Return on equity is a crucial statistic to keep in mind when picking winning stocks for the long term. Apple (AAPL -0.65%) is second to none when it comes to return on equity in the mobile industry; in fact, the company is downright destroying the competition. This says a lot about Apple and its exceptional fundamental quality.
Why return on equity matters
Return on equity, or ROE, is a profitability metric that measures a company's efficiency at generating profits from each unit of shareholder equity. The formula for ROE can be broken into many different subformulas; however, the simple version is quite straightforward: ROE is calculated as net income divided by shareholder equity. For example, if a company has $15 million in net income and $150 million in shareholder equity during a particular year, this would result in a ROE of 10%.
You don´t need to be a math wizard to understand why ROE is an important measure. If you were offered the opportunity to invest in two similar companies for the same price, but one of those companies had a higher ROE, you would naturally go for the high-ROE business. All else being the same, making more money for each dollar of shareholder capital increases a company's profitability over those of its peers.
Profitability is good for investors on its own merits. Besides, companies that can sustain high profitability over time are usually high-quality businesses with solid competitive strengths. In a free-market economy, success attracts competition, so companies must have competitive strengths -- such as a powerful brand or technological superiority -- to sustain higher profitability through the years.
Competitive strengths also reduce competitive risk, so companies with major competitive advantages tend to be both more profitable and safer investments than their peers.
Apple's amazing profitability
Apple generates an amazing ROE ratio in the neighborhood of 38%. That's more than three times the 14.2% return on equity produced by its main competitor, Samsung (NASDAQOTH: SSNLF),over the past 12 months, according to data from Morningstar.
Other industry players pale in comparison to Apple. According to estimates from Strategy Analytics, Apple retained a gargantuan 89% of all smartphone industry operating profit during the fourth quarter of 2014. The report estimates Android devices kept the remaining 11%, with Microsoft (MSFT 0.11%) and BlackBerry (BB 2.89%) producing no profit whatsoever.
Offering a similar perspective, Canaccord Genuity calculated that Apple produced $44.7 billion in operating profit during 2014, accounting for a massive 79% of all smartphone industry operating profit during the period. The research firm estimated Samsung brought in $13.9 billion in operating profit, or 14% of the total. According to these estimates, both Microsoft and BlackBerry lost money in mobile last year.
Apple's amazing profitability comes from the company's unparalleled competitive strength. Apple is rated as the most valuable brand in the world across multiple surveys, with an estimated brand value of $119 billion to $145 billion.
This is a crucial differentiating factor, and it allows Apple to charge above-average prices for its products and deliver superior profitability for investors. Most competitors are aggressively cutting prices to protect market share in smartphones, yet Apple announced a $62 increase in the average selling price for the iPhone line during the last quarter, reaching $659 per unit. Consumers seem more than willing to pay premium prices for Apple products, as unit sales in the iPhone segment jumped 40% year over year, to 61.2 million devices, during the quarter.
The mobile industry is one of ecosystems, not just devices. Apple is famous for its halo effect, meaning customers who own an iPhone are more inclined to stick with Apple when buying a computer, a tablet, and perhaps even a smartwatch. This means Apple becomes stronger from a competitive point of view as it grows in size over time.
Return on equity can be a powerful driver for investors, not only because of the direct positive implications of higher profitability, but also because companies with above-average profitability are generally top industry players with superior competitive strengths. Apple has the best return on equity in mobile by a wide margin, which is a major positive for investors in this stock.