One Fundamental Ratio To Consider Before Buying Apple Stock

 

Warren Buffett’s purchase of over $1B of Apple, Inc. (NSDQ: 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.