Apple and Microsoft

Name

Affiliation
 Introduction

The Apple Company started a low-income company by developing and designing electronic

products for its clients in the market. The company is known to be the best in the production of

computers mostly known as Mac computers as well as other electronic products with Mac

model. The company later went to the production of other related brands such as iPhone that

started from IPhone 1 to currently 7, various type of smart-phone, the iPod music player and iPad

tablet computer. The company started as a PC producer but later changed to production of other

electronic products whose success is inevitable. The company is able to remain in the limelight

because of its quality production in the production of PC and mobile devices (Hemal, 2009).

From there, a financial analysis is performed comparing Apple with its competitors based

on a plethora of common financial indicators and ratios. These values were then used to (1)

forecast the income statement, balance sheet, and the statement of cash flows and (2) analyze the

firm’s cost of capital. With this consolidation of information, our analyst team was equipped to

properly valuate the firm using intrinsic value models.

Overview of Firm
As the 31st largest company in the United States, Apple is known as a global leader in the

technology industry. The impact Apple wishes to instill is done through the numerous products it

supplies to customers around the world. The firm’s worldwide offices in more than 100 countries

allows for the widespread distribution of their products and ideas. These products initially come

to life through the research and develop conducted by Apple into advanced technologies for

software, hardware and services. In fact, the company had been able to lead in the innovation and

invention of PC computers. Despite the fact that some of the competitors such as IBM was in the

market in 1980s, it has not been easy for the Apple to challenge these. With the changes cause by

globalization as well as modernization, Apple is able to meet the needs and demands of the

clients through various ways such as changes in technology as well as constant improvement of
quality. The production of quality products is key to the success of Apple. The brand imaging of

the company was the sources of success of Apple.

Vison

“We believe that we are on the face of the earth to make great products and that’s not changing.

We are constantly focusing on innovating. We believe in the simple not the complex. We believe

that we need to own and control the primary technologies behind the products that we make, and

participate only in markets where we can make a significant contribution. We believe in saying

no to thousands of projects, so that we can really focus on the few that are truly important and

meaningful to us.

Mission
Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork

and professional software. Apple leads the digital music revolution with its iPods and iTunes

online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App store

and is defining the future of mobile media and computing devices with iPad.”

Objectives
Objective 1- Continue to create groundbreaking products. Apple has made a name for itself

becoming a trend setter in the market with every one of their products introducing something

new and exciting to the world.

Objective 2- Innovate and dictate the movement for future technology

Technology is forever changing and even the biggest companies can get left behind. The

consumer will always buy the next big thing and brand loyalty is hard to come by. This is why

Apple must continue to lead the serge of the innovative world

Current and Future of Apple

Apple Inc. is an American multinational technology company headquartered in

Cupertino, California that designs, develops, and sells consumer electronics, computer software,
and online services. The company's hardware products include the iPhone smartphone, the iPad

tablet computer, the Mac personal computer, the iPod portable media player, the Apple Watch

smartwatch, the Apple TV digital media player, and the HomePod smart speaker. Apple's

software includes the macOS and iOS operating systems, the iTunes media player, the Safari web

browser, and the iLife and iWork creativity and productivity suites, as well as professional

applications like Final Cut Pro, Logic Pro, and Xcode. Its online services include the iTunes

Store, the iOS App Store and Mac App Store, Apple Music, and iCloud.

Apple was founded by Steve Jobs, Steve Wozniak, and Ronald Wayne in April 1976 to

develop and sell Wozniak's Apple I personal computer. It was incorporated as Apple Computer,

Inc. in January 1977, and sales of its computers, including the Apple II, saw significant

momentum and revenue growth for the company. Within a few years, Jobs and Wozniak had

hired a staff of computer designers and had a production line. Apple went public in 1980 to

instant financial success. Over the next few years, Apple shipped new computers featuring

innovative graphical user interfaces, and Apple's marketing commercials for its products received

widespread critical acclaim. However, the high price tag of its products and limited software

titles caused problems, as did power struggles between executives at the company. Jobs resigned

from Apple and created his own company, NeXT.

