Apple (NASDAQ:AAPL) took five and a half years to go from a $500 billion to a $1 trillion company. Now, investors will expect AAPL stock to double in less time, ratcheting up the expectations in the months and years ahead.
Here are what I consider the pros and cons of owning AAPL stock under this intense scrutiny.
Pros of AAPL Stock
Accelerating Growth: Stocks generally move higher on sales and earnings growth. When that growth is accelerating, the share price generally increases at an accelerated rate as well.
Over the past six quarters, Apple’s revenues have gone from 3% year-over-year growth to 17% in Q3 2018. Meanwhile, earnings grew by 4.9% in Q2 2017; in Q3 2018, they rose by 32.1%, thanks in large part to a lower tax rate.
By comparison, its operating income grew 17.1% in the latest quarter compared to slightly less than 1% in Q2 2017.
No matter how you look at it, the business is operating very efficiently.
Higher Margin Businesses: To keep earnings accelerating, Apple’s got to continue growing its services revenue. So far it’s done just that, generating $9.5 billion in revenue from services in the third quarter, a record, and double what it did three and a half years ago.
Fast Company recently reported that the services business has gross margins in the mid-50% area, with room to go even higher. Given its overall gross margin was 38.3%, the more revenue Apple can grind out of services, the better for AAPL stock.
Warren Buffet Owns a Big Chunk: There’s nothing quite like the Warren Buffet seal of approval.
Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) upped its Apple holdings by 5% from April through June and now owns 252 million shares of AAPL stock worth $52.2 billion — or 27% of the assets listed on the company’s latest 13F.
As long as Buffett’s buying AAPL stock, it should continue to do well.
Cons of Apple Stock
Too Much Debt: Investors love to talk about how much cash Apple has — it had $244 billion as of the end of the third quarter — but they rarely admit that all the buybacks it’s made since initiating a dividend and share repurchase plan in 2012, have been paid for, in part, with borrowed funds.
Back out the $97 billion in long-term debt, as well as $46 billion in other non-current liabilities and you’re left with net cash of $101 billion, about the same amount as the $100 billion buyback plan announced in May.
Once upon a time, Apple had no debt. I’d be a lot happier if it revisited the good old days.
Legal Troubles: I’m not going to pretend to understand the ins and outs of the company’s royalties spat with Qualcomm (NASDAQ:QCOM). However, if the forensic accountants at CFRA Research are right about Apple putting aside far less each quarter to pay for future royalties it will have to pay Qualcomm, it’s going to have a potentially material effect on its profits.
“Apple’s operating performance and reported financial results likely have benefited from Apple accruing Qualcomm royalties at the amount Apple itself believes it ultimately will pay — if it prevails in litigation — as opposed to the amount Apple historically paid Qualcomm,” CFRA analyst Nicholas Rodelli recently stated.
That’s not a small amount when you consider a 75-basis point hit to gross margins in Q2 2018 would have cost Apple $400 million in gross profits.
That’s a lot of stock it could buy back.
No Home-Run Product: Since Tim Cook has taken command of Apple, he’s done an excellent job delivering shareholder value. What he hasn’t done is develop that “hit” product that will supplant the iPhone as the company’s biggest moneymaker.
As a result, it continues to up its research and development costs — $3.7 billion in the third quarter or approximately 5.1% of revenue, $760 million more than last year — with very little to show for the increased investment.
I don’t think it’s an issue, but it’s something to keep an eye on.
The Verdict on AAPL Stock
Of the cons I’ve listed, the debt troubles me the most. A company that generates $58 billion in free cash flow doesn’t need to carry any debt.
That said, I continue to be a fan and could see AAPL stock hitting $400 over the next three years.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.