Should I Invest in Apple?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

Today I'm looking overseas at Apple (AAPL 0.52%), which is one of the world's best-known manufacturers of mobile communication devices, personal computers, and portable digital music players.

With the shares at $457, Apple's market cap is $429,300 million.

This table summarizes the firm's recent financial record:

Fiscal years to September.

Apple's dedication to quality and innovation became fashionable with hits like the iPod, iPhone, and iPad. Mass adoption of the firm's iconic brands led to spectacular success and a share price that increased around 200 times its value between 2003 and 2012.

That's impressive, but I think the company now has more in common with clothing brands, that move in and out of fashion, than with high-tech or other types of companies. Perhaps Apple is only ever one product launch away from transformational financial results -- but that could go either way. The shares' recent downward movement could be due to that kind of thinking. It's sobering to look at the company's level of dependence on one product. Last quarter, 56% of worldwide sales came from iPhone, 20% from iPad, 10% from Mac, and 4% from iPod.

During the quarter there was a flat result on earnings per share compared to a year ago, driven by gross margins that have shrunk from 44.7% down to 38.6%. Meanwhile, the company is seeing fast-paced growth in China, which now contributes 13% of total net sales, where the iPhone and iPad have stormed forwards while sales of Mac and iPod have declined, as in other areas.

So I reckon Apple's total-return outlook is uncertain. A shrinking margin is never a good sign. Some say the shares look cheap on a price-to-earnings basis, but I say that's not so if earnings halve from here. When a firm has captured a mass market, the challenge is then to maintain sales and profits going forward. It must do that if growth in new markets, like China, is to boost investor total returns. That's a big ask.

Apple's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

1. Dividend cover: forward earnings are predicted to cover the dividend over four times. 5/5

2. Borrowings: at the last count, there was net cash on the balance sheet -- lots of it! 5/5

3. Growth: all of revenue, earnings, and cash flow have been growing strongly. 5/5

4. Price to earnings: a forward 9 or so compares well to growth and yield forecasts. 4/5

5. Outlook: satisfactory recent trading and a cautiously positive outlook. 4/5

Overall, I score Apple 23 out of 25, which encourages me to believe that, despite my reservations, the company has potential to outpace the wider market's total return, going forward.

Foolish summary
With lots of net cash on the balance sheet and robust forecast dividend cover, Apple's finances are in good shape. Historical growth has been robust, which presents a stiff comparator for future performance. The valuation looks reasonable compared to forecasts for profit growth and the outlook seems confident.

But how can we really know? If sales or profits start to slip, forecasts will be marked down at a stroke! When a company's market share is so large, there must surely be plenty of downside risk however rosy the valuation looks. But I'm happy to put Apple on my watchlist, for now, pending a closer look when there's evidence of a bottoming share price and stabilizing margins. 

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