8
P/S4.23.73.33.02.82.52.3
Market cap at current share price667,370,267640,675,456615,048,438590,446,501566,828,641544,155,495
sales growth9.6%7.0%6.0%5.0%5.0%5.0%5.0%
Operatingmargin28.5%31.5%35.8%29.3%29.3%29.0%29.0%29.0%29.0%29.0%
tax rate-26.2%-26.1%-26%-26%-26%-26%-26%
Share count evolution-6.1%-4%-4%-4%-4%-4%
cost of share purchases at current price26,69525,62724,60223,61822,673
Buyback cost as proportion of earnings64%59%54%49%45%
Dividends per share DPS1.641.822.002.202.422.662.93
Cost of dividends and equiv.10564111261175612414131091384314618
Shareholder's equity47,79076,620118,210123,549111,547114,678120,298128,431139,105152,356
Cash10,74614,25913,84417,13522,92231,23142,09155,536
Long term debt16,96028,987
Equity per share18.918.219.521.323.726.730.5
Return on Equity = Earnings/equity54.2%54.5%31.3%32.0%37.3%38.1%38.1%37.5%36.3%
Net income14,01025,92041,73037,03739,51041,58143,66145,84448,13650,543
Depreciation and amortization etc1,0301,8106,55713,52015,90016,85417,69718,58219,51120,486
Deferred taxes1,4402,8704,4101,1402,3502,4422,5642,6922,8272,968
Other, net working capital9031,170(1,740)2,2502,8601,0891,1431,2001,2601,323
Total operating Cash Flow17,38331,77050,95753,94760,62061,96665,06468,31871,73375,320
According to Apple53,66659,71361,96665,06468,31871,73375,320
Investments(33,774)(22,579)(20,225)(21,236)(22,298)(23,413)(24,583)
Financing including stock repurchases(16,379)(37,549)(38,450)(38,041)(37,711)(37,461)(37,291)
TOTAL CHANGE IN CASH3,513(415)3,2915,7878,30910,86013,445
Free cash flow excluding dividends and Buybacks41,74143,82846,02048,32150,737
End of year equity114,678120,298128,431139,105152,356
Discount rate, required return7%7%7%7%7%7%
Discount factor107%114%123%131%140%
Present value of cash flow39,01138,28137,56636,86436,175
Sum of present value of cash flow (Net Present Value)39,01177,292114,858151,721187,896
End value of business after last cash flowCF yield requirement6%6%6%6%6%6%
CF multiple16.6716.6716.6716.6716.67
End valueNext year's CF times warranted end multiple730,472766,996805,346845,613887,894
Discounted end value (End value divided by discount factor)682,684669,924657,402645,114633,056
Sum of NPV (disc CF stream + disc end value)721,695747,216772259.7476796,836820,952
Discounted cash flow value per share (end of 2014); sum of NPV divided by nr shares today (eof 2014)118122126130134
Other approaches
Required return on equity7%7%7%7%7%
RoE next year38.1%38.1%37.5%36.3%
Warranted equity multiple544%544%535%519%
Equity114,678120,298128,431139,105
Warranted value623,722654,908687,654722,036
Discounted warranted value582,918572,022561,330550,838
per share (today's number of shares)95.293.491.790.0
LT market PE103PracticalHidden assumptions
DCF126CorrectExplicit but sensitive
RoE92Crude but correctVery rough measures of Eq and rRoE
Average107


So what's Apple worth?

Given modest yield requirements, which might be appropriate today, Apple's share seems to be worth more or less the 109 USD (103, 126 and 92 respectively with three methods; average 107) it is trading at. If, however, rates on alternative investments (bonds, other stocks) or inflation increase during the coming 20 years without affecting Apple's nominal growth upward, then 6-7% yields on equity or cash seem to little to me.

Also remember that Apple's business is far from risk free. As I stated yesterday, it's unusual to stay at the top for more than 5 years, not least for consumer electronics firms, so Apple is living on borrowed time. The yield requirements and the forecasts above don't take those risks into account. 

There are a lot of other risks as well that are not included such as natural disasters, brand disasters, recessions, a general stock market crash. On the other hand, the model does not account for new products, new inventions and new unusually successful launches for Apple. It's just a status quo model, which is probably exactly what will not happen.

Anyway, now you know what the market is implicitly assuming and can adapt to that if you have a different opinion.


The model is ready for our assumptions... which will be the next exercise. 

(I really wish my book was ready, so I could refer to it instead of writing these long and boring posts. On the other hand it's a good exercise for me too, to start from scratch and step by step build a model while reasoning about it before your eyes)


1 kommentar:

  1. I don't know if I am asking for too much, but for the sake of saving time on answering formulation questions, could you possibly send this model to my email--hoopes.kyle@gmail.com.

    SvaraRadera