One Fundamental Ratio To Consider Before Buying Apple Stock

  • Warren Buffett's recent large purchase of Apple stock begs the average investor to "dive deeper" into Apple's books.
  • Apple's cash position is one of the best out of any of the largest stocks on the S&P500 or NASDAQ.
  • This article will discuss why investors such as Warren Buffett pay such close attention to excess cash, the "lifeblood of growth".

Warren Buffett’s purchase of over $1B of Apple, Inc. (NASDAQ:AAPL) stock over the past months is notable, especially considering Berkshire Hathaway Inc.'s (NYSE:BRK.A) purchases spanned a range of prices, with some at levels significantly above $100. The independent investor must ask: what sort of fundamental security analysis ratios did Mr. Buffett use in analyzing Apple to justify this investment, considering Warren Buffett’s extreme tech-averse stock selection modus operandi?

One set of ratios which Warren Buffett has spoken about and which do not garner enough media attention are liquidity ratios and these ratios work overtime when assessing Apple due to Apple’s large cash hoard (approximately $231B with $215B overseas at the end of June 2016). This ratio of cash to net assets is one way of quantifying Warren Buffett’s esteemed “margin of safety” which is paramount in his investment decisions, and we will see through analysis that Apple is indeed a very “safe” bet given its size and financial slack, relative to comparable companies.

Source: 2015 Apple Annual Report

Apple’s Cash Position

Looking at Apple’s financial statements, we see that the year-end cash and cash equivalents have grown substantially year over year, accompanied by an increase in “term debt.” The average investor can see that the cash generated from operating activities basically covers cash used by investing activities and financing activities (i.e. the capital needed to keep the business profitable over the long-term), but the cash proceeds have risen almost in lockstep with debt creation. This means the company is essentially piling all its cash from operations back into the company via investing and financing activities while building its cash hoard using cheap debt (most of which is long-term with options to hedge interest-rate exposure). The effects of debt in calculating a company’s cash to assets ratio can skew the data; as such, we will compute Apple’s net excess cash to assets ratio (as well as the other top 10 firms of the S&P500), subtracting debt from the company’s cash position to provide a clear picture of each company’s true margin of safety via excess cash.

Apple’s Cash to Assets Ratio

Company Market Capitalization Cash Position Assets Debt Net Excess Cash to Assets Ratio
Apple 582.16B 205.67B 290.48B 79.91B 43.29%
Microsoft 451.50B 108.58B 176.22B 46.77B 35.08%
Exxon Mobile 359.51B 37.95B 336.76B 43.11B -1.53%
Johnson & Johnson 339.29B 38.38B 133.41B 23.56B 11.11%
General Electric 279.72B 102.46B 492.69B 186.05B -16.97%
Amazon 363.92B 19.81B 65.44B 17.61B 3.36%
Facebook 358.58B 18.43B 49.41B 0 37.3%
Berkshire Hathaway 361.67B 117.28B 552.26B 101.54B 2.85%
AT&T 265.89B 6.73B 402.67B 133.08B -31.38%
JP Morgan Chase 235.54B 573.08B 2,351.70B 591.54B -0.78%

All numbers have been calculated as of August 10, 2016, with total assets from each company’s balance sheet. Apple clearly has the most excess cash among some of the largest firms in the S&P500, with excess cash representing over 43% of the company’s total assets. The only two firms that come close to Apple are Facebook (primarily due to the fact that Facebook has no long-term debt) and Microsoft (due primarily to its large cash hoard).

The margin of safety excess cash provides is related directly to the liquidity of the firm. In the unlikely event of a market crash or buying opportunity, the company with excess liquidity can easily capture opportunities that competitors cannot, contributing to a greater long-term competitive advantage – the primary “stuff” investors such as Warren Buffett look for.

MacDonald Chris MacDonald Chris   on Amigobulls :
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