ApeGrade Economics
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Investment in the Shares of Apple and Microsoft

Introduction

The three stocks selected for this report are AAPL (Apple Incorporation), MSFT (Microsoft Corporation), and XYZ. The reason for selecting these stocks is that all these three companies paid dividends in the last one year. Therefore, it is possible to use the dividend growth model to determine the intrinsic value of the companies’ stock and decide whether the stock is undervalued or overvalued. Moreover, the market index i.e. S&P 500 is selected for calculating its daily return and preparing graphs of each company.

Corporate Profiles

Apple Incorporation (Apple) is a leading technology company. The company’s main products include personal computers, tablets, phones, watches, and software. The company is a major threat to other companies operating in the IT sector. The company has announced various new projects that are aimed at improving its products. These projects include improvement of Apple’s voice technology, a new operating system for its products, and further enhancements in the hardware used in different products. The company is still holding a strong position in the market, and it plans to enter into new markets in Asia. The company’s main competitors include Samsung, Nokia, Microsoft, and Google (Android). It could be highlighted that Apple has its unique position in the global market, and it held almost 15.9% of the smartphones market in 2015 (Jobes par. 5)

Microsoft Corporation (Microsoft) is a major IT company that is engaged in developing, and licensing software. The company also sells hardware including personal computers, phones, and gaming consoles, etc. The company holds the largest share of operating system market. It is actively engaged in acquisitions. Microsoft acquires businesses offering products or services that complement its current business. The company has recently announced to acquire LinkedIn, which is a professional social networking website, for $26.2 billion. Although analysts feel that this deal may be too expensive for the company, it is expected to benefit the company as it targets web users for its marketing activities. The company’s main competitors are Apple, Google, and Linux. The company currently holds 85% of the operating system market (“Desktop Operating System Market Share” par. 1)

GameStop Corporation (GameStop) is a leading video game retailer based in the US. The company’s primary business activities include the development of video games and digital content, selling new and pre-owned video games and consumer electronics. The company operates more than 7,000 stores in the US, Canada, Europe and Australia. It plans to expand it store network in other countries as well. The company paid one of the highest dividends to its shareholders in the last year. The company’s main competitors are Amazon, Inc., Best Buy Co., Inc. and other electronic stores (“GameStop Corp. (GME)” par. 1). Amazon is a major threat to the company’s business as it has a cost benefit and presence internationally. The market conditions reflected that the business of GameStop is expected to slow down. There are challenges ahead related to the distribution of digital content.

Time Series

Table 1 provides values of key financial ratios related to the liquidity, activity, solvency, and profitability of the three selected companies including Apple, Microsoft, and GameStop.

Table 1. Financial Ratios. Source: (“Apple Inc AAPL”; “Microsoft Corp MSFT”; “GameStop Corp Class A”).

Apple Microsoft GameStop
2015 2014 2015 2014 2015 2014
Liquidity
Current Ratio 1.11 1.08 2.5 2.5 1.08 1.26
Quick Ratio 0.89 0.82 2.3 2.31 0.35 0.44
Asset Management
Receivable Turnover 13.62 11.96 5.00 4.69 62.61 90.56
Inventory Turnover 62.82 57.94 11.88 11.72 5.59 5.56
Payable Turnover 4.27 4.27 4.71 4.39 8.91 8.15
Solvency
Debt to Equity Ratio 0.45 0.26 0.35 0.23 0.17 0.17
Profitability
Gross Profit Margin 40.10% 38.60% 69.00% 64.70% 31.20% 29.90%
Net Profit Margin 22.85% 21.61% 25.42% 13.03% 4.30% 4.23%
Return on Equity 46.25% 33.61% 26.17% 14.36% 19.42% 18.20%
Return on Assets 20.45% 18.01% 7.00% 14.02% 9.39% 9.43%

The fundamental analysis provided in Table 1 indicates that the current ratio value of all three companies was more than one. It reflected a strong liquidity position as these companies had current assets more than their current liabilities. However, the quick ratio that does not include inventory in current assets presented a different position. The analysis indicated that Apple and GameStop had quick ratio value of less than one. It could imply that both companies were holding large inventories of finished products for sale. On the other hand, a slight difference in the current ratio and quick ratio values was noted of Microsoft. Overall, it could be stated that Microsoft had much better liquidity position than the other two companies.

