In August 2018, Apple became the first company to notch a trillion-dollar stock market valuation. By 2021, it’d comfortably crossed the $2 trillion threshold – making it, at the time of writing, the world’s most valuable public company.
Apple’s sheer size makes it a major component of most large stock market indexes: it represents 6% of America’s S&P 500 and 2% of the MSCI World Index. If you’re invested in an exchange-traded fund (ETF) tracking one of these, or in a major tech-focused fund, then you’re already an Apple investor. Failing that, your pension – if you have one – is most likely partly invested in the tech giant.
Apple’s fortune-fueling flagship has been the iPhone – one of the most successful products of all time. iPhones have brought the company more than a trillion dollars of revenue overall, along with a huge amount of profit – and they remain Apple’s biggest moneymaker, accounting for half its total revenue in 2020.
But iPhone sales are declining: the number sold peaked in 2015 at 231 million units and fell at an average rate of 2% per year thereafter until 2019, when Apple conveniently stopped reporting iPhone unit sales altogether.
The company has so far managed to offset this volume impact by increasing prices – but between global smartphone saturation and rising competition, there may be a limit to how much longer that can go on.
What happens next is therefore key to Apple’s future: can it replicate its success with new hardware products, or will it have to rely on income from its services segment to grow its future earnings? Or is a third path possible? The answers to these questions have major implications for what Apple’s stock will be worth, and therefore how your investment in the tech titan will perform.
In this Pack, we’ll explore three potential scenarios and set out what each would mean for Apple’s valuation – helping you figure out whether an investment now is worthwhile.
This scenario is relatively simple: with over 1.65 billion devices (including more than a billion iPhones) in active use worldwide, Apple has a captive customer base to which it can sell services from apps to cloud storage, not to mention subscriptions for music, magazines, video streaming, games, and more.
Not only could all this revenue offset declining iPhone sales, but it may also help Apple’s valuation another way: by giving the company higher profit margins which should in turn lead to a higher “valuation multiple”. In fact, this is precisely the thesis of several prominent Apple bulls…
80% of Apple’s sales currently come from hardware: iPhones, iPads, Macs, and wearables and accessories. Typically, hardware-focused companies trade at lower valuation multiples than service-based firms. That’s partly because hardware sales can be very seasonal, cyclical, and low-margin, whereas sales from services – especially subscription services – are more consistent, resilient, and high-margin.
Apple’s shares currently change hands at 27x the value of next year’s projected profit – whereas Microsoft, which generates the bulk of its sales from software and services, trades at 30x. If Apple can make services a bigger part of its revenue mix, then it should trade at a higher earnings multiple, providing a boost to its stock price. Granted, the fact there’s not that big a gap between the two companies’ multiples suggests that many investors have already “priced in” that very eventuality.
Looking more closely at the numbers, Apple’s gross profit margin on services sales was 66% in 2020 – more than double the 31% margin it made on hardware. If Apple can pivot towards selling more services, then its overall gross margin – currently 38% – should increase accordingly.
66% may be untenable in the long term, however. Until recently, the bulk of the company’s services revenue came from App Store sales and the fees Google pays to be the default search engine in Apple’s Safari web browser. Both require little work from Apple – and therefore come with chunky margins.
But Apple’s now more focused on selling lower-margin music and video streaming services. Apple Music, for instance, pays out a lot of its revenue to record labels, similarly to Spotify (which has a 26% gross profit margin). Apple TV+, meanwhile, has to spend big on licensing and creating content, similarly to Netflix (which has a 39% gross margin).
How big can Apple’s services become?
Apple’s services business generated $54 billion of revenue in 2020. That’s more than total revenue at Oracle, one of the largest software companies in the world. Even so, services only accounted for 24% of Apple’s sales. For Apple to be considered a services company, at least half its sales should probably come from services, which would require revenue there to more or less double.
With 1.65 billion active device owners, Apple generated average per-user revenue of just under $33 in 2020 – or about $2.75 per user per month. Doubling this would mean extracting $5.50 per user per month – perhaps not impossible, considering people pay more for services such as Spotify, Netflix, and Amazon Prime.
Apple’s had its own music streaming service for years, but in 2019 it launched video streaming service Apple TV+, News+, Fitness+, and video game subscription service Apple Arcade at between $5 and $10 a month each, or bundled together for $15 to $30 per month. These new revenue streams, combined with growth in legacy services like App Store sales and cloud storage, have the potential to increase the average amount Apple makes per user – maybe even to that magic monthly $5.50 figure.
