Beware of Falling Apple No Matter How Fast Service Revenue Grows

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street.

The market’s mood always revolves around Apple Inc. (NASDAQ:AAPL). Next week, we’ll see how well that mood holds up when we observe the corporate reality behind it.

Apple CEO Tim Cook is an accounting genius. I will be shocked and a little horrified if the company misses detailed guidance when it reports its quarterly numbers on Tuesday, Jan. 28.

I’m simply no longer convinced that hitting the target will be enough to move the fundamental needle. Apple has stalled. And no matter how bullish the analysts get, everyone on Wall Street can do the math and see.

Suspension of Disbelief

While Apple is a fantastic company, that’s no guarantee that the stock will soar from $330 to $400 in the immediate future to generate another $400 billion in market capitalization along the way.

That’s what “superbull” analyst Dan Ives at Wedbush is telling his clients to expect. He says it’s all about the 5G phone upgrade cycle.

But dig a little deeper and the argument gets thin. This might be the best iPhone sales year ever… and it won’t move the bottom line far enough to justify the Wedbush target.

After all, we’ve been told Apple is all about services now. Tim Cook now plays down hardware sales because the global phone market has peaked. The business model is focused on squeezing more revenue out of everyone who already owns an iPhone.

Paradoxically, even a windfall iPhone year will reveal that a pivot to services isn’t working fast enough on its own to take Apple to $400. The company still lives and dies on selling devices, with the iPhone accounting for 65 percent of hardware revenue.

If the 5G transition triggers 231 million people to buy new Apple phones, overall revenue in 2021 might jump $30 billion beyond what Wall Street currently expects. Such demand would be enough to raise the top line by 18 percent that year.

Exclusive  Flip-Flopping Fed Triggers Broad Market Sell-Off

You only get one 5G transition. After that one-time bump, phone sales once again will start declining as people around the world decide that the devices they have are good enough to use until they wear out.

And that takes us back to services. Apple currently derives 19 percent of its revenue from streaming media, phone payment, software and other add-on businesses. This business is ramping up a healthy 18 percent a year.

Unless that growth rate accelerates dramatically or hardware sales go over a cliff, it’s going to take until at least 2029 for the company’s center of gravity to shift from device sales to these new recurring business lines.

That’s an eternity for Wall Street. Maybe Tim Cook has figured out how to speed the process up, but it’s the reality of what the numbers tell us now. This is not a service company. It won’t be a service company for a long time, maybe another decade.

Until then, Apple will remain a prisoner of its own historical success in creating and then saturating the phone market. Just about everyone on the planet who wants an iPhone and can afford it now has one. Demand has more or less stabilized.

If Apple were a smaller company, Tim Cook could spend a decade making the service pivot and Wall Street would cheer. But here, even 18 percent growth for services only turns into $7 billion a year in incremental revenue when stretched across the $1.4 trillion conglomerate as a whole.

This is still pocket change and will be for years to come. That’s a problem.

What About the Here and Now?

Say Apple hits its numbers next week and jumps another 20 percent to ring that $400 bell. At that point, the company will command an aggressive 29X forward earnings, which is a lot to pay for a company where profit is inching up 3 percent this year and up to 9 percent in 2021.

Exclusive  Investing in High-Yield Alternative Asset Classes in a Fed-Strapped Market

Maybe the 5G revolution will give Tim Cook that $30 billion sales windfall next year. That’s enough to boost the profit growth trend close to 30 percent for that year only. Only in that scenario will the 29X multiple be justified.

After that, however, the company will be back where it is now, fighting to compensate for a stagnant phone market by spawning new and more vibrant businesses. Those new businesses are expensive to develop.

Look at the new Apple TV+ platform. In theory, it will ultimately become a profit center. For now, however, developing the shows will be a billion-dollar drag on the bottom line. Even revenue will be grudging as long as iPhone buyers get the service for free.

For all practical purposes, Apple TV+ is an extremely expensive way to give potential phone buyers a $60 rebate. Amazon.com Inc. (NASDAQ:AMZN) gets away with that because the shows feed into the existing $12 billion Prime ecosystem. Apple won’t see the cash until we’re within sight of 2021.

And in the meantime, Tim Cook will need to keep buying back his own stock to boost the per-share numbers. This is what he does. He’s a genius at it.

