Assignment
1-Using the method of comparables, perform a valuation of Apple Inc. (AAPL). Based on your valuation, what trading strategy would you recommend? Justify your decision. [40 marks]
Notes
- Use the financial database WRDS to collect firms’ accounting information and stock price
- Use the following comparable firms: Microsoft Corp (MSFT) and IBM Corporation (IBM)
- Calculate the following comparison multiples: price-earnings ratio (P/E), the price-to-book ratio
(P/B), and the price-to-sales ratio (P/S) - Use data from the last five years available (e.g. 2013-2017)
2-Discuss the merits and limitations of using the method of comparables as a valuation method.
Introduction:
This report details the valuation of Apple Inc while using comparable from its industry competitors like IBM and Microsoft Inc. The report uses comparative analysis for the valuation of the stock Apple Inc and shows the merits and demerits that it may have. The report shows how the valuation of the stock of Apple through comparable method has resulted in a sell decision for the last five years 2013-2017.
1-Using the method of comparables, perform a valuation of Apple Inc. (AAPL). Based on your valuation, what trading strategy would you recommend? Justify your decision. [40 marks]
Computations:
There are many valuation methods available for companies. A comparable method is one of the most usable and cheap methods of valuation because of its easy requirements of data and fewer costs. Even though companies tend to compare the costs and benefits of each valuation method and try to use the cheaper ones, the relative opportunity cost of using an easy alternative should also be considered.
As prescribed the comparable companies in stock of Apple Inc has been identified. These include Microsoft Inc and IBM. The data for both these companies is needed to compute a comparable value of Apple stock through an average of these values. The data is gathered from the WRDS website. The information for the last five years has been reported and used for calculation purposes. The measures that are used are.
1-Price Per Earnings Ratio
The formula to compute this ratio is.
PE or Price per Earnings Ratio= (Stock price)/ (earnings)
2-Price Per Sales Ratio
The formula to compute this ratio is.
PS or Price per Sales Ratio= (Stock Price)/Sales
3-Price Per Book Value Ratio
The formula to compute this ratio is.
PB or Price per Book Value Ratio= (Stock Price)/ (Book Value)
All three measures include the market value of the company and a different denominator. For the computation of Apple Inc comparable stock, all three measures for both companies IBM and Microsoft have been computed for the five years from 2013 to 2017. After the calculation of the measures, the average for these ratios and the earnings, book values and sales is also computed. The Average Valuation for Apple is computed, then by the formula.
Apple Valuation=Average (Average of Earnings (IBM, MSFT) ×Average of Price Per Earnings Ratio (IBM, MSFT), (Average of Sales (IBM, MSFT) ×Average of Price Per Sales Ratio (IBM, MSFT), (Average of Book Value (IBM, MSFT) ×Average of Price Per Book Value Ratio (IBM, MSFT)
Apple Valuation Per Share= {Total Average (Average of Earnings (IBM, MSFT) ×Average of Price Per Earnings Ratio (IBM, MSFT), (Average of Sales (IBM, MSFT) ×Average of Price Per Sales Ratio (IBM, MSFT), (Average of Book Value (IBM, MSFT) ×Average of Price Per Book Value Ratio (IBM, MSFT)}/ {(No of Share of Apple)}
Results:
| 2013 Decision: | |
| Stock Price | 476.75 |
| Apple’s Valuation Per Share | $ 299.03 |
| Decision: | SELL |
| 2014 Decision: | |
| Stock Price | $ 100.75 |
| Apple’s Valuation Per Share | $ 53.28 |
| Decision: | SELL |
| 2015 Decision: | |
| Stock Price | 110.3 |
| Apple’s Valuation Per Share | $ 48.39 |
| Decision: | SELL |
| 2016 Decision: | |
| Stock Price | $ 113.05 |
| Apple’s Valuation Per Share | $ 53.67 |
| Decision: | SELL |
| 2017 Decision: | |
| Stock Price | 154.12 |
| Apple’s Valuation Per Share | $ 65.41 |
| Decision: | SELL |
The results above show that for all five years the stock of Apple Inc has remained overvalued. It shows that the stock of Apple was priced high as compared to its comparable value. It means that an investor holding the stock during these years should have sold the stock to gain capital gain. Furthermore, it remained to hold the stock; there may be the chance for loss as the decline of the price of the stock of Apple with its overvaluation.
2-Discuss the merits and limitations of using the method of comparables as a valuation method.
Limitation of This Method:
There are many limitations offered by the comparable method of valuation. These include.
1-Bubble Encouragement:
The method of comparables is said to encourage bubbles development. It has been noted that periodically, the Initial public offerings for these types of firms become instantly hot making the firms sell their stocks for high prices based on the high multiples making encouragement for the comparable firms for going public as well.
2-Pyramid Schemes:
The pyramid schemes are encouraged through the use of multiples for valuation as well. Companies use multiples as a basis for offering the IPOs on high prices. The raising of the multiples can cause pyramiding schemes in which the prices are based not on fundamental values but the higher multiples. The pricing of the stocks by speculative multiples can instigate the development of bubbles. It can because the investors to pay higher prices for a stock which is overvalued (Penman, 2001).
3-Not Comparable with All companies:
These measures are not comparable with all companies as all companies do not exhibit similar characteristics. Furthermore, companies tend to consider different accounts for its calculations of earnings; this can create a misunderstanding as well. Moreover, the negative denominator value makes the ratio meaningless and irrelevant.
Benefits:
1-Easy to Use:
This method is extensively used because of its ease of use and fewer costs. It provides the benefit of ease and lower costs for the analysts (Penman, 2013).
2-Private Firms:
Companies who have thin industries or are privately owned can use it for their valuation by using the comparables for valuation of their equity value. Thus, it can provide it insight on what the company would have value if it had been publicly owned.
3-Initial Public Offering:
This method provides a basis for the Investment bankers and company’s management who are looking to initiate the Initial Public Offering for a company. It helps to assess the value of the firm when gone public from comparable measures.
Conclusion:
The report shows that the company Apple Inc stock with the valuation method comparable is found to be overvalued. The stock of the company is compared with IBM and Microsoft stocks and the measures of Price to Earnings, Sales, and Book Value have shown that it is highly priced. The overvaluation of the stock means that the stock is expensive, and it is expected to lose it’s value over time. It leads to the investment recommendation which is to sell the stock of Apple Inc as based on comparable valuation. However, it will be more beneficial if an internal valuation is also conducted to realize if the comparables are showing the real value of the stock.
References:
Penman, S.H., 2001. Fundamental Analysis: Lessons from the Recent Stock Market Bubble. Security Analysts Journal, pp.106-15.
Penman, S.H., 2013. Financial Statement Analysis & Security Valuation. 5th ed. McGraw Hill.
+447462439809