Apple vs. HP: Comparative Financial Analysis

Executive Summary

This comparative financial analysis report focuses on Apple Inc. and HP Inc. to determine the best investment opportunity for a boutique investment firm. Various metrics, namely profitability, liquidity, and debt, have been used to assess the most appealing investment firm. Margins and ratios have shown the financial health of the two firms. None of these companies is in bad fiscal situation. In fact, they are all healthy, although HP Inc. shows a trend of declining operating margin. However, the analysis has revealed that Apple Inc. has comparatively higher margins and ratios compared to HP Inc. Based on results of analysis, therefore, Apple Inc. has been recommended as the most viable investment option between the two firms.

Case Overview

For this comparative company financial analysis, the chief investment officer for a boutique investment firm considers acquiring a stake either in Apple, Inc. or in HP. The main objective of this task is, therefore, to analyze financial results of the two firms and present a recommendation concerning investment in any of the two. That is, the best corporation will be selected for the company for acquisition of stake. The investment decisions made would be based on critical analysis, interpretation, and evaluation of the data. Based on two years of data obtained from annual fiscal reports, the comparative analysis focuses on liquidity, profitability, and debt.

About the Companies

HP Inc. is a leading global IT firm that provides technologies, products, software, IT solutions, and services to corporate customers, and small-sized and medium-sized businesses, as well as individual consumers across various sectors, including governments and private sectors (HP Inc., 2015). Founded in 1939 by William and Packard, HP Inc. now offers personal computing and other Internet access devices; enterprise information technology infrastructure; imaging and printing products and services; multi-vendor customer support; and IT management software, application testing and delivery software, information management solutions, data analytics, security intelligence and risk management software (HP Inc., 2015, p. 3). In the fiscal year 2015, HP Inc. generated a net revenue of $103.355 billion while the company managed a net revenue of $111.5 billion for the fiscal year 2014 (HP Inc., 2014).

Apple Inc. designs, makes and markets “mobile communication devices, computers, digital music players and sells other various related software and peripheral pieces of hardware components, services and networking solutions alongside third party products and services” (Apple Inc., 2015, p. 1). The company is recognized for its iPad, iTune, iPod, iPhone and other devices and services, and lately Apple TV, Apple Watch, iCloud, and iBook Store among others (Apple Inc., 2015). Apple In. now sells all its products and services globally via “retail outlets, online platforms, and direct sales team, as well as through other independent mobile network operators, wholesalers, retailers, and value-added resellers” (Apple Inc., 2015, p. 1). Apple Inc. also sells other Apple compatible software and hardware products from other third parties (Apple Inc., 2014). It sells to all end users, such as “individuals, small and mid-sized entities, governments, and large businesses” (Apple Inc., 2015, p. 1). Established in 1977, Apple Inc. generated a net revenue of $233.715 billion for the fiscal year 2015 and 182.795 billion for the fiscal year 2014.

Financial Analysis

The financial analysis of the two companies is based on the annual reports of the fiscal years 2014 and 2015.

Liquidity Metrics

Two liquidity metrics were considered for analysis in this report. They included current ratio and quick or acid test ratio.

Current ratio is derived by dividing current assets by current liabilities (GuruFocus.com, LLC, 2016). This ratio is important for providing highlights of capabilities of Apple and HP to repay their short-term debts using their short-term assets. Apple Inc. and HP Inc. current ratios for the last two fiscal years are shown in the following table.

(GuruFocus.com, LLC, 2016)

The current ratios for the two companies show that Apple and HP are efficient in their operations and, therefore, issues related to liquidity may not arise. Both companies have high ratios beyond 1, and the rates continue to increase year-over-year. Notably, HP has superior current ratio relative to Apple. Generally, acceptable ratio ranges between 1 and 3. These ratios demonstrate that Apple and HP do not any current financial challenges, and they do mean that these firms will go bankrupt soon. This implies that the companies have significant fractions of asset values compared to their total current liabilities. A ratio less than 1 usually demonstrates that a firm has significantly greater liabilities compared to its assets, and it indicates that the company may not be able to pay its debt if they mature at a specified time.

Quick ratio is obtained by dividing total current assets less inventory by total current liabilities. This ratio shows whether Apple and HP can be able to meet their short-term debts based on their liquid assets (inventories are not included in the analysis).

(GuruFocus.com, LLC, 2016)

Apple and HP have quick ratios above 1. Hence, the companies can meet their short-term obligations when they fall due. However, when this ratio falls below 1 (in 2014 HP and Apple respectively had a quick ratio of 1.00 and 1.05 – extremely close to less than 1), then it should reflect stress concerning liquid assets of the company and its capabilities to meet current liabilities. Whenever the quick test ratio critically drops low relative to the current ratio, then it shows that the company’s current assets are highly leveraged by the inventory. In these cases, both companies are not highly leveraged by inventories.