The receivable turnover of Apple and Microsoft remained very low as compared to GameSoft. It implied that both companies made a significant proportion of sales on credit. The inventory turnover of Apple was the highest. It indicated that the company achieved high sales in both years and was able to convert its inventory quickly into sales.

The debt to equity position of Apple was of concern as it almost doubled in 2015. Despite holding huge retained earnings the company borrowed to invest in its new plans. The preference of debt could be due to the tax benefit it received.

The profitability of Apple and Microsoft remained strong in 2014 and 2015. On the other hand, GameSoft, which is a retail company, had low-profit margins. Apple generated the highest return on equity that reflected the company’s strong earnings. The return on assets of Microsoft halved in 2015. It implied that the company’s efficient declined in 2015.

Stock Beta

Table 2. Stock Beta. Source: (“Apple Inc. (AAPL)”; “Microsoft Corporation (MSFT)”; (“GameStop Corp. (GME)”).

Beta Adjusted Beta
Apple Inc. 1.487 (0.67×1.487)+(0.33×1) 1.326
Microsoft Corporation 1.044 (0.67×1.044)+(0.33×1) 1.029
GameStop Corporation 1.126 (0.67×1.12586)+(0.33×1) 1.084

The table provided above gives values of beta and adjusted beta of all three stocks including Apple, Microsoft, and Gamestop. Beta is an indicator of the stock sensitivity. If a stock is higher at risk, then it is likely to have higher beta value or vice versa. The price of stock with higher risk is expected to move on either side of its current level more than proportion to changes in the index value (Brigham and Ehrhardt 131). The beta value of all three selected companies is more than one. It implies that there are all highly sensitive to changes in the index value. The change in their value is greater than the change in the value of index i.e. S&P 500 (“S&P 500 (^GSPC)” par. 1). The beta value of more than one is common for technology/service companies. These companies offer a higher return to investors. However, they have a higher risk at the same time as any major shift/change in technology could make their products/services less favorable. The daily return of each stock along with that of S&P 500 are depicted in the following graph.

Daily Return.
Figure 1. Daily Return.

Valuation

The risk free rate considered for the analysis is the one-year Tresury Bill rate (“One-Year Treasury Constant Maturity”). The cost of equity is calculated using CAPM as follows.

ke = Rf + Adjusted Beta * (Rm-Rf)

Table 3. Cost of Equity.

Company Adjusted Beta Rf Rm ke Rm ke
Apple 1.326 0.59% 8% 10.42% 12% 15.72%
Microsoft 1.029 0.59% 8% 8.22% 12% 12.33%
GameStop 1.084 0.59% 8% 8.62% 12% 12.96%

The valuation of companies’ stock is carried out using Gordon’s Dividend Discount Model with 0% growth rate.

P1 = D1/( ke -g)

The instrinsic value of the three companies’ stock is provided in the following table.

Table 4. Price Valuation.

Company D0 D1 ke@ Rm8% and g = 0% ke@ Rm8% and g = 0% Current Price as of 16 June 2016
Apple 1.98 1.98*(1+0%) = 1.98 $19.01 $12.59 $97.13
Microsoft 1.21 1.21*(1+0%) = 1.21 $14.73 $9.81 $49.68
GameStop 1.44 *(1+0%) = 1.44 $16.70 $11.11 $25.93

Stock Trends

The analysis of Apple’s stock performance indicates that its stock value declined in the last one year by 22.31% ($27.90). After the departure of Steve Jobs, the company had been struggling to maintain its brand image of being the most innovative firm. The company’s stock underperformed the S&P 500 despite its decision to buy back its shares and paid dividend to its shareholders. However, analysts are of the view that the company has the potential as its revenue stream is still strong and it operates at a high net profit margin. The company’s plan to introduce new products and improve its existing technologies is likely to work as a catalyst for boosting its stock value (Booton par. 9-10). The company faces tough competition from companies like Samsung, and it is not yet able to compete with them in developing markets.

