Tech giant Apple (ticker: AAPL) reported fiscal third-quarter earnings on July 30, and the results only fueled what has been a remarkable rally for one of the world’s single biggest companies.
Despite a global pandemic, Apple stock is up more than 80% in the last 12 months. And in its most recent quarterly report, the company announced record-setting revenue for the June quarter, typically the slowest of the year.
Clearly, AAPL stock would’ve been a great buy a year ago, but what about now? And, more generally, what are the biggest issues and themes that investors in the Cupertino behemoth should watch for when deciding how the stock should fit into their portfolio?
After reporting fiscal third-quarter earnings in late July, many investors might be wondering: “Should I buy Apple stock?” Consider a few points below:
— Apple stock at a glance.
— Pros of buying Apple stock.
— Cons of buying Apple stock.
— The bottom line: Should you buy Apple stock?
Apple Stock at a Glance
Founded in 1976, Apple burst onto the scene with the introduction of the Macintosh in 1984, taking the personal computer mainstream. Led by Steve Jobs, who would become the ultimate Silicon Valley icon when all was said and done, the upstart business — which started in a garage — would go up against multibillion-dollar entrenched industry players like IBM ( IBM) and Hewlett-Packard ( HPQ).
Jobs’ insistence on building a closed ecosystem instead of catering to the masses out of the gate like Microsoft ( MSFT) did made for a slower slog, and he was forced out of his own company, only to return when the company was in deep trouble in 1997.
From there, he built Apple back to prominence — the 2001 release of the iPod became a blockbuster hit for the company, and the 2007 release of the iPhone set in motion a practically unstoppable momentum for the company that continues to the present day.
The company’s ability to merge its hardware with its own software and the creation of a product ecosystem that includes the iPhone, Mac, iPad, Apple Watch and Apple TV make for a seamless experience across all devices.
In the fiscal 2020 third quarter, Apple saw revenue advance 11% year over year despite the pandemic that was raging. Sales came in at $59.69 billion versus expectations for $52.25 billion.
Earnings per share of $2.58 rose 18%, also setting a record for the June quarter, and far exceeded the $2.04 per share analysts expected.
Pros of Buying Apple Stock
Cash (and Apple) is king. The value of cold, hard cash is difficult to overstate. In recent years, Apple’s enormous cash hoard has reached downright legendary levels. At the end of June 2020, the company had just less than $194 billion in cash and investments — money it routinely returns to shareholders through stock buybacks and dividends.
Currently, Apple’s 0.9% dividend yield is modest — but it’s nothing to scoff at, especially since the company has set the precedent of raising its payout annually since first instituting the quarterly stipend at the behest of shareholders in 2012. Since then, the company’s quarterly dividend has more than doubled, from a split-adjusted 38 cents per share to 82 cents per share today.
The company increased its dividend by 16% in fiscal year 2018, 5% in 2019 and 6% in 2020.
Over the years, Apple has spent literally hundreds of billions on share buybacks, which helped send the stock price to more than $400 per share by late July. In its most recent earnings report, Apple announced a 4-for-1 stock split, its first split since 2014, that will “make the stock more accessible to a broader base of investors.” It’s the fifth stock split in company history; for every Apple share an investor in early 1987 owned, they will own 192 Apple shares after the 2020 split goes through on Aug. 31.
Services segment growth. Arguably the biggest point of excitement for Apple shareholders nowadays is Apple’s services segment, which posted revenue of $13.16 billion, up almost 15% from a year ago.
Services, which includes many of Apple’s hit software offerings like iTunes and the App Store, is a higher-margin part of the business, meaning more profits drop down from the top to the bottom line. The newest member of the services segment is Apple TV+ — the company’s streaming service — which not only garnered its first Emmy nominations this year, but also reportedly saw a growth in new viewers from the blockbuster World War II film “Greyhound,” starring Tom Hanks.
Although Apple is giving away free one-year subscriptions to Apple TV+ with the purchase of a new Apple device, consumers may keep paying subscriptions to tune in to the latest shows — a much more regularly recurring source of revenue than iPhone purchases.
AAPL has now doubled its services revenue since fiscal 2016, achieving its goal of $50 billion in annual services revenue six months early.
The company’s installed base of active devices — which services revenue is a function of — should likely continue to climb. There are more than 1.5 billion installed devices worldwide — in fact, Apple’s Chief Financial Officer Luca Maestri said that in Q3 2020, its active installed base of devices hit another all-time high in all geographic segments and all major product categories.
A nearly insurmountable moat. The success seen in the services segment is a different side of a greater advantage enjoyed by Apple, which is the “network effect” — a type of long-term competitive advantage that investors look for when seeking stocks that are built to thrive for years to come.
The fact that Apple can instantly deploy new software and services to nearly 1 billion active iPhone users and hundreds of millions of other Apple devices is a self-perpetuating cycle that helps to virtually guarantee the company will continue to thrive.