On the other hand, only about a quarter of Apple device owners actually pay up for any of these services at present. Making its offering too good to refuse is one way to increase that, but there’ll be some Apple users who’ll never pay for additional services. In reality, Apple will hope that a growing minority of users spend a lot on services to make up for the majority who spend nothing at all.
If Apple can increase the amount it makes per user per month to $5.50, that would imply an extra $46 billion of annual revenue. While services have a 66% gross profit margin at present, this will likely fall as the product mix shifts more towards subscriptions.
Assuming a 40% “net” profit margin for services (after operating expenses, interest, and taxes), this additional revenue would add $18 billion to Apple’s annual profit.
Of course, this won’t happen overnight: let’s assume it takes Apple five years. Applying a Microsoft-esque 30x earnings multiple to Apple’s $18 billion of additional earnings equals $550 billion in five years’ time, or $375 billion discounted back to 2021 at 8%. Apple’s market capitalization is around $2.1 trillion at the time of writing – so the extra $375 billion of value represents a potential upside of slightly under 20%.
The takeaway: Doubling average services revenue per user could add 20% to Apple’s value, but it’s a scenario that investors, by and large, seem to be banking on already.
In this scenario – admittedly a long shot – we imagine that Apple manages to repeat the success of the iPhone by creating another uber-successful piece of hardware.
Apple’s had a couple of cracks at this already. When the Apple Watch was introduced in 2015, many commentators thought it was going to be the next big thing. Today, however, only around 30 million units are sold each year – a far cry from the more than 200 million-odd iPhones still shifted annually. And because they sell at a lower price, Apple Watches bring in less revenue.
More recently, Apple entered the virtual-assistant market with the introduction of its HomePod smart speaker – but it’s failed to match the success of market leaders Amazon Alexa and Google Home. HomePod sales are a minuscule fraction of Apple’s total revenue.
The company has had more luck with AirPods. Apple sells an estimated 60 million of these annually, but even at their most expensive price of $250 a pair, that translates to just $15 billion of revenue – once again, a tiny fraction of Apple’s total. In short, none of Apple’s recent product launches have been able to repeat the spectacular success of the iPhone.
Apple’s been developing electric vehicles (EV) technology on and off since 2015. And while not an entirely new product category – EVs have been around for a while, after all – neither was the iPhone. Smartphones already existed, but Apple made them more attractive and popular. It could conceivably do the same with electric cars.
Details are scant, but according to reports in late 2020, Apple’s aiming to release its own vehicle by 2024. The company’s track record combining hardware with software in a user-friendly manner suggests it could be a winning strategy, but one unlikely to make much profit. Specialist EV makers like Tesla have a 6% operating profit – and at 7%, one of the world’s biggest carmakers Volkswagen isn’t much better. Both are a far cry from Apple’s current 24%.
Apple is also reportedly working on both augmented and virtual reality projects that could launch as soon as 2022 – either as an integration into existing iPhones or as a standalone Apple Glasses product. This could be big: there’s a school of thought that believes AR and VR may represent the next major computing platform beyond smartphones.
VR could be used to train doctors through simulated surgeries, or simply to entertain millions. And AR’s applicability could be even broader: Microsoft’s existing HoloLens is targeted at businesses keen to have teams communicating and collaborating more effectively.
However, there’s some very real competition. If AR/VR does indeed become the next major computing platform, you can bet that other big tech companies will be fighting fiercely for a piece of the pie. As well as Microsoft’s HoloLens, existing challengers include Facebook (Oculus), Snap (Spectacles), Alphabet (Google Lens), and Magic Leap.
We’ll provide a framework for valuing both Apple’s EV and AR/VR projects – and within that you can play around with your own assumptions.
Annual sales of electric vehicles are projected to hit 11 million in 2026. Let’s assume Apple captures 5% of that market and sells 530,000 cars at $75,000 each (another big assumption), implying revenue of $40 billion.
Shares of Tesla, which sold around 500,000 vehicles in 2020, trade at an admittedly high valuation multiple of 12x next year’s revenue. Applying this revenue multiple to $40 billion of revenue would give “Apple Car” a value of $480 billion in five years’ time. Discounted back to 2021 at 8%, that’s $325 billion. Taking Tesla’s more normalized 5-year average sales multiple of 4.2x would yield a value of $170 billion five years out, or $114 billion in 2021.