SWOT Analysis
Strengths Weaknesses
i. Advertising capabilities, which increase i. Overdependence on iPhone sales

brand awareness and create stronger ii. Weak direct distribution channels in

demand for the company’s products India

ii. Apple is well-known for employing

multiple channels to deliver its products

to customer
Threats Opportunities
 i. The Internet of Things (IoT) market is i. Intensifying competition puts pressure

expected to grow significantly over the on Apple’s market share, revenue and

next decade profits

ii. Health-related wearable gadgets could ii. Lawsuits over patent infringements

be introduced to the market resulting in damaged brand reputation

Financial Analysis

Liquidity and Operating efficiency

The results produced indicate the liquidity and operating efficiency of the firm and its

industry. Liquidity ratios measure a company's ability to pay debt obligations and its margin of

safety through the calculation of metrics including the current ratio and quick ratio. Comparing

previous time periods, for Apple and its competitors, to current operations allows analysts to

track changes in the business. In general, a higher liquidity ratio indicates that a company is more

liquid and has better coverage of outstanding debts. Analyzing the operating efficiency of a firm

is looking at their management of inventory and other current assets. Six operating ratios have

been considered, three of which Apple is underperforming compared to the industry.

 Liquidity & operating efficiency
Ratio Performance Trend
Current ratio Average Decreasing
Quick ratio Outperforming Decreasing
Inventory turnover Outperforming Decreasing
Days’ supply of inventory Underperforming Increasing
A/r turnover Underperforming Decreasing
Day sales outstanding Underperforming Stable
Cash to cash cycle Outperforming Stable
Working capital turnover Outperforming Increasing

Current Ratio

After comparing Apple to the competitors, we found that the industry’s current ratio is

slightly trending downwards. The current ratio measures a company's ability to pay short-term

and long-term obligations. To gauge this ability, the current ratio considers the current total assets

of a company (both liquid and illiquid) relative to that company’s current total liabilities. The

formula for calculating a company’s current ratio is current assets divided by current liabilities.

Apple’s current ratio is close to the industry average but is consistently lower than Microsoft but

higher than Apple. This indicates Apple and Apple may not be efficiently using its current assets

or its short-term financing facilities, when compared to Microsoft. This may also indicate

problems in working capital management.

Quick Ratio

The quick ratio is a more conservative version of the current ratio. Although the two are

similar, the quick ratio provides a more rigorous assessment of a company's ability to pay its

current liabilities. This is done by eliminating all but the most liquid of current assets from

consideration. Inventory is the most notable exclusion, because it is not as rapidly convertible

to cash and is often sold on credit. Some analysts include inventory in the ratio, though, if it is

more liquid than certain receivables. How Apple compares to its competitors and the industry is

about the same for the quick ratio as it was with current ratio. Apple is similar to the industry

average with Microsoft being the outlier above and Apple being the outlier below the average.

Profitability
Ratio Performance Trend
Sales growth Outperforming Decreasing
Net profit margin Average Stabilizing
Operating profit margin Average Slightly decreasing
Gross margin Outperforming Stabilizing
Asset turnover Underperforming Decreasing
ROA Average Decreasing
ROE Average Decreasing
Profitability ratios are important in showing how well a company generates earnings. It is

safe to say that the tech industry has a downward trend compared to its past performances. This
trend does not indicate the industry lacks profitability, it is very profitable just not when

compared to a peak time in the industry. Apple has been proven to be a fairly average competitor

when it comes to profitability in this industry. Although, Apple’s revenue growth did drop years

back it is not conforming to industry trends. In more recent years Apple has stabilized its current

revenue growth of 5.43%. Apple, as well as the industry, seem to be stabilizing and heading

towards a positive direction after a downward trend in most categories.

Net profit Margin

Net profit margin is the ratio of net profits to revenues for a company or business

segment. Net profit margins show how much of each dollar collected by a company as revenue

translates into profit. Net profit margin is one of the most important indicators of a business's

financial health. It can give a more accurate view of how profitable a business is than its cash

flow, and by tracking increases and decreases in its net profit margin, a business can assess

whether or not current practices are working. Based on the information in the table and

illustrated on the graph below, it is assumed the current practices implemented by the 3 firms,

including Apple, is working effectively.

