I am neutral on Apple (AAPL) as its strong recent performance momentum, overwhelming analyst bullishness, and formidable competitive advantages are offset by its murky near-term growth outlook and valuation multiples, which appear elevated relative to its historical averages.
Apple is the leading global consumer electronics company and is in fact one of the largest companies in the world. In addition to its dominant computer and phone products, the company also has a thriving services business that consumers access through its variety of electronic devices. These services include Apple Music, iCloud, Apple Care, and Apple TV+. The company has also been reputed to be considering switching its iPhone business model to increase recurring revenues, and is also rumored to be working on developing an electric vehicle.
In this article, I will lay out several reasons why I am neutral on AAPL stock at its current prices.
Strong Q2 ResultsFiscal Q2 results for AAPL were quite strong, with revenue up 9% year-over-year, driven by 6% growth in the iPhone business, 15% growth in Mac sales, 17% growth in services, and the remainder of its business grew by 12%. Significantly notable was the continued strong growth momentum in the iPhone business, which reflects well on the company’s ability to innovate and create exciting new features while retaining substantial pricing power. The company also had a very successful launch of its new M1-powered MacBook Pro, and now boasts over 825 million paid members of its services business, representing 40 million in growth from just the previous quarter.
Uncertain OutlookWhile Apple’s track record, formidable brand power, scale, and technological prowess boosting competitive advantages are all very impressive, its near term outlook is a bit less clear. The company is facing numerous headwinds to additional growth, including supply chain issues, a severe chip shortage, and COVID-19's economic related headwinds in its Chinese business. Additionally, Apple decided to pause sales in Russia following its invasion of Ukraine.
While analysts still expect revenue, EBITDA, and earnings per share growth to continue over the next half decade, they are likely to be at a softer rate than was previously experienced by the company. Furthermore, the fact that the company’s base becomes increasingly massive, it is increasingly more difficult to drive revenues higher. With 7.3% expected annualized earnings per share growth, and 5.4% expected annualized revenue growth through 2026, AAPL looks like it will continue to do well, but is unlikely to crush the market like it has in the past.
Stock Price Could be BetterAlthough the business is truly one of the finest in the world thanks to its competitive advantages, AAPL’s stock price – while not massively overvalued – looks less compelling than the underlying business.
Despite decent but not great expectations for its growth over the next half decade, the forward dividend yield is only 0.7%. As a result, the earnings per share growth rate, plus current yield tallies to only 8%, with the vast majority of that sum coming from growth, making the total return proposition fairly muted here. On top of that, the price to normalized earnings ratio of 22.87x is well above its 10 year average of 16.91x and slightly above its five-year average of 21.25x, indicating that the stock could be currently overvalued.
Wall Street analysts – on the other hand – appear to be quite bullish on the stock. According to Wall Street analysts, AAPL earns a Strong Buy analyst consensus based on 20 Buy ratings, six Hold Ratings and zero Sell ratings in the past three months. Additionally, the average analyst AAPL price target of $188.80 puts the upside potential at 37.22%.
Summary & ConclusionsAAPL is a very impressive company that has generated fantastic returns for shareholders over the year, while revolutionizing communications technology and consumer electronics along the way. The stock has also proven to be an excellent dividend grower, and is also buying back shares hand over fist.
While its services business is driving much of its growth right now, the numerous headwinds facing the business at the moment, combined with its stretched valuation multiple mean that total returns for the foreseeable future may be lackluster.
Overall, the company remains one of the finest in the world and its stock is very tough to bet against. However, the valuation looks a bit stretched at the moment, so investors might want to wait for a pullback in the share price before adding shares.
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