Apple Inc. (mar 10, 2018 Update).docx

March 10, 2018

© Investment Club, RIT Croatia

Ivan Kolembus

Company Report: Apple Inc. (AAPL) Industry: Personal Computers

Sector: Technology

About The Company (Source: Apple.com) Apple Computer Inc. was founded in 1976 by Steve Jobs, Steve Wozniak, and Ronald Wayne. In the next few years they had accumulated enough capital to hire computer designers and establish product line. Apple's IPO was in 1980, and it was a great financial success. The main problem for Apple was its high price tag compared to Microsoft. Because of that, power struggles arose and Steve Jobs resigned from the company. However, the expensiveness of Apple product continued to be their biggest problem. In 1997, then-CEO Gil Amelio decided to buy Steve Jobs' company to bring him back. After that Jobs became the new CEO. In order to bring the company back to its feet, he started buying smaller software companies. Furthermore, he changed some of the hardware technology used in order to cut the price down. In 2007, the company's focus was changed to consumer electronics and the iPhone was announced. Because of that change, the company was renamed to Apple Inc. After the change, the company achieved financial success once again. Another big change in leadership is in 2011 when Steve Jobs died. Some say that it was an end of one era for the company. After Jobs' death, Tim Cook took over as the new CEO. In February 2015, the company became the first US company to be valued over US$ 700 billion. Apple employs 116,000 people all over the world and has 498 retail stores. Today, Apple is a multinational technology company headquartered in Cupertino, California. It is popular for its consumer electrics, computer software, and online services. When it comes to hardware products, Apple offers iPhone, iPod, iMac, and lots of other popular gadgets. They offer two operating systems, iOS for iPhone and macOS for computers. Samsung is Apple's greatest competitor when it comes to mobile phones. Moreover, when it comes to operating systems, Microsoft (Windows) and Alphabet (Android) are the major competitors. Apple is the world's largest information technology company by revenue, and the world's second largest mobile phone producer (after Samsung). In addition to that, Apple operates iTunes which is the world's largest music retailer. Finally, Apple's high level of brand loyalty has made it the world's most valuable brand.

About the Technology Industry *For information about the pharmaceuticals industry and the Healthcare sector, please see document “IT Industry_27.1.2018_Vlaho Miloslavić”.

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General Information about the Company (Source: Seeking Alpha, SEC, Ycharts) Metric Examined Price Per Share Shares Outstanding Market Cap R&D Expenditure * Net Income *

$179.98 5.07B $913.22 B $3,407 M ** $20,065 M **

12-2017 $163.05 5.165 B $842.15 B $11,581 M $ 48,351 M

12-2016 $115.82 5.255 B $608.63 B $10,045 M $45,687 M

12-2015 $105.26 5.544 B $583.56 B $8,067 M $53,394 M

12-2014 $110.38 5.826 B $643.07 B $6,041 M $39,510 M

*Apple's fiscal year ends on the last Saturday of September. ** Data from Dec 30, 2017.

