I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Apple Inc (NASDAQ:AAPL).
If you purchase a AAPL share you are effectively becoming a partner with many other shareholders. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently Apple is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
ROCE: Explanation and Calculation
Choosing to invest in Apple comes at the cost of investing in another potentially favourable company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Apple is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for AAPL
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$68.23b ÷ (US$367.50b – US$89.32b) = 24.53%
The calculation above shows that AAPL’s earnings were 24.53% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by AAPL and means the company creates a good amount of earnings on capital. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound well over time.
Not so fast
AAPL is efficient with the use of capital, but this is only the case if AAPL continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking three years in the past, it is evident that AAPL’s ROCE has deteriorated from 32.08%, indicating the company’s capital returns have declined. We can see that earnings have actually increased from US$64.84b to US$68.23b but capital employed rose by a relatively larger volume in response to a hike in the level of total assets , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.
ROCE for AAPL investors has declined in the last few years, however, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate AAPL or other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for AAPL’s future growth? Take a look at our free research report of analyst consensus for AAPL’s outlook.
- Valuation: What is AAPL worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AAPL is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.