Return on Equity

ROE is a true bottom-line profitability metric, comparing the profit available to

shareholders to the capital provided or owned by shareholders. Essentially, it’s the profitability

measure that equity investors care most about. Whereas return on assets and return on capital

each depict a variant of profitability available to both debt and equity investors, ROE stays pure,

comparing the income available to just equity investors to the capital owned, and put to work by

just equity investors. The ROE of Apple, Apple, and Microsoft are healthy and consistent. Apple

consistently has the highest ROE, partially due to their revenue being 2-3 times that of both

Microsoft. The stable numbers show that management is growing the company's value at a very

profitable rate.

Return on Assets

Return on assets is an indicator of how profitable a company is relative to its total assets.

ROA gives a manager, investor, or analyst an idea as to how efficient a company's management

is at using its assets to generate earnings. Return on assets is displayed as a percentage and its

calculated as net income divided by total assets. In basic terms, ROA tells you what earnings

were generated from invested capital. Apple and the comparable are all relatively the same with

Apple having a slightly higher return.

Du Pont

The Du Pont is the output of a credit-strength test that gauges a publicly traded

manufacturing company's likelihood of bankruptcy. The Du Pont is based on five financial ratios

that include profitability, leverage, liquidity, solvency and activity to predict whether a company

has a high degree of probability of being insolvent. A score below 1.8 means the company is

probably headed for bankruptcy, while companies with scores above 3 are not likely to go

bankrupt. Investors can use Du Ponts to determine whether they should buy or sell a particular

stock if they're concerned about the underlying company's financial strength. Investors may

consider purchasing a stock if its Du Pont value is closer to 3 and selling or shorting a stock if

the value is closer to 1.8. Apple and its comparables all have a z-score above 3, making them all

in very little risk of bankruptcy and in great financial strength, at lease credit wise.

Statement of Cash Flows

The last step in developing our financial forecast is to input the data assumptions to

determine the Statement of Cash Flows. The Statement of Cash Flows is the hardest to predict

because of the abnormality of cash flows. As well, the values of each line item are dependent on

previously derived data making it crucial that foregoing forecasts are calculated appropriately.

The hardest part to the Statement of Cash Flows to predict is future financing activities, because

financing activities are based on what business strategies management wants to levy at any
specific point in time. Due to this, we focused on forecasting the Cash Flows from Operating

Activities and Cash Flows from Investing Activities.

Using the CFFO/Sales ratio, we can project Cash Flows from Operating Activities. The

CFFO/Sales ratio is the most reliable figure, which provides us with a fairly stable basis for

CFFO forecasting. The ratios from the past years of the CFFO/Sales were (32.5%) in 2016, and

(41.61%) in 2017. Therefore, we noticed an increase in the CFFO/Sales ratio, meaning that

MSFT is collecting more on its sales. With this we predict that MSFT will notice a slight decline

in 2018 to (31.64%), then jump back up to (34.47%) in 2019 and continue to increase until it hits

(39.04%) in 2022.

Cash Flows from Investing Activities is most accurately projected using the NCA/CFFI

ratio, because that has shown to be most reliable ratio. Under weak economic conditions

companies are unwilling to invest, and we expect MSFT to decrease the amount it invests

throughout next year, but at the start of 2019 we expect an increase in market conditions and an

increase in the amount MSFT invests throughout the year. After 2019, we do predict a steady

decrease in the amount MSFT invests.

