Goldman Vs. Apple: Who Generates the Highest Economic Return?

I’ve been wanting to get this up all day.

First, here’s to all of God’s workers. You know who you are. Your just reward awaits.

More importantly, John Cassidy (New Yorker) had a great Rational Irrationality piece today. In full below…..

Contrary to appearances, I’m not obsessed with Goldman Sachs, and this will be my last post on the subject for a while. But the Wall Street firm issued its latest profit report today, and I thought it would be interesting to compare its results to those of Apple, another iconic American business, which yesterday published its own profit figures.

Many people are put off by financial accounts, but they provide an invaluable window into what is really going on in a given corporation, and to how much it is contributing to society. I may be weird, but sometimes I actually like poking around in 10-Qs, 8-Ks, and other disclosure forms that public companies have to file with the Securities and Exchange Commission. One word of warning, though. What follows should be considered a process of me thinking out loud, and pointing out some things that strike me, rather than reaching any definitive conclusions.

As everybody knows, Goldman and Apple are both making tons of money (although Goldman’s latest results disappointed investors somewhat). In the final quarter of 2010, the bank generated net profits of $2.39 billion on revenues of $8.64 billion. Apple, which has a much bigger turnover, made profits of $6 billion on revenues of $26.4 billion.

On Wall Street and in the computer industry, quarterly profits tend to bounce around a bit, so it is perhaps more illuminating to look at the entirety of 2010. With Goldman, whose fiscal year follows the calendar, this is easy. In the past twelve months, Goldman recorded net profits of $8.35 billion on revenues of $39.16 billion. Apple’s financial year ends in September, but by combining the results from its first fiscal quarter of 2011, which has just ended, and the final three quarters of 2010, I came up with the following figures. Apple made $17.63 billion on revenues of $76.28 billion.

On the face of it, the two firms’ profit margins seem pretty similar. For every dollar of revenue it generates, Goldman makes a profit of about twenty-one cents; Apple makes about twenty-three cents. But that is where the comparisons end. From an economic perspective, the real measure of a business is the return it generates on the capital it employs, which could be used in alternative projects. By this metric, Apple leaves Goldman far behind.

One popular measure of capital is “shareholders’ equity,” which consists largely of money invested in the firm and retained earnings. Wall Street analysts tend to fixate on return on equity (ROE), but it can be a misleading, especially when applied blindly to financial institutions. In good times, banks can increase their ROE simply by taking on more leverage (borrowing). Until the fall of 2008, this was precisely the strategy that Goldman and its rivals pursued: in the boom years, Goldman often generated a return on ROE of more than twenty per cent, but this wasn’t sustainable. When the credit bubble burst, high levels of leverage destroyed some banks and forced others into the arms of the government. In effect if not intention, the banks had been creating fictitious profits, much of which ultimately ended up as losses.

During the past couple of years, the banks, Goldman included, have cut their leverage ratios sharply, partly by issuing more equity to shareholders, partly by selling assets and paying down debts. As a result, we now have a more realistic estimate of their earnings power. Despite its return to profitability in 2009 and 2010, Goldman’s ROE last year was just 11.5 per cent. Apple, by contrast, generated a ROE of about thirty-two per cent in 2010, almost three times the Goldman figure.

Another way to gauge a firm’s performance is to take everything it possesses—its buildings, its machinery and other equipment, its product designs, and its financial holdings—and look at how much profit it generates for each dollar of assets on its books. In my opinion, this measure, which is known as return on assets (ROA), is the best way to judge a business, because it excludes the amplifying effect of leverage. Now let’s apply it to Goldman and Apple.

According to its latest filing with the S.E.C., Goldman ended 2010 with assets of $911 billion, which means its ROA for the year was roughly .91 per cent. (Yes, that is less than one per cent.) Apple ended 2010 with total assets of $86.7 billion, which means it generated an ROA of about 20.3 per cent.

To summarize: Apple isn’t merely generating a higher return on the capital it employs than Goldman; it is more than twenty times as profitable! How can this be?

Part of the answer is an accounting foible. Unlike some corporations, Apple doesn’t record on its balance sheet much of the value of its patents and other intellectual property—the look and feel of the iPad, for example. If it did this, the figure for total assets recorded on its books would be considerably higher, and its ROA would be lower. But accounting is only a small part of the story. (As far as I know, Goldman doesn’t capitalize its intellectual capital, such as it is, either.)

The main reason why Apple is so much more profitable than Goldman is a reassuring one. It makes tangible things—iMacs, iPhones, iPads—that millions of people want to buy, and for which they are willing to pay a premium price. (I am writing this post on an iMac.) Despite operating in a highly competitive industry, Steve Jobs’s firm has successfully differentiated its product line to such an extent that it now has considerable monopoly power: it can charge considerably more for its gizmos that they cost to manufacture.

Goldman, for all its reputation and smarts, has no such franchise. It does some things that its clients value and are willing to pay for—making markets, raising capital, providing investment advice, hedging risky positions—but rival banks, such as JPMorgan Chase and Morgan Stanley, provide practically the same suite of services, and pricing power is limited. (Not limited enough in some areas, such as I.P.O.s.) The only way Goldman (or any other investment bank) can increase its profit margins in a big way is to leverage up its balance sheet and live by its wits in the financial markets. But when banks all try this together, the consequences are usually disastrous.

Another thing that differentiates Goldman from Apple is how much it pays its employees. In 2010, Goldman’s 35,700 employees took home an average of $430,700. Apple doesn’t publish much information about its labor costs. According to the jobs Web site Simply Hired, the average salary at Apple is $46,000. Another Web site, Salary List, quotes a substantially higher figure—$107,719—but that doesn’t appear to include people working at Apple’s more than three hundred retail stores. Whichever number is more accurate, the basic message is the same. Apple employees earn a lot less than their counterparts at Goldman despite the fact they generate a much higher return—private and social—on the capital they use.

Go figure.

Can Bad Reviews Hurt Apple?

h/t to reader Scott. Frankly, we’re still looking to buy one. But hmmmmm.

Consumer Reports officially retracted their recommendation of the IPhone 4 due to the signal issues the phone is seeing.

Just another reason to look to Android as a viable competitor to RIM and Apple in the mobile marketplace.

TechCrunch:

Steve Jobs recommends getting a case for this issue, but Consumer Reports calls it a design flaw. It suggests a duct-tape fix. Already there are lawsuits brewing..

Other than the antenna problem, Consumer Reports loves the phone:

it sports the sharpest display and best video camera we’ve seen on any phone, and even outshines its high-scoring predecessors with improved battery life and such new features as a front-facing camera for video chats and a built-in gyroscope that turns the phone into a super-responsive game controller. But Apple needs to come up with a permanent—and free—fix for the antenna problem before we can recommend the iPhone 4.

It also continues to sell like crazy. So is the antenna problem real and widespread, or do people just not notice it or care because they figure it is AT&T’s fault?