Why Apple Might Be Rotten

Why Apple Might Be Rotten

over 3 years ago4 mins

Mentioned in story

Apple’s stock has risen almost 50% this year and became the first US company to be worth more than $2 trillion. But diving into the numbers, Finimize analyst Carl Hazeley thinks Apple’s shares are overpriced.

What does this mean?

The vast majority of Apple’s revenue comes from hardware – MacBooks, iPads, and iPhones. In fact, iPhones alone contribute 44% of sales. Before the pandemic, the number of iPhones Apple was selling each year was falling – and since the pandemic, sales have been dented by forced store closures, and the company delaying its new iPhone launch by a month.

Analysts are well aware of the headwinds: Apple missed expectations in 2018 and 2019, and since then revenue forecasts for next year have fallen slightly while profit estimates are down 5%. Over the same period, however, Apple’s stock has tripled.

Apple’s estimated FY21 operating profit vs. share price
Apple’s estimated FY21 operating profit vs. share price

And that’s left Apple’s valuation looking relatively high: it’s at the greatest premium to US stocks’ average price-to-earnings (P/E) ratio for almost a decade – and it’s trading in line with faster-growing tech giants. Apple’s on a forward P/E of 28x compared to Alphabet, Microsoft, and Facebook at 27x, 30x and 26x. But Apple’s only expected to grow revenue by 10% next year compared to an average 18% for its fellow giants.

Apple’s trading at a premium to US stocks
Apple’s trading at a premium to US stocks
And adjusted for growth, Apple’s pricer than other tech giants
And adjusted for growth, Apple’s pricer than other tech giants

You might argue that Apple’s simply settling into its role as the leading giant, but the company’s track record proves it’s not as reliable as its peers. Microsoft has beaten analyst expectations every year since 2017 while increasing its sales growth rate. And Amazon’s beaten revenue forecasts each year since 2016.

Apple hasn’t been so consistent recently – and it might now have run out of time to build momentum. That’s because hardware companies typically expect to enjoy a 10-year cycle of leadership before falling by the wayside like Palm, Nokia, and BlackBerry experienced – and Apple’s iPhone’s already had 13 years of dominance. We’ve already seen Apple’s iPhone shipments slowing as smartphones converge and the incremental difference versus the last model convinces fewer and fewer people to upgrade each year. And Apple Watches or AirPods just aren’t expensive enough to make up the shortfall and give Apple the revenue-beating consistency of its peers.

Why should I care?

Ordinarily a short-term blip in a company’s earnings shouldn’t outweigh a more positive long-term investment case. Unfortunately with Apple, it’s long-term thesis falls short too.

We know Apple’s “services” segment which includes iCloud, the App Store, Apple Music, News+, TV+, and now Fitness+ has a “gross margin” of 67% compared to hardware’s 30%. And Apple believes that’s the opportunity: only a quarter of iPhone users pay for Apple’s additional services, and the hope’s that the recently announced subscription bundles should increase that figure, resulting in highly profitable recurring revenues.

Except, Apple’s been banking on services doing just that since it launched iCloud in 2011 and it’s consistently failed to do so. And with competition abound in music and TV streaming from Spotify, Netflix, and Amazon to name a few, and the all-important App Store subject to a legal battle from Fortnite-maker Epic Games, future services growth looks at risk.

So, if the short-term hardware blip is actually a longer-term slowdown and won’t readily be replaced by services revenue, you’re left with a company where the narrative has outpaced the numbers – and that’s a recipe for disappointment. Tech company Intel is a cautionary tale: the company had a great run as global PC penetration grew, and as it slowed it turned its focus to data center chips. But that wasn’t enough to offset stagnant PC sales leading the company to miss analyst estimates for years.

Intel’s revenue missed forecasts for years…
Intel’s revenue missed forecasts for years…
… and so did its annual profits
… and so did its annual profits

As the charts show, 2012 was when reality began to bite for Intel. And since then its stock has underperformed other US chipmaker stocks by over 470%.

Intel’s stock vs. US semiconductor index
Intel’s stock vs. US semiconductor index

That fate could await Apple as reality collides with the company’s high hopes. Of course, Apple’s such a big component of the US stock market that its drop could drag down the average of all stocks, hurting your portfolio even if you’re not a direct investor in the company.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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