This year alone, buybacks turned what would otherwise be a sluggish 3 percent net income growth into a 10 percent expansion when translated into earnings per share. Next year, Wall Street suspects that Cook will reduce the Apple float enough to add another 10 percent to the growth curve.

The problem with that, of course, is that as your stock appreciates, every share you buy back gets more expensive. Here at $330, that 10 percent per-share growth bump might cost Cook $115 billion. At $400, he’ll need to find another $30 billion to accomplish the same goal.

Exclusive  Will Washington’s Elite Shoot the Messenger Before the Economy Shifts?

That’s not going to happen. Even a 5G boom isn’t going to generate that much extra profit. Apple can’t go up much more without straining its once-immense cash reserves or cutting back on buybacks.

If your models rely on big buybacks while we’re waiting for service growth to move the needle, that’s not a great proposition.

We can love the company and its products without buying its mature stock. I’ve launched a new IPO service to hunt the dynamic Apples of tomorrow while they’re still small enough to make a difference in your portfolio.

And if Apple loses its shine next week, rest assured that my 2-Day Trader subscribers will be in position to capture the downside. We short the NASDAQ in that service all the time and, when Apple slips, the whole market shudders.

Join me for the Orlando MoneyShow, Feb. 6-8, at the Omni Orlando Resort at ChampionsGate. I will be speaking on Friday, Feb. 7, 3:00 p.m. about The Stealth Value Investor: Ten Amazing Dividend Yield Plays Flying Under the Radar. On Saturday, Feb. 8, I will talk at 5:15 p.m. about Identifying the Real Future GameChanger Stocks: Ten Companies Positioned to Double — Even if the Bears Take Over Wall Street. Other investment experts who will be speaking include retirement and estate planning specialist Bob Carlson, income and options expert Bryan Perry and world-traveling, free-market economist Mark Skousen, who leads the Forecasts & Strategies newsletter. Register by clicking here or call 1-800-970-4355 and mention my priority code of 049252.

Like This Article?
Now Get Mark's FREE Special Report:
3 Dividend Plays with Sky-High Returns

This newly-released report by a top-20 living economist details three investments that are your best bets for income and appreciation for the rest of the year and beyond.

Get Access to the Report, 100% FREE


img
previous article

Small-cap telecom stocks offer the potential to outperform industry giants and now might be a good time for investors to look beyond the biggest names. The tendency for small-cap telecom stocks to grow faster than large ones is a big driver of stock prices, since its simply more practical for a small company to grow exponentially. Every company with a $100 billion market capitalization first began a $10 million company, an

PREMIUM SERVICES FOR INVESTORS

Dr. Mark Skousen

Named one of the "Top 20 Living Economists," Dr. Skousen is a professional economist, investment expert, university professor, and author of more than 25 books.

Product Details

LEARN MORE HERE

Bryan Perry

A former Wall Street financial advisor with three decades' experience, Bryan Perry focuses his efforts on high-yield income investing and quick-hitting options plays.

Product Details

LEARN MORE HERE

Jim Woods

Jim Woods has over 20 years of experience in the markets from working as a stockbroker,
financial journalist, and money manager. As well as a book author and regular contributor to
numerous investment websites, Jim is the editor of:

Product Details

LEARN MORE HERE

Bob Carlson

Bob Carlson provides independent, objective research covering all the financial issues of retirement and retirement planning. In addition, Bob serves as Chairman of the Board of Trustees of the Fairfax County (VA) Employees’ Retirement System, which has over $2.8 billion in assets.

Product Details

LEARN MORE HERE

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street. Since 2010, Hilary's financial publications have provided stock analysis and investment advice to her subscribers:

Product Details

LEARN MORE HERE

Jon Johnson

Jon Johnson's philosophy in investing and trading is to take what the market gives you regardless if that is to the upside or downside. For the past 21 years, Jon has helped thousands of clients gain success in the financial markets through his newsletters and education services:

Product Details

LEARN MORE HERE

DividendInvestor.com

Used by financial advisors and individual investors all over the world, DividendInvestor.com is the premier provider and one-stop shop for dividend information and research.

Product Details

Popular tools include our proprietary Dividend Calendar, Dividend Calculator, Dividend Score Card, and many more.

LEARN MORE HERE