General Stocks | 15 Mins Read | by AG Latto
Apple divides opinion. But the group has more staying power than pundits give it credit for. While the smartphone market is mature, the Apple brand will endure.
Apple Inc (AAPL) is the world’s second-largest company with a market value of US$1 trillion. If you invest in trackers, you already own a piece of Apple.
We can evaluate Apple from both a product and an investment perspective. The two are interlinked. If Apple makes great products it will work out well for investors.
Apple's 10th September event announced the iPhone 11. It will be available in stores from 20th September.
Article highlights
- Fund Hunter forecasts that Apple's share price will hit a record high (over $232) within six months. Currently $221.
- The iPhone 11 (standard and Pro) will be a winner. (2 min video of 10 Sept launch event)
- Apple Arcade and Apple TV+ will strengthen the customer relationship.
- The sceptics have been wrong about Apple for decades and will remain wrong.
Alongside the latest iPhone, Apple is releasing an upgraded iWatch, and two new services: Apple Arcade and Apple TV+.
Apple can also be used as a marker of how fund managers invest.
It is possible to have a strongly negative view on Netflix and Tesla. It is much harder to have a bearish view on Apple and to be right.
So why bother?
Some companies reduce our ability to think rationally. Apple appears to be one such company.
Apple’s Regent Street store in London
Source: my iPhone 6s
Buffett on Apple
Warren Buffett first bought Apple in 2016 and continued buying in 2017. Shares in Apple were under US$100 for much of 2016 and are now over $220. Berkshire Hathaway is the third largest investor in the business with a 5.5% stake.
Buffett told CNBC in August 2018 that:
millions of people with loads of buying power…spend hours a day [using it]…[The iPhone] is an indispensable part of their lives. It is an extraordinary product.
I am with Buffett on this one.
Fund managers on Apple Inc
The bearish views that fund managers have on Apple jump out at you. Apple is truly a marmite stock; you love it or hate it.
Allianz Technology Trust (ATT) – no exposure. The manager stated on 6th August 2019:
we expect to see a lull in the 2019 iPhone product cycle ahead of the 5G iPhones in 2020. Furthermore, we are seeing lower demand from Chinese consumers…we see limited upside potential. As a result, we are not currently invested
This kind of thinking seems very short-term to me. Shares in Apple Inc are up 13% since ATT made the above comment.
Scottish Mortgage (SMT) – sold Apple in 2017. Tom Slater told What Investment in 2017:
the problem with Apple is that it seems to be still operating in the shadow of its late founder Steve Jobs. Of course the company makes a lot of cash now, but the question is, what has it actually created that is really new since the founder died?
This is a false narrative. Investors and consumers do well if companies focus on making good products. Creating new products just for the sake of it rarely ends well e.g. Sony. The stocks that SMT has bought instead seem much more risky with Alibaba a case in point.
Blue Whale Growth Fund – no exposure.
Apple is described as Gruesome on Blue Whale’s website (FAANG tracker). Blue Whale notes that the iPhone was 60% of Apple’s revenue in 2017. The manager argues that competitors are making better smartphones.
This argument makes little sense in my view. Apple is about the overall product experience and not whether the iPhone is the best smartphone on the market in any single year. The vast majority of consumers are not focused on which smartphone has the best hardware.
Polar Capital Trust – underweight Apple. The manager stated in July 2019:
the product-driven growth story that we fell in love with has morphed into a cashflow/financial engineering alternative with most of the bottom-line growth currently modelled coming from future buybacks.
I don't understand this argument. Just because Apple has changed doesn't mean that it isn't a good investment.
Fundsmith and Lindsell Train - both have never owned Apple
Both managers have never owned Apple. Terry Smith has argued that Apple performed well in large part due to the return of Steve Jobs. He prefers to own businesses where investors do not have to keep an eye on management.
I would personally feel a lot safer and secure owning Apple than Philip Morris, a tobacco stock held by Fundsmith.
Apple and the iPhone
From an investment perspective, Apple has been driven by the iPhone. The iPhone was launched in June 2007 and the group’s free cash flow per share has taken off since then.
Apple and the iPhone effect
Source: SharePad
The iPhone was less than 10% of Apple Inc’s revenue in 2008 but was over 50% of revenue from 2013 to 2018. In some quarters the iPhone generated almost 70% of Apple’s revenue.
The iPhone is very profitable and drives a greater share of the bottom-line that the top-line.
In the third quarter of 2019 (to June) revenue from the iPhone was 48% of total revenue - the first time that it has been below 50% since 2012. The growth of services revenue and weak iPhone sales has driven this change.
Source: statista
The iPhone will continue to drive Apple
The iPhone continues to be Apple's engine. It drives the App Store, Apple Music, iWatch, Apple AirPods and the recently introduced Apple Card.
It will be the main driver of Apple Arcade and Apple TV+. These products and services help sell the iPhone and vice-versa.