Short Commentary In 2015, price per share is lower than in 2014 despite the repurchase of almost 300 million shares. Since repurchases should increase price per share, it is obvious that Apple had some troubles in 2015. So, main problems in 2015 were that everyone estimated lower sales of iPhone (estimates were incorrect). Strong dollar made Apple's product more expensive to foreign markets which influenced already expected lower sales. The third reason was that smart phone market is slowing down and that cheaper rival Android is getting better and cheaper (more here). Price per share rose in 2016. Again, almost 300 million shares were repurchased which certainly played some role in the price increase. Other reasons may be successful iPhone 7 launch and recall of Samsung Note 7, which probably shifted some of the Samsung customers to Apple. In 2017, we see huge increase in price per share. Again, around 100 million shares were repurchased, but that doesn't explain such a huge increase in share price. Some people estimated that Apple share price will be around $202 at the end of the year, making its market cap over one trillion dollars. Today, we can see that the estimate was too far-fetched, but Apple’s market cap is steadily approaching towards one trillion, and I believe that it will happen eventually. Furthermore, Warren Buffet's company (Berkshire Hathaway) doubled its bullish bet on Apple (link). Also, we can see that Apple's net income on July 1, 2017 ($ 37,637 M) is more than 80% of the whole 2016 net income. When one combines that with expectations that tech sector will be the main market pusher in the incoming quarters, it becomes clearer why Apple's shares are on the record rise. To confirm that, we can see that net income from the end of the fiscal 2017 was higher than that of the fiscal 2016. On October 27, 2017, we saw huge increase in Amazon, Alphabet, and Microsoft earnings. Moreover, on November 2, 2017, Apple published its quarterly revenues, which were 12% higher than the year-ago quarter. However, expected rise in share price of 8% was not realized. Apple shares went up 4% (from $166 to $174). In the meantime, Apple had troubles because they admitted that they slowed down their devices, but that didn’t influence their share price so much, and today it is at the all time high, which is probably largely influenced by Buffett’s constant support for the company (more here). When it comes to R&D expense, it is high, but that is normal for the industry. Net income varies greatly from year to year, so it deserves a special section.

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Historical Net Income (Statista.com)

First of all, increase from 2005 to 2015 is almost unbelievable, and I think that it tells a lot about the company. So, in 2007, we have the first iPhone release. It seems as if financial crisis didn't have much influence on Apple because its net income rose in 2008 and 2009. In 2010, 2011, and 2012, the increase can be explained by their iPhone sales, but then in 2013, we can see the first drop in net income since 2005. In 2013, iPhone sales were higher than in 2012, which is odd because net income is lower. The problem is that sales of tablets and computers were same as in 2012 or lower. That was a great concern for the investors, especially flat sales of tablets, because in that time it was a young market and was expected to grow. In 2014, again increase in iPhone and tablet sales, and net income started increasing towards 2012 level. In 2015, Apple had record Q4 iPhone sales, Apple watch was a great success, and all time record sales for Mac. 2015 fiscal year was the Apple's most successful year. It may be confusing that at the end of 2015, Apple's price per share was lower than in 2014, but one must take into consideration that the price per share data is from the end of the year, and the net income is from the last Saturday of September. Price per share at the end of the September 2015 was $110.30 and it rose to 119.50 in October, and then it started to decrease. Net income drop in 2016 can be explained by the first time ever lower iPhone sales on year-to-year basis. After that analysts started to worry that this is the "peak Apple" and that we won't see something similar to 2015 from the Apple again. When it comes to this year, I think that it will prove that there is no "peak Apple" yet, and, in my opinion, there is a good chance that the company's net income will come close to 2015 record. Net income in 2017 confirmed that Apple is getting closer to the 2015 record. Furthermore, net income of quarter ended on December 30, 2017, which is already at the 40% of the overall 2017 net income indicates that Apple could set a new record this year. However, concerns about “peak Apple” are getting stronger because their iPhone sales (in units) continue to drop from quarter to quarter, but iPhone X higher price is making their revenues higher (link). On the other hand, Apple saw increase in demand for iPads , which Page 3 of 9

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also boosted their revenues and is responsible for the already high earnings. Today, I am more concerned about Apple’s ability to continue with so high profits because they are apparently losing market share, and I doubt that Apple will be able to increase their revenues with ever increasing prices because iPhone X’s price tag of $999 is, I believe, near the maximum even for the most loyal Apple customers. In addition to that, even though Apple’s admission that it slowed down devices on purpose didn’t impact the share price, I believe that it had impact on customers and that a discount on iPhone batteries won’t be enough to get some customers back.

