The above numbers summarize Apple’s key achievements over its last four fiscal quarters (data from Refinitiv). Not holding the stock cost us a good 300 bps in 2019, and we were hoping that this would not repeat in the new year, but we have been wrong so far. Yet, we do not change our stance, and here is why.
Don’t worry: it’s our second article about Apple in a few months, but we are not becoming obsessed with the firm. We could also have written something similar about Tesla or Rite-Aid, but the world’s “true” largest market capitalization deserves a priority.
As Growth-oriented stock pickers, we aim to select holdings that we feel have a strong chance to deliver a steady, meaningful profit growth over a typical, multi-year investment horizon. Growth may come from product line or geographic expansion, innovation, pricing power, productivity gains or a strategic turnaround, but a stock’s price can’t rise durably if profits are not growing. As it happens, Apple doesn’t meet our criteria.
- More innovation is needed for iPhone sales to recover: the iPhone has long been Apple’s growth driver, but this was when every new model was truly differentiated. The latest versions only got extra cameras, a slightly longer battery life and a broader choice of colors. Granted, the iPhone 11 appears to be selling well, but this owes more to low expectations, an overdue replacement cycle and a zero-cost financing offer than its real attractiveness.
- The “wearables” segment is growing fast, but it doesn’t have the same size potential: this group, which mainly includes the Watch and the Airpods, admittedly posts a strong sales growth (+41% in 2019) but neither volumes nor price points are equivalent to those of the iPhone. The health monitoring functionalities offer an opportunity but, at this stage, they remain more a “nice-to-have” than a sales driver. Moreover, the business is increasingly competitive, which probably explains why the segment’s growth decelerated to 37% in Apple latest reported quarter. Huawei’s watch, for example, is admittedly selling in much lower volumes, but enjoying a much faster sales growth. Also, producing a high-quality wireless earphone is not as complex as designing a smartphone that will offer a smooth, user-friendly experience, and barriers to entry are thus much lower.
- The “services” segment is unlikely to provide the same growth in the long-term. Streaming can be a rather stable source of revenue, but competition will be tough as the market attracted many new players with deep pockets, including Disney. Apple’s decision to offer its streaming service for free for one year to every iPhone buyer confirms that customer acquisition won’t be easy not cheap either.
- EPS growth is mostly driven by share buy-back: just with its free cash flow, Apple can boost its EPS by about 4%, and much more if it decides to tap into its existing cash, which is as high as $100bn. However, while we always view share buy-back as a nice complement to a company’s organic growth, we don’t really like to see it become the sole growth driver, especially when the stock is trading at about 21 times forward earnings.
All in all, while acknowledging that Apple is a great, very strong company and that this may help its stock price in uncertain backdrops, we feel there are other opportunities in the US market that better match our investment criteria, and better deserve their current valuation. This, in our view, will remain even if the coronavirus threat, which is currently impeding production in China, gets removed soon.