For the two fiscal years, Apple and HP have recorded increasing quick ratios, which demonstrate that the firms are not highly leveraged, but they continue to increase and sustain sales. Thus, the increasing trends are healthy, and HP and Apple can cover their financial obligations.

Profitability Metrics

Gross margin is gross profit divided revenue or sales (a fraction of gross profit from revenues or sales).

(GuruFocus.com, LLC, 2016)

These ratios show a significant difference in profitability of Apple and HP. Apple currently has a gross margin above 40, which demonstrates that the company has durable competitive advantage. On the other hand, HP has a relatively low ratio of 23.96, which indicates that its competitors have started to erode the margin. This observation is true for HP Inc. because it has reported declining revenues. The firm is fighting to gain the market share and establish a competitive edge over its rivals. Nevertheless, both firms have positive gross profit margin, which is only the first indicator for a firm to generate a net profit. It is imperative to recognize that the gross profit needs to be sufficiently large in order to cover all costs related to business operations, such as labor, equipment, lease, advertising, research and development and other costs incurred in selling products and services.

Operating margin also referred to as “operating income margin, operating profit margin or return on sales (ROS) reflects a ratio of operating income divided by net sales or revenue, usually presented in percent” (GuruFocus.com, LLC, 2016).

(GuruFocus.com, LLC, 2016)

Just like gross margin, it is necessary to observe if a firm sustains its operating margin over time. Within the same industry, a firm with higher operating margin is more efficient in its operation, as well as more stable during economic slowdown and industry downturns. Thus, firms with higher margins are often preferred for investments. In this case, Apple has extremely higher margins compared to HP. These low ratios demonstrate that HP is facing fierce competition. As noted, HP’s revenues are now declining, implying that its operating margin is also declining year-over-year. Notably, operating margin drops before revenue or profit declines and, thus, this margin is the best indicator to demonstrate that HP is facing some critical challenges. Although the case of HP is not so serious, other previous examples demonstrate the relevance of operating margin. When Nokia was facing problems in 2012, its operating margin had already started to decline as early as 2002 while earnings per share continued to rise. The same case was also observed in BlackBerry Inc. (Research in Motion) (GuruFocus.com, LLC, 2016). Investors who are keen on operating margin often avoid later losses. Thus, operating margin is a critical indicator and a filter for investment decisions. It, therefore, is recommended that operating margin should be consistent or increasing.

Return on equity is determined as net income divided by average shareholder equity to demonstrate the rate of return on shareholders’ equity or ownership interest of the common stock owners (GuruFocus.com, LLC, 2016). This ratio demonstrates how the two companies are efficient at creating profits from every unit of owners’ interests. That is, how effectively firms use investment funds to realize growth in earnings. Favorable ratios usually range above 15%.

(GuruFocus.com, LLC, 2016)

For the fiscal year 2014 and 2015, Apple, Inc. has a good ROE that rose from 33.61 % to 46.25% and, thus, good returns for shareholders. On the other hand, HP return on equity ratio has dropped from 18.57% in 2014 to 16.71% in 2015. Such a decline could be attributed to a decline in net income, which ultimately affects shareholders’ returns. It is advisable to invest in companies with good ROE over time. The current state of Apple, Inc. is therefore good for potential investors. This shows that the company has managed to maintain its profitability and rarely relies on shareholders’ equity for its growth. Although HP also has good ratio, it is relatively low compared to Apple.

Debt Metrics

Debt to Equity indicates the financial leverage a company has i.e. how much debt a company is relying on to fund its assets compared to the amount of value shown in shareholders’ equity. A high debt to equity ratio normally implies that a firm has been aggressive in funding its expansion with debt. This situation could lead to low earnings because of more interest costs.

(GuruFocus.com, LLC, 2016)

Apple debt to equity is relatively high for the fiscal year 2015. It implies that the company uses more debts to finance its growth compared to HP. While these figures are acceptable, relatively low debt shows that a company has low risk associated with debts. Apple is using debts to finance its growing operations and generates more incomes that it would have without such external sources of funds. More importantly, it is vital to grow earnings by a larger amount compared to the cost of debt (interest) to benefit shareholders. On the other hand, if the interest paid proves to be costly and outweighs the earnings that a firm gets on the debt after investment and business operations, then shareholders’ share values are most likely to drop. Further, if interests become excessively high for a firm to handle, it could force a firm to bankruptcy and eventually leading to lost investments. In this analysis, however, Apple and HP debt to equity ratio are within the acceptable range.

Interest coverage ratio is applied to gauge how easily Apple and HP are able to pay interest expenses on any unsettled debt.