Valuations

Discounted Dividends Model

Growth Rate
8.10% 8.20% 8.30% 8.40% 8.50%
9.50% 57.74 61.82 66.58 72.21 78.97
9.70% 50.65 53.72 57.23 61.28 66.00
Ke% 9.88% 45.64 48.08 50.84 53.96 57.54
10.10% 40.74 42.64 44.76 47.12 49.78
10.30% 37.13 38.68 40.39 42.27 44.37
Over v 10% Under V
$73.43 $81.59 $89.75
 For the sensitivity analysis located above, the median growth rate used is Apple’s long-

run growth rate

Perpetuity Growth Rate
-10.00% -20.00% -30.00% -40.00% -50.00% of 8.3%. The
3.00% 56.07 52.38 51.45 50.97 50.67
6.00% 41.76 42.36 42.63 42.78 42.87 lower bound is
Ke% 9.88% 34.02 33.27 34.17 34.71 35.07
8.1% and the
11.00% 31.95 31.20 32.19 32.79 33.21
13.00% 26.01 27.99 29.07 29.73 30.18 upper bound is
Over v -10% Under V
$73.43 $81.59 $89.75 8.5%. The

median Ke value used was the cost of equity for Apple, which is 9.88%. The lower bound is

9.5% and the upper bound is 10.3%. The discounted dividends model is a very poor choice for

evaluating Apple due to its high growth rate. This forces any scenario where the cost of equity is

lower than the growth rate to create a negative stock value. For this reason, we are choosing to

not include this model in our decision-making process. If this model was to be used Apple, at a

cost of equity of 9.88% and long-run growth rate of 8.3%, the stock would be considered to be

overvalued.

Residual Model
In every scenario presented in the model, Apple Corporation appears to be overvalued. Part of

this could potentially be explained by a restatement of goodwill and R&D. However, after

reviewing the other models we came to the conclusion that the results would likely be very

similar to the ones presented here and in the other models.

Vertical Analysis

A firm’s cost of capital refers to the value-weighted average of the

required return on the securities in order to finance the firm. Capital can be

raised via debt, equity, or issuing securities. Our team of analysts

incorporated the required rate of return for investors as well as each firm’s

unique mix of financing in finding the cost of capital. WACC (weighted

average cost of capital) is an important tool for analysts.

FIRM WACC (%) COST OF EQUITY (%)

APPLE 8.89 9.88
Microsoft 9.18 10.25

WACC is a great measure of a company’s risk profile. Since cost of debt and risk are both

correlated positively, the risk of a firm increases with the cost of debt. Apple has a WACC of

8.89%, which in comparison to our chosen benchmark firms is exactly the average. This means

that every $1 of capital that Apple raises costs them 8.89 cents. From an investor’s perspective,

Apple’s risk level is middle of the road for the industry. This means that even though there are

firms who are less risky or who have better returns, Apple is very well rounded in regard to both

risk and return.

Value investors will also find information regarding WACC useful. If a firm’s WACC is

higher than its return, this means the company is destroying value. A few common measurements

of return for investors include return on investment, return on assets, and return on equity. As
you can see below, Apple’s values surpass the WACC except in regard to ROA, in which the loss

was minimal.

Conclusion

While performing a comprehensive intrinsic analysis of MSFT we were able to determine

a recommended fair value of the company. These intrinsic models are not as prone to errors and

biases as other valuation methods tend to be. After analyzing the technology industry, we

compared MSFT to some of its competitors. Using the analysis of the technology industry,

MSFT, and its competitors, we gained a better understanding of how the firms compete within

the technology industry using Porter’s Five Forces Framework. Using the competing firms, we

were able to determine Apple’s position in the industry, as well as total market share, compare

ratios, and forecast MSFT’s future value. Using the dividend discount model we saw MSFT to be

overvalued. Under the discounted FCF model MSFT was majority overvalued. While using the

residual income models we estimated MSFT value to be overvalued as well.

Overall, we can safely conclude that Apple is overvalued within the industry. We can

support our claim by putting more weights on the discounted FCF model and residual income

models since and residual income accurately capture the Market Value of Equity of the firm

while discounted dividends model did not accurately valuate the firm since Apple has historically

been paying out dividends and at a continuously increasing rate.

