An Introduction to Financial Analysis
The fact that the Apple stock price almost doubled during the last year, was evidence enough for many people to say that investors had gone crazy. Other people say that this price is totally justified and one just has to take a look at the fundamentals to see why. How can we decide, whom to believe? Maybe the answer to the question whether Apple is overvalued or not is a matter of the point of view. The chartist, who sees all price data statistically, would say that on average, a very intense price jump is usually followed by a decline in that price. With a personal trading system that makes use of this observation, a chartist would make money with an average trade.
The problem is that if we are talking about a concrete firm, we are not talking about arithmetic averages, so a chartist alone could give us little help in solving our question about apple. In order to get an answer, we have to collect more information and go deeper than just observing prices. This is where financial analysis begins.
The purpose of financial analysis
To get more information and not only to rely on market prices, the financial analyst uses accounting data. But he uses this data not as an accountant, who is primarily concerned with establishing income statements and balance sheets according to the IFRS or GAAP. The financial analyst reorganizes and mixes up numbers from both income statements and balance sheets using ratios, to identify critical relationships that might otherwise not be readily identifiable. Ratios have one big advantage over pure accounting data: you can make comparisons with them.
You cannot do this if you only observe the numbers as stated in the balance sheet. It will help you very little if you know that one firm had an operating profit of 1M $ and another firm had an operating profit of 5M $. You can compare those firms a lot better if you know that the first had an operating return on assets of 20% and the second of only 5%. Also, you can compare the firm’s current to the firm’s past performance as well as the firm’s ratios to the industry norm.
There are many groups who are interested in those financial ratios, not only intelligent investors. Managers, for example, use financial ratios to identify deficiencies in the firm’s performance and to take corrective action. Lenders use them to decide whether to make a loan to the company and credit-rating-agencies determine the firm’s creditworthiness using ratios.
We want to start our financial analysis now. We will do that by asking five important questions concerning apple’s financial performance. The first is:
1. How liquid is the firm?
Liquidity is the firm’s ability to pay its bills on time. This ability is related to two things:
First, the ease and quickness with which a firm can convert its noncash assets into cash.
Second, the size of those noncash assets that could be converted into cash relative to its shortterm liabilities. If you increase either of the two, you will increase the firm’s liquidity. The first aspect mentioned above for example is measured by the “average collection period”
(lower = more liquidity) and the” inventory turnover” (higher = more liquidity).

Average collection period
Inventory turnover
Apple
46 days
Industry norm
?
Apple
83X
Industry norm
19.89X
The second aspect of liquidity, the size of noncash assets relative to current liabilities is measured by the current ratio (higher = more liquidity).
Current ratio Apple
1.61
Industry norm
1.19
2. Are managers creating adequate profits on the firm’s assets?
The operating return on assets (operating profits/total assets) is determined by the effectiveness with which the firm creates sales out of its assets (sales/total assets) and its management of operations, i.e. how much remains of the sales as operating profit (operating profits/sales). You can say for all three ratios: the higher the better.
Operating Return on Assets (OROA)
Apple
29%
Industry norm
8.04%
Operating profit margin
Total asset turnover
Apple
31.2%
Apple
0.93X
Industry norm
7.35%
Industry norm
1.75X
Operating
Return on
Assets (OROA)
=
3. How is the firm financing its assets?
Operating profit margin
X Total asset turnover
To describe how the firm’s assets are financed, we usually calculate the “debt ratio”. Banks and other lenders want to know, whether the firm is likely to make its interest payments. To answer this question we can use the “times interest earned” ratio.
Debt Ratio Apple
Times interest earned
0.34
Apple
?
Industry norm
0.4
Industry norm
3.8
Note that interests are paid with cash, not earnings. The “times interest earned” ratio is only some crude measure.

