Today’s Headlines: Is Apple In Transition?

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Today’s Headlines: Is Apple In Transition?
February 2, 2016

Taking a Bite out of Apple

Stockholders of the once golden Apple (NASDAQ: AAPL) have been taking a beating of late. Since May of 2015, the company’s stock has lost over one-quarter of its value. Sales of the latest iPhones have been relatively sluggish, and the combination of a strong dollar and slowdown in China's economy has taken a huge bite out of Apple’s equity value.

The near future doesn’t look much better. This week, Apple disclosed that the company expects their first decline in quarterly revenue since March 2003. First quarter revenue for 2016 is predicted to reach $51.5 billion, which would be an 11% drop from the first quarter of 2015. Apple's projections were lower than the $55.4 billion predicted by Wall Street analysts.

Some investors believe Apple is now so large and mature that it should be considered a dividend-producing value stock, rather than a growth stock. Basic math says Apple must hit that point eventually, as perpetual double-digit growth is unsustainable. So the question for many is: has Apple finally reached that point in its evolution? And if they have, it that necessarily a bad thing?

When $75.9 Billion in Earnings Just Isn't Enough

Because of its size and reputation, Apple's bar for growth is set enormously high. In spite of all the pessimistic talk, Apple did rake in a record $75.9 billion in income, a 1.7% year-over-year increase. Corresponding profits were $18.4 billion, also a quarterly record.

Unfortunately, this was below Wall Street expectations of $76.6 billion in revenue. Apple's stock price dropped from a pre-announcement price near $100 to fall as low as $92.80 the next day. It closed the week on a rally and stands at $97.34 as of this writing. Apple's market cap has fallen to $521.7 billion, putting it within striking distance by Alphabet (NASDAQ: GOOGL) to overtake them as the largest company by market capitalization. Alphabet's market cap is currently listed at $508.6 billion and the stock is slowly rising.

It doesn't mean all that much in the broad financial picture, but the psychological effect of Apple being surpassed as the largest company could be significant to investors. They could conclude that Apple's glory days are over.

Where Does Growth Come From?

The products Apple introduced in 2015 simply didn’t have the "wow" factor of many previous new products. Apple Watch does not appear to be a growth driver, and resistance from larger retailers is blunting the acceptance of the Apple Pay mobile payment service. Newer iPhone models 6S and 6S Plus offer a few new features, but nothing groundbreaking, and they are generally considered a stopgap until the release of the iPhone 7 in the fall of 2016. Moreover, while the latest iPad releases — the oversized iPad Pro and diminutive Mini 4 — were well received by technology critics, they aren’t causing any stampedes by consumers.

Since Apple has begun a pattern of alternating their iPhone releases between incremental improvements and those with technological advances that drive people toward upgrades, the iPhone 7 and its variations may well be the next growth driver. Apple is also rumored to be releasing a 4" iPhone model that can provide a lower-cost, high-battery life alternative to the larger 6 and 7 series models, although it is unclear where this fits into the overall strategy. It is unlikely to be priced low enough to tap into emerging markets.

Smartphones currently provide 68% of Apple's revenue, but Apple's services sector may hold the key to future growth. Just as Apple transitioned from primarily computer sales to phones and mobile devices, the next transition may be to services that may diverge from sales of corresponding Apple devices. For example, can Apple Pay establish the same sort of niche as iTunes while being limited to Apple devices? If not, can the growing Apple Music and Apple TV services pick up the slack?

The Transition to Value

If growth flattens out, Apple is still positioned well to become a value stock. Most quarters result in at least $20 billion in income, and the company has approximately $216 billion in cash reserves to get it through such a transition. During the last quarter, Apple paid out over $9 billion to investors through dividends and share repurchases, and the company could certainly continue to provide healthy returns with their available cash.

Such a transition would be a gradual shift spurred by widespread investor perception that Apple has settled into the value category. They will be selling the stock, driving the price down until value investors pick up the slack. It has happened to Apple before, such as the 2013 period when FTSE Russell determined that Apple no longer met the criteria as a pure growth stock and split Apple between the Russell Growth Index and the Russell Value Index. The success of the iPhone 6 one year later persuaded Russell to place Apple back into the purely growth category.

Much is riding on this year's iPhone introductions. If they fail to impress, the balance will tip more toward a value-stock assessment, since it will logically take any of the service segments several years to pick up the slack created by consecutive underwhelming iPhone releases.

The Takeaway

Whether or not you consider Apple a growth stock may depend on your definition of acceptable growth. Their future annual growth probably lies somewhere between the 2% quarterly growth observed in the last quarter and the 28% growth of the previous fiscal year, and maybe closer to the 2% in the short term. There is not much evidence to suggest a short-term return to double-digit growth.

If you are wearing your value stock hat, opportunities to buy should be coming up in the next few months — if you don't consider the current price as a value option. Anticipation, and likely the stock price, will build once the features of the iPhone 7 and any lower cost alternative come more into focus.

Those wearing the growth stock hat are looking for evidence that the upcoming iPhones have enough features that are likely to entice upgrades, and for indications that the Apple Watch or the service sectors are gaining enough traction to drive growth.

Apple must eventually transition into a value stock, but the only question is whether the current market is the beginning of that transition or a temporary dip in growth between major product improvements — not an unfamiliar pattern for Apple stockholders.

In either case, Apple is still a strong company with premier products, a loyal customer base, and more than a billion active devices in the marketplace. Whether you consider it a growth or a value stock, most analysts still consider Apple a good buy. The question is: does it fit into the growth or value part of your portfolio? You'll have to answer that question for yourself based on your growth requirements and risk tolerance.

[Editor’s Note: The editor is long on Apple]


Photo ©iStock.com/Bosca78

  Conversation   |   10 Comments

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Steffanie | 02.02.16 @ 18:12
I personally prefer Apple so I will continue to help them grow. Interesting to see how they are doing in the market too.
Carla Truett | 02.02.16 @ 18:14
I think Apple will always do well and will always bounce back if it dips.
Irene | 02.02.16 @ 18:14
I think Apple will be fine, people still line up to buy their products
Erin | 02.02.16 @ 18:14
I do not like Apple products, so I can't say I'm really upset about this. It's not like they're gasping their last breaths though either. The profit they make on their products will keep them in good stead for decades to come.
Jackie | 02.02.16 @ 18:15
Apple is my computer of choice. I like their customer service.
Bobbie | 02.02.16 @ 18:16
I love my apple products, and I feel that they are very well made. My issue is that they keep out dating the software on older models, that still work perfectly fine. Apple will be around for a long while and I can;t wait to see how they grow.
Heather | 02.02.16 @ 18:17
Even without Steve jobs I think Apple is innovative enough to keep growing. They have a very loyal fan base.
Elaine | 02.02.16 @ 18:18
I enjoy everything Apple so far, so I hope they continue on their growth.
Amanda | 02.02.16 @ 18:19
I have and use Apple, but other companies are reaching to their levels and exceeding them now. Apple has been the giant for years but like everything you can't always win or be on top. I'm sure Apple will be just fine with the billions of dollars they will still rack in.
Christina | 02.02.16 @ 18:20
Apple is going to have to keep working hard to keep its reputation as a leader in new tech... the competition is fierce, and in some cases, far more affordable and practical.
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