Analyst Recommendation

We safely evaluated MSFT Intrinsic value to be overvalued. The use of the discounted

dividend model would not be accurate to include in our valuation of the firm since dividend

payout has been increasing continuously at approximately an 8.9% rate yearly. Apple could very

well reach a period of paying all net income out in dividends if this growth is continuous and for

that reason we chose to ignore the discounted dividends model. The most weight was put on the

discounted FCF and Residual Income models because FCF gave us a more realistic spread of
under and over valuations. Residual Income model took into account the relative cost of equity,

growth rate, and decay rate to give us proper earnings based on risk and allow us to compare it to

reported earnings. There was one sub section of the sensitivity analysis that showed it to be fairly

valued.

References

Cassell, Warren. “An Overview of Businesses Owned by Apple (MSFT).” Investopedia, 7 Dec.

2015, www.investopedia.com/articles/investing/120715/overview-businesses-owned-Apple.asp

“Financial Review.” Business Description, www.Apple.com/investor/reports/ar13/financial-

review/business-description/index.html.
 Ross, Sean. “Apple Vs. Apple Vs. Microsoft: How Their Business Models Compare (AAPL,

MSFT).” Investopedia, 10 Nov. 2015, www.investopedia.com/articles/markets/111015/apple-vs-

Apple-vs-microsoft-how-their-business-models-compare.asp.

“Technology Companies.” NASDAQ.com, www.nasdaq.com/screening/companies-by-

industry.aspx?industry=Technology&sortname=marketcap&sorttype=1.

“Competition in the Technology Marketplace.” Federal Trade Commission, 11 Nov. 2015,

www.ftc.gov/tips-advice/competition-guidance/industry-guidance/technology.

Keizer, Gregg. “Windows smartphone sales collapse.” Computerworld, Computerworld, 18 Aug.

2016, www.computerworld.com/article/3109198/smartphones/windows-smartphone-sales-

collapse.html.

“Sourcing Responsibly | Apple Corporate Social Responsibility.” Apple, 2016,

www.Apple.com/en-us/about/corporate-responsibility/responsible-sourcing.

Appendix

Financial Analysis Data

Apple

Apple
Liquidity & Operating Efficiency Ratios 2012 2013 2014 2015 2016 2017
Current Ratio 2.6 2.71 2.5 2.47 2.35 2.48
Quick Ratio 2.41 2.53 2.31 2.3 2.22 2.37
Inventory Turnover 13.91 13.17 11.78 11.88 12.72 15.46
Days Supply of Inventory 26.19 27.71 30.99 30.72 28.77 23.61
Cash to cash cycle 13.98 27.64 28.33 26.86 29.55 24.58
A/R Turnover 4.79 4.68 4.69 5 4.72 4.73
Days Sales Outstanding Apple
76.37 77.98 77.83 73.04 77.61 77.24
Working Capital
Probability ratiosTurnover 2012 1.41
2013 1.22
2014 1.27
2015 1.2820161.06 6.38
2017
Sales Growth Rate 5.40% 5.60% 11.54% 7.77% -8.83% 5.43%
Net Profit Margin 23.03% 28.08% 25.42% 13.03% 19.68% 23.57%
Operating Profit Margin 29.52% 34.38% 31.97% 19.41% 23.65% 24.82%
Gross Margin 76.22% 73.99% 68.82% 64.70% 61.58% 61.91%
Asset Turnover 0.64 0.59 0.55 0.54 0.46 0.41
ROE 27.51% 30.09% 26.17% 14.36% 22.09% 29.37%
ROA 14.77% 16.58% 14.02% 7.03% 9.13% 9.76%
 Apple
Capital Structure Ratios 2012 2013 2014 2015 2016 2017
Debt-to-equity 18.00% 19.76% 25.22% 44.07% 74.25% 119.06%
Times Interest earned 77.15 71.14 55.23 30.88 21.56 14.00
Du Pont 4.79 4.79 4.47 3.93 3.45 3.33
Debt service margin 25.69% 12.47% 16.16% 3.96% 2.58% 3.90%
Sustainable Growth Rate 16.62% 19.50% 15.18% 2.42% 7.08% 12.68%