4. Are the firm’s managers providing a good return on the capital provided by the company’s stockholders?
Usually we determine the accounting return on the common stockholder’s investment, if we want to answer this question
Return on equity
(ROE)
Apple
33.8%
Industry norm
15%
The higher the OROA, the higher ROE. Note that you can easily increase the ROE, by using more debt (leverage effect).
5. Are the firm’s managers creating shareholder value?
One way to answer this question is to use market value ratios. The price/earnings ratio indicates, how much the investors are willing to pay for 1 $ of reported earnings. If this ratio is very high, investors either expect the company to grow or perceive their expected profits less risky. The price/book ratio is the relation between the market value of the firm and its value as reported in its balance sheet. If this ratio is greater than 1, the firm has created shareholder value. If it is less than 1, the firm destroyed shareholder value.
P/E
Price/book ratio
Apple 2011
14
Apple 2011
4.8
Apple now
14.11
Apple now
5.28
Industry norm
13.5
Industry Norm
2.08
Conclusion
Apple has an average liquidity. Its long average collection period is outweighed by its high inventory turnover and its above-average current ratio. Although Apple’s asset efficiency is not so good, its OROA is outstanding, due to its outstanding operating profit margin. This high operating profit margin may either result from high mark-ups in product prices or very good management of operations. The high OROA enables Apple to have a high return on equity although its debt ratio is low. The leverage effect is not working here, which means that Apples ROE is even less risky than that of its competitors. The fact that Investors are willing to pay more for 1$ book value in Apple than for 1$ in other firms may result from the fact that a dollar of Apple’s book value just yields a higher return than the equity of other firms. The P/E ratio is close to the industry norm and remained almost constant over time, since earnings had been growing a lot while the price per share increased. The lower riskiness of apples earnings due to its lower debt ratio may justify a higher P/E and thus an even higher stock price. The same would be true if apple had some more growth potential. You can infer from these numbers that apple is an as good investment now as it was a year ago. We cannot speak of an overvaluation. Apple’s stock price just kept up with its financial performance.

Income Statement
Period Ending
Sep 23, 2011 Sep 24, 2010 Sep 25, 2009
Total Revenue
Cost of Revenue
108,249,000
64,431,000
Gross Profit
Research Development
Selling General and Administrative
43,818,000
Operating Expenses
2,429,000
7,599,000
Non Recurring
Others
-
-
65,225,000
39,541,000
25,684,000
1,782,000
5,517,000
-
-
Total Operating Expenses - -
Operating Income or Loss
Total Other Income/Expenses Net
Earnings Before Interest And Taxes
Interest Expense
Income Before Tax
Income Tax Expense
Minority Interest
33,790,000
Income from Continuing Operations
415,000
34,205,000
-
34,205,000
8,283,000
-
Net Income From Continuing Ops
Discontinued Operations
Extraordinary Items
Effect Of Accounting Changes
Other Items
25,922,000
Non-recurring Events
Net Income
Preferred Stock And Other Adjustments
Net Income Applicable To Common Shares
-
-
-
-
25,922,000
-
25,922,000
18,385,000
155,000
18,540,000
-
18,540,000
4,527,000
-
14,013,000
14,013,000
-
14,013,000
-
-
-
-
42,905,000
25,683,000
17,222,000
1,333,000
4,149,000
-
-
-
11,740,000
326,000
12,066,000
-
12,066,000
3,831,000
-
8,235,000
-
-
-
-
8,235,000
-
8,235,000

Balance Sheet
Period Ending
Sep 23, 2011
Cash And Cash Equivalents
Short Term Investments
Net Receivables
Inventory
Other Current Assets
Total Current Assets
Long Term Investments
Property Plant and Equipment
Goodwill
Intangible Assets
Accumulated Amortization
Other Assets
Deferred Long Term Asset Charges
Assets
Current Assets
9,815,000
16,137,000
13,731,000
776,000
4,529,000
44,988,000
55,618,000
7,777,000
896,000
3,536,000
-
3,556,000
-
Total Assets
Accounts Payable
Short/Current Long Term Debt
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Liabilities
Deferred Long Term Liability Charges
Minority Interest
Negative Goodwill
Total Liabilities
Misc Stocks Options Warrants
Redeemable Preferred Stock
Preferred Stock
Common Stock
Retained Earnings
Treasury Stock
Capital Surplus
116,371,000
Liabilities
Current Liabilities
23,879,000
-
4,091,000
27,970,000
10,100,000
1,686,000
-
-
-
39,756,000
Stockholders' Equity
-
-
-
13,331,000
62,841,000
-
-
Sep 24, 2010
11,261,000
14,359,000
11,560,000
1,051,000
3,447,000
41,678,000
25,391,000
4,768,000
741,000
342,000
-
2,263,000
-
75,183,000
17,738,000
-
2,984,000
20,722,000
-
5,531,000
1,139,000
-
-
27,392,000
-
-
-
10,668,000
37,169,000
-
-
Sep 25, 2009
9,453,000
-
2,053,000
11,506,000
-
3,502,000
853,000
-
-
15,861,000
-
-
-
8,210,000
23,353,000
-
-
5,263,000
18,201,000
6,192,000
455,000
1,444,000
31,555,000
10,528,000
2,954,000
206,000
247,000
-
2,011,000
1,727,000
47,501,000

Other Stockholder Equity
Total Stockholder Equity
443,000
76,615,000
Net Tangible Assets
Financials (yahoo finance, 31.05.2012)
P/E: 14.11
Price/book: 5.28
Number of shares outstanding (Sept 2011)
925M
72,183,000
(46,000)
47,791,000
46,708,000
77,000
31,640,000
31,187,000