Whether the iPhone is below 50% of Apple's revenue is beside the point. It will be the mainstay of the business for the foreseeable future.
Most people need a smartphone and will replace it every two to four years.
There won’t be another iPhone-like product
The view that Apple is failing to innovate is simplistic and misguided. Apple is focused on making the best products in categories that it can win. It is also focused on making high-margin products.
A self-driving car or a TV will never be high margin products. Apple is unlikely to dominate either category. Why waste their effort in these areas?
It is simplistic thinking to imagine that Apple has to revolutionize every product category. It doesn’t make any sense.
Apple performed well since 2000 on the back of mobile devices. Designing both the software and hardware has allowed Apple to make the best mobile devices.
There are only so many mobile product categories. What else can we carry around with us on top of the iPod, iPhone, iPad, iWatch and AirPod.
There won’t be another iPhone-like product, where the potential market is everyone. It has been described as “The One Device” and is unique.
What should Apple be doing?
Apple should be reinforcing the attractiveness of the iPhone. They are doing this with ancillary products and services that include the Apple Watch, AirPod, Apple Card, Apple Arcade and Apple TV+.
Apple should also be making sure that the iPhone itself remains competitive.
The key to Apple’s success is to maintain the attractiveness of the iPhone.
Everything else is an added bonus. Apple is reportedly working on some sort of automotive technology. A virtual reality device that may debut in 2020 and would play to Apple's strength.
Apple from an investment perspective
The cult of growth is very alive with stock market investors.
Many have cut Apple because the smartphone market is no longer growing. They have also attacked a supposed lack of innovation since Steve Jobs left.
The pace of revenue growth has slowed down, but this was always inevitable. Apple was driven by the growth of the now mature smartphone market.
Apple’s use of cash
To Apple’s credit it has used excess cash flow to buy back shares. This will be a key driver of earnings growth going forward. Even large acquisitions are unlikely to dent Apple’s ability to buy back shares.
Revenue at Apple is forecast to decline 2.6% in the fiscal year to September 2019. It is then expected to increase by 4.3% in the following year and by 5.8% in the year to September 2021.
Earnings per share at Apple are forecast to decline by 2.1% this year and then increase by 9.1% in the following year. In the year to September 2021 earnings per share are forecast to increase by 13%.
Apple’s share count is in decline
Source: SharePad
The big event: iPhone launch 2019
Apple’s 10 September 2019 event was impressive. Just the iPhone line-up was enough to satisfy most Apple fans.
The iWatch series 5, an upgraded iPad and the launch of Apple TV+ and Apple Arcade were all icing on the cake.
Anyone buying an Apple device gets the Apple TV+ service for free for a year. With a subscription of £4.99 a month, this is worth £60.
Apple is often accused of being over promotional but the 10 September special event delivered the goods.
A two minute video summery of the event is available here.
The iPhone 11
The price of the iPhone X (10) was introduced in November 2017 and the iPhone XS came out in September 2018. The iPhone X came with a significant sticker price shock for consumers.
In my view, the iPhone X has been largely responsible for weak iPhone sales in recent years.
Apple came across as a high-end brand with the iPhone X, and put a lot of people off the brand. They made a hash of things.
The iPhone 11 has a base price of £729 for the 64GB model. The iPhone X had a base price of £999 back in November 2017.
Apple came out with the cheaper iPhone XR model just a year later in October 2018 at £729. But no one wants to buy an also-ran device.
I have been told the pricing for the iPhone X was related to facial recognition technology. While this may be the case, it weakened the appeal of the iPhone's franchise.
In 2019 Apple has got the branding right. The iPhone 11 is a great device at a reasonable price. Nobody needs to buy the premium iPhone 11 Pro model.
The bottom line is that the iPhone 11 will get Apple back on track. It is a significant upgrade on the camera front, with Apple catching up with rival smartphone makers.
What next?
I am told that Apple does big refreshes and new product launches every four years. Next year is year four. We should see a 5G iPhone launched in 2020 and there may be a virtual reality device.
Apple will continue to increase the number of Apple Stores with plenty of scope to grow in emerging markets. Apple is set to bring online iPhone sales to India in the coming months, and may be able to open Apple Stores in India the medium-term.
Analysts have generally sold the narrative that Apple is losing in emerging markets. But it was inevitable that low priced competitor devices would do well in low income per capita countries.
As incomes increase in emerging markets, we may see Apple’s market share improve. The key, though, is for Apple to hold its own in the West, in particular in the United States and Europe.
The Apple edge
Apple has a duopoly market position in smartphones alongside Android devices. It is hard not to sound like an Apple fanboy when discussing how the company is differentiated from rivals. I will try my best.
1) Apple Stores – These allow consumers to try out products and get advice. They offer an added extra that rivals cannot match. Apple stores host events and training sessions.
2) Hardware and software – Apple’s success in mobile devices is in no small part due to the seamless integration of hardware and software. Microsoft and Google make some devices, but third parties make the bulk of the devices that run their software.
