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For Apple Inc. Stock, It’s All About Growing Services

Having delivered a spectacular quarter and fiscal 2017, Apple Inc. (NASDAQ:AAPL) is planning an even bigger Christmas rush for its Apple X and Apple 8 phones, as well as its Apple Watch. This has propelled the AAPL stock price to record levels and pushed Apple’s market cap to almost $900 billion.

For AAPL Stock, It's All About Growing Services
Source: Shutterstock

But investors need to take their eyes off the product in looking for growth.

Revenue for the fourth quarter of Apple’s fiscal year came in at over $52.6 billion, up over 10% from the previous year. Christmas season revenue is expected to top $85 billion, with $3.75 per share of profit, which would be over $19 billion.

Apple will need to deliver to justify its present market cap. The AAPL stock price is up 51% so far in 2017, and the price to earnings ratio is approaching the market average at 19, which itself is much higher than normal.

Meanwhile, no matter what it does in production and marketing, pressures against Apple are building.

The Tax Man

The biggest threat to growing profits, and thus shareholder equity, is taxes.

Apple insists its tax rate on foreign earnings is 21%, and its effective rate in the U.S. is the statutory 35%. But the so-called Paradise Papers claim Apple has moved most of its profit out of Ireland to other tax havens to build a cash hoard that now totals $252 billion, about the gross domestic product (GDP) of Chile or Pakistan. Apple’s 2017 revenues were greater than the GDP of Vietnam.

Companies as big as countries need an infrastructure to match. Apple’s new “spaceship” headquarters is bigger than many national capitol buildings, but it is not a country. Apple is a company subject to real countries’ laws, and it is facing an international political backlash of unknown size.

While new products have given Apple a great 2017, those are already priced into the stock. As Tim Biggam notes, Apple stock may already be priced at perfection.

The Next Catalyst for AAPL Stock

If Apple is to keep growing, then its service revenue must keep growing, and it must create new services to keep that growth going.

For all of 2017, services were up 34% to a run rate of $34 billion per year. This is the real miracle CEO Tim Cook has created. By investing cash in cloud, Apple has created a business that is twice as big as the iPad and bigger than the iMac. Services could be over 20% of revenues in 2018.

That has been achieved with me-too services like apps and music. If Apple had services others couldn’t duplicate, the stock might be worth buying. Right now, it’s betting on augmented reality (AR), which you may have first noticed in 2016 through Pokemon Go.

The Apple X has a complete view of time, space and who is using it. Some analysts consider the X to be well ahead of competing technologies from Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOGL), meaning the client side of creating true AR-based services is done. As the technology of the Apple X rides the cost curve down, Apple should stay ahead.

Apple may try to accelerate consumer adoption with an AR headset, and it has a complete developer framework for creating AR services, but the question remains, what money-making services will result?

The Bottom Line on AAPL Stock

The big risk with AAPL stock is that such services may not come out, or that they may not deliver the 25% margins Apple is accustomed to.

In the past, Apple products and services were easy to understand, because there were real-world analogs to what it was doing — phones, music and TV. Today, it is going where only science fiction has gone before. Can it succeed there, and quickly?

If you buy AAPL stock today, you’re betting that it can.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance, The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he owned no shares companies mentioned in this story.

Article printed from InvestorPlace Media, https://investorplace.com/2017/11/apple-its-all-about-growing-services/.

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