HowMuchDoesAppleMake?

ADuPont
Analysis
ByTimothyP.Connolly,CFA

Oneofthemoreinterestingandinsightfulmodels
orsystemsinfinancialanalysisistheDuPont
analysis,namedaftertheU.S.chemicalcompany
thatbegansystematicallylookingatthese
numbersinthe1920s.
TheDuPontanalysisisawayofdecomposing
andexaminingthefinancialratioreturnonequity
(ROE).ROElooksathowmuchacompany
earnedinthepreviousperiodcomparedwiththe
totalamountofownersequityinvestedinthe
business.TheDuPontanalysislooksatwhyROE
iswhatitisandidentifiessomeoftheunderlyingdriversoftheratio.
OneofthenicethingsabouttheDuPontanalysisisthatallthenumberscanbe
takenstraightfromtheincomestatementsandbalancesheetsprovidedby
companiesintheirquarterlyandannualearningsreleasesorSECfilings.Forour
purposes,weareusingthemostrecentlyfiledForm10KannualreportforApple,
Inc.,dated29September2012.
Startwithreturnonequity
ADuPontanalysisbeginswiththecompanysreturnonequity(ROE).The
formulaforthatisROE=NetIncome/Equity,asbelow:
$41,733/$97,413=42.84%
Whencalculatingfinancialratiosthatmixbalancesheetnumberswithincome
statementnumberslikethisone,itsimportanttakeanaverageofthebeginning
andendingbalancesheetnumbersfortheperiod,whichiswhatwehavedone
here.

Thereasonforthisapproachisthatincomestatementslookatactivitythat
happenedovertheentireperiod,whereasbalancesheetsaresnapshotsofthe
companyononeparticulardayattheendoftheperiod.
So,theirreturnonequitywas42.84%.Whatdoesthatmean?
Goodquestion.ItmeansthatAppleearnedalmost$42billioninthemostrecently
endedfiscalyear.ThatswaymorethanIearnedlastyear.Theydidthatwhile
havingaverageinvestedownersequityinthebusinessof$97.4Billion.
Manyinvestmentprofessionalschoosetolookatthisbycomparingthe
opportunitytoinvestinthisbusinesswithsomeotheralternatives.Theycould
havehadthat$97.4BillioninvestedinshorttermTreasuryBillslastyearand
wouldnothavemadenearlyasmuch.
ThequestionisWHYorhowdidtheyearnthat42.84%returnonthecapital
theyhadinvested.Wasitbecausemanagementwasefficient?Becausetheyhad
highfinancialleverage?Whatdrovethatnumber?
DecomposingReturnonEquity
ItturnsoutthatwecandecomposeorbreakROEdownintocomponentparts
throughamathematicalidentity.
ROE=NetIncome/Equity=(NetIncome/Sales)*(Sales/Assets)*(Assets/
Equity).
Thisworksbecauseitsanidentity:
NetIncome/Equity=(NetIncome/Sales)*(Sales/Assets)*(Assets/Equity).
ExtractingInformationfromtheComponentPieces
ProfitMargin=NetIncome/Sales
$41,733/$156,508=26.66%
Profitmargin,asthenameimplies,tellsyouhowprofitablyyouarerunningthe

