By Bob Ciura
Apple, Inc. (AAPL) stock whipsawed after the company posted quarterly earnings. After initially dropping 2%, shares turned up 3.5% in after-hours trading, only to give up the gains and decline nearly 3% on Friday, February 2nd.
Indeed, there is reason for the market’s mixed reaction. On one hand, Apple sold fewer phones than it did a year ago. And, after a massive 32% rally in the past one year, the stock is trading well above its average valuation.
On the other hand, Apple is still generating strong growth rates. Average iPhone selling prices continue to rise, and the services business is booming. Apple also has appeal for dividend growth investors. Since Apple re-instituted its dividend in 2012, it has increased its dividend by 10% each year. Apple is one of 331 stocks in the technology sector that pays a dividend. You can see all 331 dividend-paying tech stocks here.
There seem to be good reasons for both the bullish and bearish case for Apple. This article will discuss why the tug-of-war could continue.
Earnings Overview
For the fiscal 2018 first quarter ended December 30th, Apple had earnings-per-share of $ 3.89, on revenue of $ 88.3 billion. Earnings-per-share beat analyst forecasts by $ 0.04. Revenue increased 12.7% from the same quarter a year ago, and beat expectations by $ 670 million. Apple sold 77.3 million iPhones in the quarter, which was down from 78.3 million in the same quarter last year. Apple was expected to report 80 million iPhones sold.
At the same time, average iPhone selling price increased over $ 100, from $ 695 last year to $ 796 in the most recent quarter. Analysts were forecasting an average iPhone selling price of $ 737. This could be the reason why Apple stock jumped over 3%, after initially selling off. While Apple sold fewer phones overall, the bigger-than-expected increase in average selling price indicates a more favorable shift to higher-priced models. Stronger demand for upper-end iPhones, such as the iPhone X, would be a very good sign.
Once again, Apple’s cash mountain continued to grow. Cash, marketable securities, and long-term investments hit $ 285.1 billion, which represents an all-time high. Cash and investments totaled $ 268.9 billion in the same quarter last year. Apple’s current cash pile amounts to 33% of its market capitalization. This is a huge amount of cash, which Apple can use to reward shareholders with cash returns, and invest for future growth.
Growth Prospects
Overall, Apple had a good quarter. Revenue and earnings-per-share increased 13% and 16%, respectively. Both measures hit all-time records, and going forward, there is plenty of room for growth to continue. Apple continues to be hugely popular; its active installed base of devices reached 1.3 billion in January, a 30% increase in the past two years.
Earnings growth of 10%+ each year is within reach for Apple. Consumers love their Apple devices, and are willing to pay a premium for them. Apple is the most valuable brand in the world, and as a result, the company holds tremendous pricing power. Since the iPhone business is Apple’s most important by far, the ability to sell higher-priced iPhones is crucial to future earnings growth.
Another catalyst for Apple is its booming services business, which includes iTunes, the App Store, Apple Pay, and more. Services revenue is now a $ 30 billion-a-year business for Apple. In the most recent quarter, services revenue increased 18%, the highest-growth product aside from the “other” category. Services are now Apple’s second-largest segment, behind the iPhone.
Valuation & Expected Returns
Apple is a very high-quality business, with continued room for growth. But even after its strong quarter, the stock fell over 2% after earnings. After a huge gain last year, Apple seems to be taking a breather, which is confusing since the company is still generating strong growth. One reason for the market’s cautious tone toward Apple, could be the valuation of the stock, which has expanded significantly in recent years.
Apple had earnings-per-share of $ 9.73 in the past four quarters. As a result, the stock has a price-to-earnings ratio of 17.8. At first glance, Apple does not seem to be undervalued, relative to the broader market index. The S&P 500 trades for an average price-to-earnings ratio of 26.3.
But in a different context, it is reasonable why investors might be reluctant to bid the stock up even further. In terms of its own historical average, Apple’s valuation is at a multi-year high. Apple has not traded for a price-to-earnings ratio above 18 since 2009. According to ValueLine, over the past five years, Apple has held an average price-to-earnings ratio of just 13.1.
Apple currently trades at a 35% premium to its average price-to-earnings ratio of the past five years. A reversion to the mean would negatively impact the stock. For example, if Apple reverted back to a price-to-earnings ratio of 15-16, the stock would decline approximately 10% to 15%.
To be sure, Apple will generate positive returns, from earnings growth and dividends. In the past 5 years, Apple has increased earnings at a 10% average rate, each year. A potential breakdown of future returns is below:
- 6%-8% sales growth
- 3% share repurchases
- 1.5% dividend yield
The combination of earnings growth and dividends could yield annual returns of 10%-13% each year. But even in this scenario, total returns could still be mediocre, if the valuation multiple declines. For example, if Apple’s price-to-earnings ratio declines to 15 over the next three years, contraction of the valuation multiple would reduce annual returns by 5% per year. In that case, total annual returns would be in the 5%-8% range over that time.
Final Thoughts
Apple is a fantastic business, and the company is growing revenue and earnings at impressive rates. The only significant risk for the stock moving forward, could be the valuation. While Apple is not overvalued relative to the S&P 500, it does trade at a much higher valuation than it has over the past five years. If the stock were to return to its average valuation, it could be a headwind for the stock.
Investors looking for superior returns should consider high-quality dividend growth stocks, such as the Dividend Aristocrats, which have increased their dividends for 25+ consecutive years. The Dividend Aristocrats have outperformed the S&P 500 Index in the past 10 years. Apple is not yet a Dividend Aristocrat, but there are many other high-quality Dividend Aristocrats, with lower valuations and higher dividend yields. Find them with our service Undervalued Aristocrats provides actionable buy and sell recommendations on some of the most undervalued dividend growth stocks around. Click here to learn more.
Disclosure: I am/we are long AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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