(GuruFocus.com, LLC, 2016)

By any standards, Apple is a comparatively cash-rich firm with little debt (Constable, 2015). Hence, the high interest coverage ratio compared to HP. In this case, HP is also cash-rich firm based on the expected interest coverage ratio above 2. A low interest coverage ratio 1 indicates that a company lacks any cushion at all. The ability of Apple and HP to remain current with interest payment obligation is utterly vital for their going concern. Although failure to service debt is a serious issue for a company, any firm with operational or financial challenges can run for some periods if it can service due interest expenses. The most important aspect of borrowing is being prudent because interest expenses have negative impacts on a firm’s profitability. Thus, a cost-benefit analysis requires that any assets funded by borrowed funds should yield positive returns. For Apple, the interest coverage ratio is ample and shows the company’s additional debt capacity. Thus, Apple leads HP in this ratio with a larger margin. It is also noteworthy that Apple can borrow as much as necessary because it can. Hence, creditors prefer such companies because they demonstrate high capabilities to service debt interest payments easily, and Apple is in a privileged position.

Cash to debt ratio shows a firm’s cash, cash equivalents, Marketable securities to its debt, which included both current part of long-term debt and long-term debt (GuruFocus.com, LLC, 2016). This ratio gauges the financial strength of Apple and HP.

(GuruFocus.com, LLC, 2016)

Both of these firms have cash to debt ratio less than 1, implying that they can pay off their debts using cash in hand. As such, Apple and HP have more debts compared to cash in hand. In this scenario, one must look at their interest coverage ratios to understand their capabilities to service debts. As previously noted, Apple and HP can pay off their debts using available cash.

Apple Inc. and HP Inc.: Investment Decision

For HP Inc., it is established that the company is financially healthy relative to Apple Inc. The company is the leader in some of its core businesses, such as personal computers and printing solutions. Nevertheless, the major issue is now the declining revenues, which affect its margins (HP Inc., 2015). From the analysis, it is demonstrated that such declining margins are attributed to strong competition in the market. This implies that HP’s market for software and hardware continues to shrinking, a challenge that could be extremely difficult to fix over time. As determined during the analysis, the company’s operating margin is declining. Investors rely on this margin as the best indicator to demonstrate that HP is facing some critical issues. While the case of HP is not so serious, the analysis referred to some previous case, such as Nokia and the current BlackBerry Inc., which also experienced operating margin declines earlier before the real fiscal crises (GuruFocus.com, LLC, 2016). When Nokia was facing problems in 2012, its operating margin had already started to decline as early as 2002. However, this view about HP Inc. could also be too cynical because the company has already acknowledged the presence of such challenges in the market. As such, the company executives have embarked on a ‘return to growth’ strategy focusing on aggressive cost reduction and a long-term plan to introduce additional new products (HP Inc., 2015). HP Inc. now aims to revamp its software, storage, and network solutions to position itself for improved service and product delivery. Further, the printing section of HP Inc. strives to deliver positive results with its sophisticated graphic production, which are expected to grow the current copier market and acquire new market shares in the emerging 3D printing market. In addition, the company has shown some good margins and ratios. As such, HP is also an alternative attractive investment firm because of its potential growth.

Apple Inc. presents the most attractive investment opportunity compared to HP Inc. Apple has robust, high ratios and margins when a comparative analysis is done. In addition, limited risks are associated with the company. Thus, any investor should consider healthy financial position of the company. Therefore, it is strongly recommended that the chief investment officer for a boutique investment firm should consider acquiring a stake in Apple Inc. This decision is purely based on the results of the analysis of the two fiscal years (2014 and 2015) and not speculation. Specifically, Apple Inc. has demonstrated relatively stronger operating margin and ratios compared to HP.

Conclusion

Overall, the financial analysis presents Apple Inc. as an extremely healthy company compared to HP Inc. Although the two companies are not in any form of fiscal challenge, Apple Inc. has demonstrated comparatively good performance. Therefore, Apple Inc. is recommended for investment based on the results of the financial analysis. While investments are characterized by risks, the analysis was based on indicators obtained from annual fiscal statements of 2014 and 2015. Nevertheless, there are always risks, specifically external factors that could influence the company’s profitability and affect returns on investments. Profitability, debt, and liquidity metrics should be carefully evaluated before making any investment decisions. Investors, therefore, must be recognize of these elements when making investment decisions in any potential companies.

References

Apple Inc. (2014). Form 10-K for the fiscal year ended September 27, 2014. Rockville: EDGAR Online, Inc.

Apple Inc. (2015). Form 10-K for the fiscal year ended September 26, 2015. Rockville: EDGAR Online, Inc.

Constable, S. (2015). What is the interest coverage ratio? The Wall Street Journal. Web.

GuruFocus.com, LLC. (2016). Financial ratios. Web.

HP Inc. (2014). 2014 Annual Report. California: HP Inc.

HP Inc. (2015). 2015 Annual Report. California: HP Inc.