Given automakers’ low profit margins – arguably not reflected in Tesla’s revenue multiple – you might want to consider a more conservative approach for Apple’s car business. Applying a 7% profit margin and 6x profit multiple (in line with Volkswagen) to Apple Car revenue would yield a valuation of $17 billion in five years, or $11 billion in 2021.
Investment bank Goldman Sachs estimates the AR/VR market will be worth $130 billion by 2026, with a roughly 45/55 split between software and hardware products. Let’s assume Apple captures 20% of that – similar to the market share the iPhone captured in the middle of its technological life cycle – and scores revenue of $26 billion.
Apple’s stock currently trades at 5.8x the value of next year’s sales – and applying this to $26 billion of revenue would give Apple’s AR/VR tech a total value of $150 billion five years from now, or $103 billion in 2021. Taking Apple’s 5-year average sales multiple of 3.3x would yield a value of $86 billion five years out, or $58 billion in 2021.
Combining the two new businesses outlined above would lead to a potential increase in Apple’s overall value of $630 billion in five years using current multiples, or $250 billion using average historical multiples. Discounted back to 2021, that’s $430 billion at the high end or $172 billion at the lower end. That’s a wide range which could add between 8% and 20% to Apple’s current stock market valuation of $2.1 trillion at the time of writing.
The takeaway: An Apple-brand electric vehicle or augmented/virtual reality gear might move the needle on Apple’s valuation – but it requires some pretty optimistic assumptions to do so.
In this scenario, we assume the smartphone market remains saturated and that Apple continues to sell newer but ever fewer iPhones each year, mainly to those replacing older models. The company generates a stable amount of annual profit as a result – but rather than reinvesting this in developing new products, Apple uses the majority to pay investors in its shares solid dividends every quarter, effectively making it an “income stock”.
With approximately one billion active iPhones today, a five-year replacement cycle implies 200 million iPhone sales each year. The average iPhone cost $766 back in 2018. Let’s assume this settles at $800: selling 200 million iPhones at an average price of $800 would deliver $160 billion of annual iPhone revenue.
In this scenario we’re also assuming that Apple neither transforms itself into a services company nor comes up with another game-changing product, but continues to reap respectable revenue from its current hardware and services setups. We’ll assume zero growth in Mac sales, a little growth in iPad sales, and strong growth in both services, wearables, and home/accessories. Totting all these up gives us a base case of $128 billion of annual revenue from products and services other than the iPhone.
Combining this with our previous estimate of $160 billion in annual iPhone revenue, our mature, stable imagined future Apple generates total annual revenue of $288 billion – compared to the actual $275 billion figure for the firm’s last financial year.
Using Apple’s different profit margins for products and services and working in some other assumptions based on historical trends, we’ve estimated that $288 billion of sales would generate $56 billion of annual “free cash flow” (FCF).
If Apple paid out all of this cash to its shareholders in the form of dividends, then it’d have a “dividend yield” of 2.6% based on its market valuation at the time of writing. This lands right around the dividend yields of other mature income stocks like Coca-Cola (3.3%) and Procter & Gamble (2.5%).
We’ll use a “dividend discount model” to value Apple on this basis. All you need to know for this is the dividend level, its long-term growth rate, and the discount rate. (Learn more in The Tricks And Techniques You Need To Value Stocks.)
We already know the dividend. Let’s take a long-term growth rate of 2%, in line with long-term inflation (assuming that Apple can increase its pricing and therefore its FCF and dividends by at least this rate). And while we used an 8% discount rate for our fast-growing Apple scenarios, a lower discount rate of 6% might be more appropriate for a mature, stable company.
Plugging these assumptions into a dividend discount model gives us a total value of $1.4 trillion for steady-Eddie Apple – a third lower than the company’s valuation at the time of writing. While that might sound bad, remember that this scenario doesn’t require Apple to do anything new or risky: it just has to carry on with business as usual. And investors probably wouldn’t mind a 2.6% dividend yield – the stock currently offers just 0.6%!
The takeaway: If Apple simply kept on selling iPhones and became an income stock paying out solid dividends, its shares would potentially be worth around a third less than today.
🔹 The iPhone makes up the bulk of Apple’s revenue – but with sales declining, the company is keen to start making more money elsewhere.
🔹 If Apple can transform itself into a services company and double average services revenue per user, then it could add a fifth to its total market value.
🔹 New Apple-brand electric vehicles and augmented/virtual reality gear could add 8-20% to Apple’s share price – but that requires optimistic assumptions.
🔹 If an iPhone-centric Apple simply focuses on upping its dividends, it’d potentially be worth a third less than it is today.
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