Apple Inc. (AAPL) is a company primarily driven by the iPhone. While many consumers think Apple has a lot more to offer, the reality is that AAPL stock derives roughly two-thirds of its revenue from its flagship smartphone.
That’s a good thing, and also a bad thing for Apple stock holders.
Since the first iPhone sales were recorded in late 2007, AAPL stock has soared over 500% while the S&P 500 is up only about 30% from those pre-recession levels.
That’s a great return in any market, but it’s particularly impressive given that the financial crisis erased so much wealth elsewhere.
On the other hand, the reliance on the iPhone means that despite some pretty impressive raw growth numbers, Apple is under pressure right now thanks to fears of a slowdown in smartphone sales.
Shares of Apple stock are off about 15% from their July highs despite fiscal Q4 earnings showing 22% top-line growth and a nice earnings beat.
So what do shareholders do in this environment? They either hope that iPhone sales snap back strongly, or they look to another growth area.
While there may not be much hope of the former scenario in the short-term given the weakness in China and other disappointing iPhone sales data, the latter case may come to pass — eventually — for Apple stock as it increasingly moves into services and software.
And leading the charge on this front is Apple Pay.
Apple Stock Looks Beyond Hardware
The margins on the iPhone are nice, but investors in AAPL have gotten addicted to growth in this hardware segment thanks to geographic expansion coupled with a strong upgrade cycle as smartphone users swap old devices for new ones.
Click to Enlarge But Apple is now so large that growth is getting much harder to come by. Heck, it sold over 230 million iPhones last year! Thinking that annual figure can double or even grow by 50% is awfully ambitious.
The answer, then, lies in software and services for the hundreds of millions of Apple gadgets out there already. The margins aren’t as grand, but if you can get a few bucks each month from each user, that will add up to real money in a hurry.
Fundamentally, this is why Apple is working with banks to develop a mobile person-to-person payment platform to rival PayPal (PYPL) service Venmo. Supplementing this with Apple Pay technology to purchase goods both online and in brick-and-mortar locations, the “Bank of Apple” could become a real player in a hurry if it just moves a tiny percentage of iPhone users over to this platform.
And the regular fees from those transactions would be a boon to Apple stock holders, and wouldn’t be subject to the same upgrade cycle challenges as the iPhone itself.
I am very optimistic about these kinds of services and software offerings from Apple given its built in user base. Products like Apple Music, which competes with Pandora (P) and Spotify, are hoping to tap into the reach of the platform and the power of the Apple brand to juice revenue; and it’s a great long-term plan even if the initial pop may not be substantial.
Bottom Line on AAPL
Look, the iPhone will continued to be the story for the forseeable future. But look at the most recent 10-K and you’ll see that the services segment is growing at a double-digit rate and could soon become the No. 2 revenue source for the company.
Services includes iTunes and App Store sales as well as Apple Pay and Apple Music, and collectively this segment taps into the platform and brand power that Apple has in spades.
Will the services segment evolve fast enough to offset recent weakness in iPhone sales? Probably not.
But before you count out this tech giant, look hard at efforts like Apple Pay and Apple Music to see what the future of Apple stock really looks like.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.
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