The more people using Apple products, the more time developers spend making fun and useful apps to go in the App Store, which in turn keeps current customers on the platform and attracts new ones. And, of course, Apple takes a 30% cut of App Store revenue.
The seamless integration between Apple devices created a cultlike following of loyal customers, and it makes switching away from its products somewhat of a pain. Consider all the custom hardware, chargers and wearables that are useless with other manufacturers.
The fact that certain features are only available when an iPhone user is communicating with another iPhone user just reinforces the network effect, making Apple devices more useful as more and more people use them.
As for those customized wearables that can only be used with other Apple products? The wearables, home and accessories segment is another high-growth division, with revenue jumping 17% year over year to $6.45 billion in the most recent quarter.
Cons of Buying Apple Stock
The iPhone’s not the force of yesteryear. The first downside to owning AAPL is unmistakable: The iPhone is no longer the unstoppable growth engine it once was. In fact, iPhone sales are essentially flat, and with the smartphone making up about 44% of the company’s revenue, there’s enormous pressure on Apple to diversify its revenue streams and grow other divisions quickly.
For a worst-case case study, consider the BlackBerry ( BB) phone, which was once a blockbuster product but quickly faded into obscurity as it got overtaken by, you guessed it, the iPhone. Shares of the company plummeted from about $140 to $7 in just a few years.
Is there any such single competitor threatening to turn the iPhone into the next BlackBerry? No imminent threat seems obvious today. And while Apple’s ecosystem does help insulate it from this risk, the point is that tech is a constantly shifting landscape and change can be swift and unforgiving.
Even without a single obvious threat on the horizon, iPhone revenue rose just 1.7% in Q3 2020. While that may be due in no small part to both demand and supply shocks stemming from the pandemic, slowing growth in the smartphone segment has been a broader problem since well before 2020 started throwing its vicious curveballs.
Content (not Apple) is king. Apple TV+ has positioned itself as a low-cost alternative to Netflix ( NFLX) among the growing list of new competitors in the area. For a monthly fee of just $4.99, it certainly is on the cheaper side of the streaming market.
How much Apple has invested in Apple TV+ to date isn’t exactly clear, but what is clear is that it likely wasn’t cheap: The streaming wars have created a bubble in the price of the Hollywood talent needed to produce quality original content, and if AAPL hopes to hold a candle to Disney ( DIS), Netflix, Hulu and Amazon.com ( AMZN), it will have to commit to spending billions annually to do so.
Although analysts estimated the service brought in more than 33 million subscribers by the end of 2019, it’s unclear how many of those subscribers are watching because the service was free.
The service is far too new to have a backlog of content like Netflix, and production of new shows has been dramatically slowed by the global economic shutdown. The longer production is paused and the closer those new subscribers come to the end of their free year of Apple TV+, the more crunched for content Apple will become.
Valuation. Apple’s trailing and forward price-to-earnings ratios are about in line with the broader market at around 30 and 25, respectively. For perspective, Apple is one of the most valuable publicly traded companies in the world, with a market capitalization around $1.7 trillion.
The fact is that the larger a company becomes, the harder it is to post market-beating growth. The reason why boils down to simple mathematics: If any company grows at a rate higher than gross domestic product for long enough, it’ll eventually overtake the economy of the entire world.
Clearly, AAPL isn’t at that stage yet, but these theoretical limits imposed by population, the velocity of money and other factors all come into play for companies like Apple and Facebook ( FB), with billions of users.
For this reason, Apple should clearly trade for less than 30 times earnings. Something in the low 20s seems more reasonable considering the company’s already significant size.
The Bottom Line: Should You Buy Apple Stock?
Apple is a great company. It’s one of the world’s biggest cash cows, and even in the midst of a global pandemic, AAPL continues to churn out profits for its investors. This company will be around for a long time, and this fact alone gives Apple shares value.
Still, its reliance on the iPhone — a legacy product that arguably hasn’t had a meaningful change to new models for years — is quite worrisome. And while CEO Tim Cook is a great financial engineer, he doesn’t seem to be a great actual engineer: Apple Watch is really the only meaningful new hardware product Cook has launched since becoming CEO in 2011 (excluding accessories like its wireless earbuds, AirPods).
Perhaps there’s not a whole lot more Apple can offer within the hardware space while remaining true to its focus and brand. If that’s the case, fine — but don’t take half-measures like trying to sell a $4.99-per-month, sparsely populated “me too” streaming platform like Apple TV+. Do something bold. Switch things up. Think different.
Yes, Apple is a great company and likely will be for a while. But now is not the best time to invest. Until the company figures out a better way to utilize its cash, or share prices get down to a more reasonable level, it’s best holding off on buying AAPL shares anywhere near 30 times earnings.
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