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Why It's Not Smart to Bet Against Apple's iPhone Business

Nicholas Rossolillo, The Motley Fool

There was a lot of investor angst ahead of Apple's (NASDAQ: AAPL) quarterly report on May 1. Analyst estimates and Apple component supplier reports suggested that iPhone demand was waning.

That speculation negatively affected the stocks of many semiconductor companies as well as Apple.

XSD Chart

Data by YCharts.

While the quarter did show signs that the iPhone business is aging, it was also proof that betting against the tech giant doesn't make sense.

What's good for the goose isn't always good for the gander

The reason has to do with an oft-forgotten financial situation: monopsony. Celebrating the good day I had following Apple's report, I went to a trivia night at a favorite taphouse where I was reminded of the term (go figure). While a monopoly is a situation in which a market has only one seller of a good or service, a monopsony is a market where there is only one buyer.

Just as a monopoly gives a company power over what it can charge customers, a monopsony can give a company the power to dictate prices it pays for product. That can have an impact on the price to produce a final good and provide a big boost to bottom-line profitability.

In today's world, pure monopolies are hard to find; the same is true with pure monopsonies. As for our case in point, Apple isn't the only smartphone maker out there. Nevertheless, Apple is a leader among just a few other tech companies that sell smartphones, giving it a lot of control over suppliers -- especially chip makers. There are many people out there who chalk up double-digit percentages of revenue attributable to the iPhone. As a result, fortunes have been made when small Apple suppliers leverage that relationship to grow into other markets (think Skyworks Solutions, for example). Even more investments have been broken, though, when a supplier's relationship is given the ax (who remembers InvenSense?).

Two iPhone X smartphones displayed back-to-back. Both phones have a silver case.

The iPhone X, starting at $999. Image source: Apple.

What does that mean for Apple investors?

Trying to judge the health of Apple's bread-and-butter business from the fate of other companies can be risky. Just because iPhone sales aren't providing the boost to chip makers like they used to doesn't mean that the company's moneymaker segment is in trouble. Apple can wield a great deal of control over its supply to increase final pricing of its flagship product with innovative features, helping offset a slowdown in the number of units sold. In the current fiscal year, the pricey iPhone X is a testament to that, helping give revenue a big boost with its premium capabilities.

Fiscal Year

iPhones Sold

Year-Over-Year Change

iPhone Revenues

Year-Over-Year Change

2018 Year-to-Date

129.5 million

0.3%

$99.6 billion

13.7%

2017

216.8 million

2.3%

$141.3 billion

3.4%

2016

211.9 million

(8.3%)

$136.7 billion

(11.8%)

2015

231.2 million

36.6%

$155.0 billion

52%

2014

169.2 million

12.6%

$102.0 billion

11.7%

Chart by author. Data source: Apple quarterly results.

Even though iPhone sales are off all-time annual records set in 2015, Apple is still driving revenues higher and thus growing profitability for shareholders. Granted, there are new products and services like the Apple Watch and Apple Music helping out, but to date the iPhone still makes up two-thirds of the total business.

AAPL Net Income (TTM) Chart

Data by YCharts.

The smartphone industry is mature, but it's a monopsonistic one that favors the tech giants making the phones. Trying to frontrun Apple based on what its iPhone suppliers are experiencing is a fool's errand.

This last quarter is proof of that as the company continues to leverage its powerful device business to return value to shareholders.

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Nicholas Rossolillo and his clients own shares of Apple and Skyworks Solutions. The Motley Fool owns shares of and recommends Apple and Skyworks Solutions. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.