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Apple (AAPL): 2019 Top Picks' Mid-Year Update
07/24/2019 5:00 am EST
Back in 4Q18, the big story with Apple was lagging iPhone sales. The stock lost 1/3 of its value over the quarter, and at the time, investors were worried that the days of iPhone sales blowing away Wall Street expectations were in the past.
Fortunately for Apple, the company is evolving into much more than just a hardware manufacturer. During 1Q19, management introduced a slew of diversified product offerings, including Apple Card, Apple News+ and Apple TV+.
And these aren’t mere superficial rollouts – Apple is aiming to disrupt each of the industries it is expanding into. For example, the Apple Card allows users to make purchases through an app on their iPhone. That means no more credit card numbers, which essentially makes credit card theft meaningless.
The other reason we went long on Apple this year was our belief that 4Q18’s lagging iPhone sales were a blip, not the start of a new normal.
Foldable phones and 5G are both on the horizon, and each represents a much steeper technology upgrade than the mere introduction of a larger screen and higher-quality camera. And it’s not like Apple has been hemorrhaging market share to competitors, either.
The company still owns 16% of the North American mobile phone market, operates at at 40% gross margin and 30% EBITDA margin, and maintains an enormous stockpile of cash which keeps growing ($250 billion at the end of 4Q18.)
With the fundamentals securely in place and management exploring diversified revenue streams, a slight drop in iPhone sales shouldn’t be enough to turn Apple bulls into bears. Plus, the company is doing a fabulous job of monetizing its installed user base (1.5 billion active devices, 900 million of which are iPhones).
iTunes, iCloud, The App Store, AppleCare and other Service offerings have quadrupled in revenue over the last seven years to $37 billion. Apple’s Services business makes up 15% of total revenue and maintains 60% gross margins.
That’s double the average gross margin for Apple’s product lines, which means Services is disproportionately contributing to the bottom line. Management set a goal of $48 billion of Services revenue in 2020 and is currently on track to exceed that goal.
So expect broader company margins to increase, and gross profits to stabilize (as opposed to being dependent on iPhone sales). Services already makes up ¼ of Apple’s 2019 gross profits. That number will continue to grow.
Those who sold Apple during 4Q18 succumbed to broader market panic, or mistakenly perceived this company as a one-hit wonder. While the iPhone remains the core product, it is far from the only one. We believe in management’s ability to penetrate ancillary markets by leveraging the company’s formidable brand loyalty and are confident Apple will top $1 trillion in market cap in the not-too-distant future.
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