Valuation Analysis (Source: sec.gov, own calculation) Metric Examined AAPL Technology Industry * P/E Ratio 19.23 27.39 P/B Ratio 6.52 5.57 * iShares US Technology ETF was used for the industry average

Undervalued/Overvalued Undervalued Overvalued

Short Commentary When it comes to P/E ratio, Apple is undervalued, which is great since we would like to invest in stocks with lower P/E ratio. It is usual for the industry to have higher P/E ratio, but Apple is different (Microsoft: 66.12, Alphabet: 64.59). Its P/E ratio is surprisingly low and that means that investors have to pay less for one dollar of earnings, which is good for them. However, P/E ratio is on the rise, it was 11.4 in 2015 and 13.9 in 2016, which could mean that it is the right time to buy shares before P/E ratio goes over the industry average. When talking about rise, on October 30, 2017, Microsoft’s P/E ratio was 28.35, Alphabet’s was 49.73, and Apple’s was 18.53. It is obvious that the first two companies saw huge rise in their P/E ratio, which may be an indicator of some problems with their earnings because their price did rise. At any rate, such an increase of P/E ratio makes companies look overvalued and investors could start questioning their earnings. On the other hand, Apple’s P/E ratio has barely changed, but in the General Information table, we can see that Apple’s price didn’t stay the same, which means that Apple’s earnings have also increased and that is good for investors. More about Apple’s price to earnings ratio: link. When it comes to price to book ratio, Apple is slightly overvalued, but that should not be looked upon as a problem since the P/B ratio doesn’t have very significant role in evaluation of tech industry.

Debt Analysis (Source: SEC, own calculation) Metric Examined Total ST Debt* Total LT Debt Quick Ratio Debt/Equity Ratio

12-2017 $6,498 M $103,922 M 1.2 1.9

09-2017 $6,496 M $97,207 M 1.223 1.79

09-2016 $3,500 M $75,427 M 1.32 1.51

09-2015 $2,500 M $53,329 M 1.07 1.43

09-2014 $28,987 M 1.04 1.08

*Current portion of long-term debt Short Commentary According to quick ratio, Apple has more than enough cash and cash equivalents to cover its current liabilities, which makes it look safe to the investors. As in Microsoft and IBM analysis, we can see Page 4 of 9

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increasing long-term debt and debt to equity ratio. Current D/E ratio of 1.9 may look concerning, but as others, Apple was using low interest rates and when one takes into consideration that Apple is the richest company in the world, there is no need to worry about Apple’s capabilities to repay those debts. Moreover, it was cheaper for Apple to issue debt against its foreign funds than to use those profits because of the high taxes, which also could explain growing D/E ratio. Decreasing quick ratio as well shouldn’t be cause for a concern because as Apple issues more debt, current portion of debt increases and so do their current liabilities and therefore the quick ratio is getting lower. Investors will probably neglect these quick ratio decreases as long as it is above 1. TAX REFORM Apple is well known for its foreign funds and unwillingness to repatriate it because of the high taxes. However, the announced tax cuts really happened and are beneficial for Apple. Some had fears that Apple will have problems because it will have to pay $38 bn in taxes, which certainly can’t be good for any company, but it is not that simple. First of all, that amount can be paid over 8 years without any additional interest. Secondly, Apple had already planned that it will eventually have to pay for its foreign cash, and the estimate was $36.4 bn, which is very close. And finally, Apple had already announced that it will invest $30 bn in the U.S. economy over the next five years. (source). Apple estimates that economic impact of its investments to the U.S. economy will add up to $350 bn over five years. To see what Apple plans to do with $30 bn investment click here. Also, with additional funds, Apple announced bonuses for its workers and dividend increase is possible, which will transfer some of the tax burden onto shareholders. To conclude, it seems as Apple is becoming an example of Trump’s promise that his policies will allow companies to bring their cash back to the U.S. When one takes into consideration all the controversies about production of Apple products in China, all of these investments, apart from being beneficial for the U.S. economy, will also improve Apple’s image, which wasn’t really harmed by all the controversies, but Apple could see additional benefits in terms of market share or brand value because of the announced investments. When it comes to benefits for the U.S. economy, one should take into consideration that American companies have more than $2 trillion of earnings in overseas subsidiaries, and that sudden repatriation of that money could overheat the economy, which could lead towards higher inflation, which after taking the steps to fight the inflation could lead to a new recession. So, in short run, benefits seem great for the economy and companies could see their share prices go up, but in the long run, if not done properly, this could be very detrimental for the economy.

