When Call‘s (NASDAQ: AAPL) Market capitalization crosses for $ 1 trillion for the first time in 2018, few investors would imagine that the company will add another trillion dollars worth to its name over the next two years. But it happened.
The enormous run of the stock (up by 133% in the past 12 months) has brought a lot of new attention from individual investors to the already most popular tech stock. Many investors are probably wondering if there is still a sharp upturn ahead for the company, especially ahead of its 4-for-1 deeds split later this month.
That Apple is buying, holding, or selling today?
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Momentum where it counts
On the surface, Apple’s 5.7% behind-12-year year-over-year revenue growth is not impressive. But this misses the underlying story that shareholders have been so excited about.
Perhaps the most important pillar in a bulky business for Apple stock today should be its fastest-growing service business. The lucrative segment is growing as a percentage of turnover and looks set to grow after years with double growth. This is key because the segment has a much higher gross profit margin than Apple’s product sales and a more reliable revenue stream, given the recurring nature. The segment’s revenue is generated from third-party app sales and subscriptions; Apple services like Apple Pay, AppleCare and iCloud; advertising in the App Store; and other largely recurrent currents. And these growing revenue streams make Apple less dependent on the successful launch of new products.
To illustrate why investors are willing to pay a higher premium for Apple’s earnings, as their service segment becomes a larger part of their overall business, take a look at the segment’s impressive performance in the tech company’s latest venture.
- Service revenues are growing rapidly: Total services revenue increased 15% year over year in fiscal Q3. During the same period, product revenues increased by 10%.
- The segment has an impressive gross margin: Fiscal Q3 services gross margin was 67%, compared to gross margin of products of 30%.
- The segment is becoming increasingly important to Apple’s business: Services accounted for 39% of the quarter’s total gross profit, up from 36% in the year-ago period.
With the segment growing as a percentage of total revenue, and given the much higher gross profit margin compared to the rest of Apple’s business, it may help drive substantial revenue growth for the tech company in the coming years.
What about rating?
While Apple’s momentum in services is promising, here’s where the stock’s value proposition is starting to break today: The valuation is becoming difficult to justify.
Apple now has a price-to-earnings ratio of 37. To justify such a high price-to-earnings multiple, the company would likely have to grow its earnings per share at rates of around 13% to 15% annually over the next five years, after which growth only moderately declines thereafter. However, even analysts model for annual average compounded earnings-per-share growth of around 12.5% over the next five years.
While the growth prospects for Apple are strong, especially with the help of a fast-growing wearable business and an expanding service segment, the stock is likely to have a better grip at this level than a buy.
Of course, it is also worth emphasizing that selling the stock today could be a mistake. While there is always a chance that the stock may fall in the very near future (especially after such an enormous run-up), it does not seem to be grossly appreciated until the stock that shareholders will see poor returns in the long run .