business.Areyoubarelycoveringyourcostsordoyouhaveaprettygood
cushion?Themorecommoditizedaproductistheslimmeritsmarginswillbe.
ApparentlypeopledontviewtheproductsApple,Inc.sellsasacommoditysince
26%isaverycomfortablyprofitablebusiness.
AssetTurnover=Sales/Assets
$156,508/$146,218=107.04%
AssetTurnovermeasurestheamountofsalesacompanyhasrelativetothe
assetsithastoownandmaintaininordertogeneratethoserevenues.The
amountofturnovercantellusafairbitabouthowthebusinessoperates.If
turnoverishigh(asitmightbeatahotdogstandorsupermarket)orlow(asit
mightbeatalowturnoverbusinesslikeacardealership)wecanreachdifferent
conclusions.Tothinkabouthowsalesworkdifferentlyinthesetwolinesof
business,rememberthatthereareno10ItemsOrLesssignsinacar
dealership:customersusuallybuyjustonecaratatime.
FinancialLeverage=Assets/Equity
$146,218/$97,413=150.10%
FinancialLeverageisanindicationofhowmuchDebtthecompanyusesto
financethegenerationofrevenues.Aswellsee,Apple,Inc.isintheenviable
positionofhavingnolongtermdebtoutstanding,meaningithasnothadto
borrowmoneytoacquiretheassetsitusestogeneraterevenues,orhaspaidany
debtbackalready.
Soputtingthosethreecomponentratiostogether,wegetthebasicDuPont
Analysis:
ROE=ProfitMargin*AssetTurnover*FinancialLeverage
42.84%=26.66%*107.04%*150.10%
TheExtendedDuPontAnalysis
Itshelpfultoknowalittlebitmoreaboutwhythereturnonequitywas42.84%%,

andthisgivesussomefinerdetailstoexamine.Wecanactuallydotothefirst
componentoftheanalysis,theProfitMarginRatio,whatwedidwithROE.That
is,wecanbreakProfitMargin,againusingamathematicalidentity,intoitsown
componentpartsgivingusanevenfinerlevelofdetailtoexplore.Thisiscalled
TheExtendedDuPontAnalysis.
Aswehaveseen:
ProfitMargin=NetIncome/Sales
26.66%=$41,733/$156,508
Thiscanberewrittenusinganothermathematicalidentity:
ProfitMargin=(NetIncome/Sales)=(NetIncome/EarningsBeforeTaxes)*
(EarningsBeforeTaxes(EBT)/EarningsBeforeInterestandTaxes(EBIT))*
(EBIT/Sales)
WecannowlookatwhatdrovetheProfitMargintobe26.66%.
TaxBurden=(NetIncome/EarningsBeforeTaxes)
$41,733/$55,763=74.84%
TaxBurdenisanindicationofhowmuchthecompanyispayingincorporate
taxesorhowmuchoftheprofitisfallingtothebottomline.Thiscalculation
indicatesthatasofthemostrecentquarter,Applekeptalmost75%ofevery
dollartheymakeafterexpenses.
InterestBurden=(EarningsBeforeTaxes/EarningsBeforeInterestandTaxes)
$55,763/$55,763=100%
AsmentionedearlierApple,Inc.hasnolongtermdebtoutstandingandtherefore
hasnoInterestExpensetopaytolenders.ThismeansEBTisthesameasEBIT.
UsuallyInterestExpensereducesNetIncomeandthereforelowersROE.
SalesMargin=(EBIT/Sales)

$55,763/$156,508=35.63%
SalesMarginisyetanotherwayoflookingathowprofitableeachdollarof
revenueisafterdeductingoperatingexpensesbutbeforedeductinginterestand
taxes.
Soagainputtingthethreeratiostogetherweget:
ProfitMargin=TaxBurden*InterestBurden*SalesMargin
26.66%=74.84%*100%*35.63%.
AndfinallythecompleteExtendedDuPontAnalysis:
ROE=(NetIncome/EBT)*(EBT/EBIT)*(EBIT/Sales)*(Sales/Assets)*
(Assets/Equity)
42.84%=($41,733/$55,763)*($55,763/$55,763)*($55,763/$156,508)*
($156,508/$146,218)*($146,218/$97,413)
ROE=TaxBurden*InterestBurden*SalesMargin*AssetTurnover*Financial
Leverage
42.84%=74.84%*100%*35.63%*107.04%*150.10%
Naturally,asananalyst,itwouldbeamosthelpfulexerciseindeedifonewereto
performtheExtendedDuPontAnalysisonApple,Inc.goingbackovertimetosee
howthetrendshavebeengoingwiththeindividualcomponentsovertime.Even
moreinsightfulwouldbetoperformtheanalysisontheothercompetitorsin
Apple,Inc.sindustrytoseehowtheystackuprelativetoAppleaswellashow
theircomponentratioshavebeentrendingovertime.Letmeknowhowthatgoes!

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