Management Compensation (Source: Seeking Alpha) All of the Board members seem qualified for their position because of their past experience as either C-level executives in companies like Boeing, Xerox, and General Motors, or as members of another boards. I would like to mention that Al Gore is a member of the Board, which is great because of his experience from politics and environmental activities. It may be partly because of him that most of the Apple’s production is powered by renewable energy. Furthermore, Tim Cook is already well known as Apple’s CEO. He became CEO in 2011 and managed to save Apple from its crisis. In 2012, he was included in Time’s 100 most influential people in the world. Overall, Apple’s good performance shows how capable and skillful board members and executives are, so I believe that none of those people could do something that could harm the company.

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Metric Examined CEO, Chairman, President (2017) CFO Salary (2017) Net Income (2017) CEO Salary/Net Income

Cash $3,057,692

-

$1,019,000

$20,000,113

Nonequity incentives $9,327,000

Ivan Kolembus

Other*

Total

$440,374

$12,825,066

$3,109,000 $13,271 $ 48,351 M 0.027%

$24,141,615

* Other Compensation covers all compensation-like awards that don't fit in any of these other standard categories. Numbers reported do not include change in pension value and non-qualified deferred compensation earnings.

Short Commentary Apple is performing very well, and there is no doubt if CEO and CFO are well incentivized and motivated, but the table shows that there were no stock awards for CEO in 2017. Moreover, according to Definitive Proxy Statement, Mr. Cook hasn’t received stock awards since 2015. That is strange because most of the people connect stock awards with higher motivation to perform well. However, we can see that CFO did receive stock awards in that year. The problem is California’s “ungodly” tax rate and Tim Cook’s multiyear payday of 135 million dollars. Apple had to sell all of his stock awards to pay for his 52% tax rate. More about it here. CEO salary/net income was expected to be that low because of the Apple’s huge net income. In 2016, C-level executives didn’t receive full non-equity incentives because they didn’t meet their goals, but in 2017, C-level executives have met their goals, so they received 155.5% of target incentive.

Dividends (source: Macrotrends.net)

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Until 2013, dividends were sharply increasing, but since 2013, they are steadily rising, which is what most of the institutional investors like to see. Today, Apple is the biggest dividend stock. It surpassed Exxon Mobil in May 2017. Apple’s payout ratio is 0.2526, which is certainly not too much for the richest company in the world. In my opinion, payout ratio is not higher because Apple is repurchasing it stocks each year and that is also one way to give investors their money back. Furthermore, proceeds from issuance of $7 billion of debt in 2017 were used to increase dividends and stock repurchases. Risk of not being able to continue paying increasing dividends is, in my opinion, very low. It may be confusing that the company is financing its dividends and buybacks through debt instruments, but that is mostly because Apple is trying to avoid bringing its cash back to US, but that is about to change because of the tax reform which allowed Apple to repatriate its cash at favorable tax rate. Furthermore, Apple plans on becoming cash neutral company by spending its cash on buybacks and dividends. More about that here. It is generally accepted that growth companies don’t pay out their earnings, but they use it to finance further growth. Even though Apple is already biggest dividend stock, it still increases its R&D expenses, which means that one cannot say that Apple is not a growth stock. But, the above mentioned announcement combined with declining sales (in units), may look like Apple’s way of accepting that the golden age has ended for them and that it should focus on keeping the investors by offering higher payouts. Anyhow, Apple won’t just stop innovating and producing new products because of the decline in sales, but with their financial power, I believe, that they will make most of the every opportunity in order to generate ever increasing revenues.