The stock performance of Microsoft indicated a gain in value after September 2015. The reason for the gain in its stock value was the company’s focus on cloud computing and its ability to generate revenues from this technology. The company also announced various new games for Xbox console and targeted emerging markets such as China to boost its game sales (Niu par. 1-2). In May 2016, the company announced to sell its phones segment to another company. Although the company invested $9.5 billion in Nokia to develop and sell smartphones, it failed to gain a major share of the market forcing it to roll back its plans for phones. A slight decline in the stock value is also observed in the last four weeks. The company announced its purchase of LinkedIn. However, the market did not respond well to its decision as there is a lot of skepticism regarding the company’s investment in LinkedIn (Frey par. 2-3).

The capital market reported a decline in the value of GameStop’s stocks in May 2015 after the company reported a decline in its first quarter sales. Furthermore, the company’s co-founder and former CEO also resigned from the board of directors. The market did not respond positively to this news and the stock value further plunged in May 2015. Finally, another major factor that affected the company’s stock value in May 2015 was the announcement by its major competitor to roll back its digital distribution website. The decision was viewed negatively by the market participants as it reflected a weak position of the digital content market. It is the reason that the company’s stocks experienced a significant decline in the months after May 2015, and it was reported that the stock value fell by 35% in the last 52 weeks reported by the company (Bylund par. 2-3). Currently, the company’s stock value is close to its bottom, and the analysts are of the view that it could bounce back after testing this threshold.

Assessment

The analysis presented above indicates that the shares of the three companies are overvalued.

Graph

Apple: Stock Price vs. Normalized S&P 500.
Figure 2. Apple: Stock Price vs. Normalized S&P 500.
Microsoft: Stock Price vs. Normalized S&P 500.
Figure 3. Microsoft: Stock Price vs. Normalized S&P 500.
GameStop: Stock Price vs. Normalized S&P 500.
Figure 4. GameStop: Stock Price vs. Normalized S&P 500.

Recommendations

Based on the analysis provided in this report, it could be indicated that Apple and Microsoft performed better than GameStop. The financial ratio analysis highlighted that both companies had strong asset management, solvency, and profitability. The companies’ plans are promising, and they both are likely to generate a strong stream of revenues in the coming periods. The stock analysis indicated that the stocks of all three companies are overvalued. It suggests that investors should track the companies’ decisions that could affect their performance. The graphs indicated that Apple and Microsoft out performed S&P 500. Therefore, investment in the shares of Apple and Microsoft is recommended on the basis of analysis. However, upon a comparison of Apple and Microsoft, it is recommended to make an investment in its shares as Apple has much stronger position and capability to generate high earnings.

Works Cited

Apple Inc AAPL 2016. Web.

Apple Inc. (AAPL) 2016. Web.

Brigham, ‎Eugene F., and Michael C. Ehrhardt. Financial Management: Theory & Practice, Mason: Cengage Learning, 2013. Print.

Booton, Jennifer. Could this send Apple’s stock rocketing to $130? 2016. Web.

Bylund, Anders. Why GameStop Corp. Fell 11.3% in May. 2016. Web.

Desktop Operating System Market Share 2016. Web.

Frey, Suzanne. Microsoft’s LinkedIn Corp Acquisition: 3 Reasons to Be Skeptical. 2016. Web.

GameStop Corp Class A 2016. Web.

GameStop Corp. (GME). 2016. Web.

Jobes, Chuck. Apple’s iPhone: Market Share Vs. Profits. 2016. Web.

Niu, Evan. Microsoft to Launch Minecraft in China. 2016. Web.

Microsoft Corp MSFT 2016. Web.

Microsoft Corporation (MSFT) 2016. Web.

One-Year Treasury Constant Maturity 2016. Web.

S&P 500 (^GSPC) 2016. Web.

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