3) A focus on quality – Apple is known for premium pricing. But it also makes high-quality devices that stand the test of time. Rival consumer electronic businesses focus on gimmicks and emphasise pricing at the expense of quality.
4) The App store – Apple closely regulates applications while the Android market place is more of a free-for-all. There is more that can go wrong on Android devices.
5) Personal data and security – Apple takes privacy and security seriously. The business model of Google is about selling personal data to advertisers.
6) Apple has excellent after-sales support - If something goes wrong you can be in contact with a call centre in Portugal or Greece on the weekend. If that fails, you can head into the nearest Apple Store for advice.
Many IT people use Apple products
My website developer is a fan of, and uses, Apple products. He describes them as much easier to use than those of rivals. If Apple products were gimmicks, we would tend to see IT professionals give them short shrift.
A product like Nurofen can be considered to be a gimmick. The generic brand alternative does exactly the same job and is a fifth of the price. No medical professionals purchase Nurofen.
You don’t have to love Apple
Apple generates strong views and is therefore a Marmite company. You don’t have to love the company or their products. The fact Apple generates strong views shows that it offers a differentiated product.
Marmite will endure because some people love it and stick with it. The same is true of Apple. While iPhone X pricing was poorly received, the iPhone 11 should broaden Apple's appeal.
Apple AirPods have been a hit and the iWatch continues to do well. Both devices make the iPhone more attractive.
Terry Smith doesn’t invest in companies that need good management to succeed. With the iPhone franchise becoming stronger, Apple Inc may meet this description.
The launch of Apple Arcade and Apple TV+ will strengthen the relationship Apple has with consumers. At least one of these services is likely to be a hit.
Apple's valuation
Apple trades on a forecast P/E of 19.1X for the current fiscal year to the end of September 2019. This is a year in which revenue and earnings are forecast to decline.
The forecast P/E is 17.5X for 2020 and 15.5X for 2021. The forecast free cash flow yield is 6.3% and 6.6% in both years. Apple doesn't look expensive.
Apple's forecast valuation ratios (year to September)
Source: SharePad
The bear case
Apple has been driven by new products but now needs to retain the appeal of its current lineup. Perhaps the shift from a Steve Jobs to a Tim Cook was inevitable.
Tim Cook was reportedly been described by Jobs as "not a product person." Given where Apple is today, he may not need to be a product person.
At the same time a lack of focus on product innovation may hurt in the long term.
Steve Jobs would spend much of his time talking to Jony Ive about products. They both had a keen interest in design and product development.
It is hard to see Tim Cook doing the same. Jony is leaving Apple because he had reportedly become disillusioned.
If Apple needs winners in new product categories to do well, this is a problem. In my view, Apple just needs to hold on to its iPhone franchise to do well.
Summary
Fund managers and commentators tend to make outlandish comments on Apple to get attention. It also helps differentiate fund managers from the benchmark they are trying to beat.
Apple will not grow as rapidly as it has done in the past, but the underlying consumer franchise remains strong. Quality should be the first port of call for investors and there is no doubt that Apple is a high-quality business.
Making stock price forecasts is a foolish business. But it is fun and garners a lot of attention. I therefore forecast that Apple’s stock price will hit a record high within the next six months (over US$232).
This is on the back of a successful launch for the iPhone 11. The iPhone X was overpriced and Apple hasn’t made the same mistake this time around.
Additional comments below.
Additional comments
1) Apple and big tobacco
Apple shares some similarities to big tobacco. The tobacco sector was written off by investors in the late 1990s and has been face with declining demand.
But tobacco stocks have performed exceptionally well in the first 15 years of this century. Tobacco companies bought back their shares and didn't try to do anything clever.
Apple is not trying to do anything clever. It is only seeking to maximise the value of the iPhone franchise. Unit sales of the iPhone may now see minimal growth or experience modest declines.
But the iPhone remains a successful and highly profitable product. Ongoing share buy-backs will help drive earnings per share.
Investors wrote off big tobacco which proved to be a mistake. Writing off Apple today may also prove to be a mistake.
2) Where can Apple go from here?
New products capture our attention. Apple's run of hit products has been based on mobile devices.
At some point we will surely run out of mobile devices? Are there anymore digital devices we can carry around with us?
Services are key going forward with Apple now having Apple Music, Apple Arcade and Apple TV+. These help make Apple products more appealing.
A virtual reality headset might be interesting. But it is unlikely to be a major hit.
Apple's main aim should be to continually improve the iPhone. The camera is where we may see meaningful upgrades down the road. It helps justify the overall cost of the device.
An Apple Car or an Apple TV would not work out well.
1) Gene Munster on Apple on 28 December 2019
Munster sets $350 price target on Apple on the basis of valuing it in-line with consumer staple companies. Munster argues a $400 target would price the company in-line with Facebook.