Technical Analysis (Finance.yahoo.com)

Price Analysis: The price was increasing until mid-2015 and then it started to go down. Despite record earnings in that year, Apple’s price decreased, probably due to estimates about low iPhone sales. It is important to realize that Apple is a popular stock and that any news about it will have some influence on Page 7 of 9

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the price. After 2015, lows are starting to get lower and highs are not as half as strong as they were in 2015. Since mid-2016, we can see strong increase which is still continuing. In the beginning of the February 2018, we can see drop from nearly $180 per share to $150, but despite that correction, Apple’s share price recovered very soon and is back to $180. When it comes to that recovery, I would say that Buffett’s support had a significant role because it instills confidence since he is one the most famous investors in the world. Moreover, analysts expect that Apple will reach market cap of one trillion very soon and as the price approaches to $200 per share it becomes more and more possible. Finally, announced dividend increase could also push price per share up. Volume Analysis: Volume followed price changes, but since the stock started its upwards trend, we can see lower volume, which indicates that people are holding the stock. We can see higher sell volumes during the correction, but after that the green columns take over. I believe that it will continue that way because of the high earnings euphoria and Buffett’s support. Moving Averages analysis: The stock was trading pretty close to the 50 day MA (except for highs in 2015 and lows in 2016, when the difference was around $20). Since mid-2016, stronger divergence is visible, and if stock continues this way, and fulfills expectations for the future, correction will be needed. However, correction happened and price per share decreased to the level of 50 day MA, but it stayed that way only for a short time. That may be understood as confirmation of the upwards trend, but there is always a chance of a trend reversal if divergence between moving averages becomes too big. Trend Analysis: Trend is upwards and if we draw a resistance line, we can see that since end of the 2017, excluding correction in February 2018, price bounces against the resistance and tries to get over $180 per share. On March 10, 2018, price per share was 179.98 and I considered $180 as some kind of a boundary, and I thought that if the price goes over $180, the resistance line could become a support. However, today (March 13, 2018) price is already above that boundary and if it continues that way, we could see Apple’s price per share above $200 this year. For bullish investors that seems possible because of the Apple’s high earnings, announced investments, dividend increase, and share buybacks. In addition to that, they would really like to see Apple’s market cap at one trillion, which could make them act even more bullish because that goal is so close. On the other hand, there is a fear that Apple won’t be able to generate this kind of revenues anymore and that rising interest rates will make equity market less attractive. In the end, this will probably be very interesting year for Apple and all of its shareholders and, as usually, the trend’s future will depend on who wins-bears or bulls. Relative Strength Index: It has been around 60 for most of the time. Now it is almost 62, which means that Apple outperforms 62% of the market. We can see pretty strong positive correlation between RSI and price per share, and if we look at the graph we can see that decreases in share price usually occur when RSI is close or over 70, which could mean that the price still has room to increase before investors start considering Apple shares as overbought and start selling them and consequently lowering the price per share.

Final Conclusion OVO JOS NISAM DIRAO. SPOMENI ONO S KRAJA DIVIDEND PARTA ZA NJIH KONSTANTI GROWTH AKO SE NASTAVI DA NEMA KRAJA I TAKO TO…Apple is a stable and wealthy company, but its price is more volatile than one would expect it to be for the company of those characteristics. I would buy it, but I wouldn’t hold it for too long. To explain, I believe that the stock is going to grow, especially after the Page 8 of 9

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report is published. Furthermore, I think that it will continue to grow in the Q1 of 2018. After Q1 or even during it, I think that some estimates and projections will appear which will drive Apple’s price down again. So, my final decision is to buy it and hold it almost until the end of Q1 of 2018, and then sell it. Metric Price target (end 2017) Price Target (end of Q1, 2018) Buy/sell Level of Riskiness

Value $185-190 $195-200 Buy Moderate

Thank you for reading. Disclaimer: This document is the property of Investment Club at RIT Croatia (legal name: Capital Investment Association of Croatia) and will not be replicated in any form without the Club’s consent. The purpose of it was to examine investment opportunities in more detail in order to create a portfolio of investments that is going to be managed by the Club. Most sources are listed in the document, but some come from the author’s previous knowledge, and therefore no reference was made for it.

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