Microsoft

Microsoft
Liquidty & Operating Efficiency Ratios: 2012 2013 2014 2015 2016 2017
Current Ratio 4.22 4.58 4.69 4.67 6.29 5.77
Quick Ratio 3.9 4.25 4.4 4.38 6 5.58
inventory turnover 81.72 47.25 120.62 114.72 92.59 63.41
days supply of inventory 4.48 7.73 3.03 3.18 3.95 5.76
Cash to cash cycle 30.52 25.66 23.42 30.92 35.22 32.37
A/R turnover 7.54 6.62 7.23 7.16 7.03 7.67
Days sales Outstanding 48.55 55.12 50.5 50.96 52.09 47.59
Working Capital Turnover 8.95 8.39 9.09 8.43 8.03 8.81

Microsoft
Profitability: Ratios 2012 2013 2014 2015 2016 2017
Sales Growth Rate 32.37% 10.65% 18.88% 13.62% 20.38% 19.83%
Net Profit Margin 21.40% 23.27% 21.42% 21.80% 21.58% 20.09%
Operating Profit Margin 25.43% 27.74% 24.99% 25.82% 26.27% 24.02%
Gross Margin 58.88% 60.39% 61.07% 62.44% 61.08% 59.87%
Asset Turnover 0.6 0.54 0.55 0.54 0.57 0.6
ROE 16.54% 16.25% 14.79% 14.12% 15.02% 14.43%
ROA 12.91% 12.62% 11.77% 11.82% 12.37% 12.03%

Microsoft
Capital Structure Ratios 2012 2013 2014 2015 2016 2017
Debt-to-equity 7.72% 6.01% 5.54% 4.43% 2.83% 2.52%
Times Interest earned 52.66 238.79 212.42 234.84 240.81 237.18
Du Pont 9.16 12.3 11.24 14.41 14.21 15.15
Debt service margin 6.52% 6.20% 11.14% 8.24% 16.65% 13.03%
Sustainable Growth Rate 16.54% 16.25% 14.79% 1.12% 15.02% 14.43%

Apple

Apple
Liquidity & Operating Efficiency Ratios 2012 2013 2014 2015 2016 2017
Current Ratio 1.5 1.68 1.08 1.11 1.35 1.28
Quick Ratio 1.04 1.23 0.67 0.73 1.05 0.91
Inventory Turnover 112.12 83.45 57.94 62.82 58.64 40.37
Days Supply of Inventory 3.31 4.36 6.28 5.79 6.21 9.19
Cash to cash cycle -52.97 -43.71 -48.24 -52.68 -67.27 -75
A/R Turnover 19.2 14.22 11.96 13.62 13.23 13.63
Days Sales Outstanding 19.32 25.59 30.43 26.72 27.52 27.21
Working Capital Turnover 8.19 5.77 35.98 26.65 7.74 8.21

Apple
Profitability: Ratios 2012 2013 2014 2015 2016 2017
Sales Growth Rate 44.58% 9.20% 6.95% 27.86% -7.73% 6.28%
Net Profit Margin 26.67% 21.67% 21.61% 22.85% 21.19% 21.09%
Operating Profit Margin 35.30% 28.67% 28.72% 30.48% 27.84% 26.76%
gross margin 43.87% 37.62% 38.59% 40.06% 39.08% 38.47%
Asset Turnover 1.07 0.89 0.83 0.9 0.7 0.66
ROE 42.84% 30.63% 33.61% 46.25% 36.90% 36.87%
ROA 28.54% 19.34% 18.01% 20.45% 14.93% 13.87%

Apple
2012 2013 2014 2015 2016 2017
Debt-to-equity 25.03% 13.73% 31.64% 53.64% 67.86% 86.30%
Times Interest earned 197.17 409.97 157.42 112.53 48.44 30.78
Du Pont 9.44 5.71 5.18 4.46 3.74 3.62
Debt service margin 10.04% 12.45% 9.47% 6.98% 5.67% 3.44%
Sustainable Growth Rate 40.30% 21.91% 24.23% 36.35% 27.24% 27.29%