A woman uses a smartphone while walking past an Apple Inc. store in Shanghai, China, on Tuesday, Nov. 27, 2018. Photographer: Qilai Shen/Bloomberg© 2018 Bloomberg Finance LP
Return on equity is one of the most closely watched financial ratios for investors, as it indicates how efficiently a company has been deploying shareholder capital. Companies with a higher ROE compound their capital more efficiently and also often see more attractive valuations. Moreover, having a higher ROE means that companies are less likely to raise additional capital to fund their businesses, avoiding shareholder dilution. Smartphone behemoth Apple has a healthy ROE of about 49%, which is more than double that of its key rival Samsung. In this note, we try to explain some of the reason for the difference using Dupont analysis, which breaks down ROE into five separate metrics: namely the Tax Burden, Interest Burden, Operating Margin, Asset Turnover, and Equity Multiplier. The calculations are based on numbers for the company’s most recent fiscal years (FY’17 for Samsung and FY’18 for Apple).
Our interactive dashboard on Apple’s valuation details our forecasts and estimates for Apple. Our price estimate of $225 for Apple’s stock is around 25% ahead of the current market price.
What’s Driving Apple’s High ROE?
There are three major drivers of Apple’s higher ROE compared to Samsung. Firstly, the company’s Equity Multiplier (Total Assets divided by Equity) is higher than Samsung’s, standing at 3x versus 1.4x for Samsung. While Apple has taken on sizable debt (upwards of $110 billion) Samsung remains almost debt-free, with just about $1 billion in long-term debt. Moreover, Apple’s operating margins are also higher, coming in at 27% versus about 21% for Samsung, driven by Apple’s higher-margin consumer electronics products. It’s also noteworthy that Samsung’s margins over the last fiscal year were boosted by soaring DRAM prices, which are likely to cool off significantly in the near term. Apple’s tax burden is also favorable, coming in at 0.82, versus Samsung’s 0.75. This is driven partly by the recent corporate tax reforms in the United States. However, Samsung has a slight edge over Apple in terms of asset turnover as well as its interest income. These factors can largely explain Apple’s favorable ROE.