Technology juggernaut Apple Inc. (NASDAQ:AAPL) had quite a week last week. Apple stock hit all-time highs last week and is also having a stellar start to 2017 — it is up more than 20%. Also last week, billionaire investor Warren Buffett detailed that Berkshire Hathaway Inc. (NYSE:BRK.B) had accumulated 76 million Apple shares worth about $17 billion, or 2.5% of all Apple shares outstanding.
That is about as good as it gets for a company, and is all the more impressive given Apple sports a market capitalization of approximately $733 billion.
It is often suggested Apple could be the first company to be worth over $1 trillion. The problem is that AAPL generates so much cash, it’s easily able to buy back billions of dollars of its own stock. Last quarter alone, the company bought back $10.9 billion in Apple stock.
But what’s up next for Apple stock?
The Bull Case for AAPL
In his morning talk with CNBC last week following the release of his annual shareholder letter, Buffett said he found that Apple has a sticky product, suggesting that millions of customers around the world find its products an indispensable part of their day. It echoes his sentiments about soda, candy and auto insurance where people buy the product as part of their daily lives. Few can question the Oracle of Omaha’s investment savvy.
During the quarter, Apple experienced the strongest revenue growth in the Americas and Japan. China-based sales fell 20% versus the fiscal first quarter of last year, but the strength of global iPhone sales helped offset the weakness. Service revenue also jumped 18% to $7.2 billion and could soon account for 10% of the total top line.
Total quarterly sales came in at $78.4 billion for respectable year-over-year growth of 3%. Net income actually fell slightly versus last year, but those share buybacks helped save the day and sent diluted earnings per share up a couple percent to $3.36. Management said this was the highest quarterly profit in its history.
Apple stock now trades at a forward price-to-earnings of 15.7, which is still below the market average of 19.5. Though still reasonable on a relative basis, the valuation is getting above Apple’s five-year average P/E of only about 13.5.
The quick rise is only a mild concern at this point.
The Bear Case
Thinking of the potential downside in Apple stock, it’s admittedly difficult to envision a scenario where customers abandon the firm’s products altogether. However, the fact that most sales stem from hardware (mostly iPhones, but also iPads and Mac computers), there is precedent for it.
Motorola, Nokia Corp (ADR) (NYSE:NOK) and Blackberry Ltd (NASDAQ:BBRY) phones were once thought to be undisputed leaders in the mobile device space, yet fell heavily out of favor when a new, more popular phone emerged.
Loyal shareholders, including Buffett, don’t expect Apple to lose its devout following any time soon. And lucrative service revenue helps diversify the hardware revenue stream. Competitors have also had plenty of time to out-innovate Apple, but can’t collectively manufacture devices as dependable or software as intuitive as Apple engineers.
Bottom Line on Apple Stock
The best conclusion I can come up with on Apple stock is for existing shareholders to stay put and prospective ones to stay on the sidelines. The run to all-time share price highs could suggest the stock is due for a breather, and rapid growth is highly unlikely going forward.
The valuation also is stretched based on historical P/E levels. Yet analysts project a 13.5% earnings increase between this year and next year, which will come from a combination of operational growth and share buybacks. They also expect high-single-digit sales growth in each of the next two fiscal years.
Rounding out the big-tech rivals, I think Apple is a more compelling play than either Microsoft Corporation (NASDAQ:MSFT) or Oracle Corporation (NASDAQ:ORCL). Both software players are working frantically to migrate software businesses that is quickly embracing cloud computing. Their giant legacy businesses continue to generate billions in cash flow, but are struggling to grow.
Alphabet Inc (NASDAQ:GOOGL) also is a compelling play given its exposure to online advertising and a much higher reliance on software, though it recently developed its own mobile phones to try and capture a larger share of the hardware space. It also trades at a much higher P/E that Apple stock, and the market as a whole.
As of this writing, Ryan Fuhrmann was long GOOGL.