Apple is a stock to hold for this year — and perhaps decade
For roughly 10 years, Apple has been the belle of the ball on Wall Street.
Shares of the Apple Inc. (AAPL) have soared over 750% in the last 10 years — more than eight times the return of the S&P 500 (^GSPC). It pushed aside Exxon Mobil (XOM) a few years ago to become the largest U.S. company by market capitalization, and has a good shot at being the nation’s first-ever trillion-dollar stock.
In fact, just Apple’s $280 billion stockpile of cash and investments is more than the value of all but 13 other S&P 500 corporations.
The iPhone is an iconic device that has won over consumers, the steady flow of profits have won over shareholders... what’s not to like?
Apparently plenty. The Dow Jones Industrial Average(^DJI) twice slumped more than 1,000 points in a single session this past week and the major indexes are down about 2% year-to-date — but Apple shares have skidded 7.7% in 2018, thanks in part to trouble after its fiscal first-quarter earnings.
Has Apple actually lost a step, and facing trouble in 2018? Or is this downturn just an overreaction that will present a rare buying opportunity on this stock?
Personally, I think it’s the latter. There are indeed signs of weakening at Apple, but the enormity of this company and its bulletproof balance sheet make it a stock to hold for the coming year — and perhaps decade.
But let’s pop the hood and take a look at the good, the bad and what’s next for Apple.
3 bright spots you may have overlooked
Look, everyone likes to talk about the same old things with Apple. It’s huge, it’s got a ton of cash and its forward price-to-earnings ratio of just 12 is significantly lower than most other S&P components.
But those arguments for the stock are well-worn. A deeper look at Apple’s fiscal first-quarter report, marking the end of the December quarter and released on Feb. 1, shows a few powerful trends that are at work under the radar. They include:
Installed devices and service sales: We talk a lot about the need for iPhone launches to juice revenue. However, let’s not overlook the amazing reach of Apple. The company recently announced that 1.3 billion of its devices are in-market, a 30% increase from two years ago. And even when these folks don’t buy the latest iPhone or iPad release, they are still buying briskly in the App Store and on iTunes; in the latest SEC filing, its “services” arm that includes digital content tallied $8.5 billion in quarterly sales — more than total iPad or Macbook sales, and up an impressive 18% year-over-year. This is an amazing baseline unshackled from the upgrade cycle, and one that continues to grow briskly.
Interest income: Speaking of an amazing baseline, consider that Apple also generated nearly $1.5 billion in interest and dividend income from its ridiculous stockpile of cash. That’s up from $1.2 billion a year ago, thanks to the growth in its bank account. The SEC filing revealed the average rate of return was about 2.1% — up from 1.9% a year ago — and if the Federal Reserve continues to raise rates, that could pick up even more in the coming year.
Share count: We talk a lot about buybacks, but what do they mean? Apple’s latest filing shows us in living color. As of Jan. 19, the company had 5.07 billion shares of common stock in circulation. That’s down over 3% from the start of 2017. Longer term, that’s down almost 9% from 2016 and about 13% from 2015. This persistent and aggressive repurchase plan should not be overlooked as a powerful way to defend per-share earnings and create a foundation for share prices going forward.
3 trouble spots investors aren’t talking about
If some Apple bulls are lazy with their arguments about scale, many bears are equally tedious with continued talk about dependence on iPhone revenue. These takes were out hot and heavy after earnings, with talk of disappointing iPhone trends and how consumers stick with their old devices for three or four years nowadays instead of just one or two.
So let’s look beyond that upgrade cycle argument, and dig deeper into the fundamentals of how Apple makes its money — because there are worrisome signs, even if they’re not as easy to see from 10,000 feet.
Big prices, smaller margins: Forget tired arguments about customers waiting to upgrade — let’s talk about how those upgrades aren’t as valuable anymore. Perhaps the most disturbing sign I saw in the latest 10-Q filing is that margins dropped across the last three months of 2017, from 38.5% in 2016 to 38.4% in 2017. That’s hardly a big decline, but incredibly noteworthy given the exorbitant price tags of $999 and $1,149 on the newly launched iPhone X. Apple’s game has always been higher-priced items driving higher margins, but even after moving up into four figures it couldn’t improve profitability at all. That’s a big red flag.
Still tough going in China: Revenue increased almost 11% year-over-year in China, but that’s only slightly better than growth in the Americas. And from a raw revenue perspective, the region represents only 20% of total sales, down from 21% at the same time a year ago. Throw a January report from BI Intelligence that iOS devices are losing market share in the region and it doesn’t bode well for growth in this key region. Remember, there’s no upgrade cycle if you don’t get consumers hooked on your product in the first place, and this region is full of valuable potential customers Apple is struggling to reach.
Analysts rolling over: Of course, I’m just a balding stock picker who gets things wrong constantly. But you may be interested that a host of pedigreed investors are souring on Apple stock, with downgrades recently from Nomura, BMO Capital Markets and Bernstein just to name a few. Additionally, Goldman Sachs (GS) initiated coverage at “neutral” with a $161 target — hardly any upside from here. The so-called smart money can be stupid at times, but when Wall Street moves in the same direction it can often be painful to go the other way. Remember this before you chalk up the declines in this stock to simply being punished along with the broader market.
What’s next for Apple?
Of course, this is all Monday morning quarterbacking. If you’re an Apple shareholder — or a prospective dip buyer — what you’re interested in is how the stock moves going forward.
Here are a few things to watch:
Short-term trends don’t look good: Apple officially hit “correction” territory over the last week or so, with a 10% decline from its 52-week high of $180. Furthermore, Apple broke below its 200-day moving average of around $158 on Thursday afternoon, and its steep fade into that close was not encouraging. If the market-wide volatility continues and pushes shares under their September lows around $150, the next stop could be much lower.
Guidance is the big story: We talk a lot about the most recent earnings reports for good reason, but remember that the stock market is a forward-looking indicator. And while the overall numbers were objectively strong in this report — revenue up almost 13% to beat the Street’s targets and comfortably top internal guidance, earnings that handily topped consensus and records across several areas of the business — the future didn’t look so hot. That included second-quarter revenue guidance and margin guidance below the consensus. This, even with the prospect of lower tax rates, does not inspire confidence for the next three months. That means it could be hard for Apple stock to break out of its rut until the next 10-Q drops.
Supercycle vs. upcycle: The idea of an iPhone “supercycle,” where a new gadget opens a floodgate of demand, seems highly unlikely this year after the tepid results immediately after the iPhone X launch. However, it’s not crazy to think that we will see a modest but sustained growth cycle over 2018 — and perhaps 2019 and beyond — that will show Apple still has something to offer.
Right now, investors are resetting their expectations as to how dynamic the company’s growth path is. But if Apple can consistently prove that path is still higher, Wall Street will surely come back in force to this tech powerhouse.
Of course, that narrative isn’t as easy to detect via one big earnings report, so investors will have to look more closely at the stock over many more weeks to figure this one out.
Jeff Reeves is the editor of InvestorPlace.com. Follow him on Twitter @JeffReevesIP.
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