Apple (NASDAQ:AAPL) recently made stock market history. It beat all the challengers, topping Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), and other potential rivals to the crown. The prize? AAPL stock recently became the first equity in American history to sport a market capitalization of $1 trillion.
That puts the market cap of AAPL stock on par with the GDP of the nation of Indonesia or the entire state of Florida. Pretty heady stuff. But following great success often comes mediocrity or worse. And sadly, it looks like Apple may follow in the footsteps of other highly successful entities.
The Success Paradox
There’s a so-called jinx related to Sports Illustrated magazine covers. When a player appears on the front cover of the magazine, often his or her performance will soon go into a tailspin. Losses and injuries often follow appearances on the cover.
There’s unlikely, however, to be any dark force at work. Instead, there’s a great deal of statistical variance in human behavior. This is the basis for the idea of reversion to the mean. If something runs unusually hot or cold for awhile, it’s likely to return to a more normal level of performance. When an athlete or team gets the hot hand, and people take notice, it doesn’t necessarily imply that the players’ skills have improved; they may have just enjoyed a string of good fortune.
Similarly, the stock market has a winners’ curse of its own. Companies that rise to the top of the heap, as measured by market cap, tend to go on to badly underperform the stock market in the coming years and decades. This century’s first two market cap leaders are good examples of this trend.
In the late 1990s and early 2000s, General Electric (NYSE:GE) seemed like the perfect industrial company. Jack Welch, its CEO, had perfected revolutionary management techniques, and the conglomerate racked up success after success. But once he moved on, it soon became clear that GE had experienced an unusually good period. Its performance soon reverted to the mean, and then fell well below the baseline when the financial crisis hit. Years later, yet another new management team is still trying to mop up the ongoing mess.
The other market cap leader of note since the turn of the century is Exxon Mobil (NYSE:XOM). While XOM stock hasn’t been a disaster like GE has, Exxon’s shares have badly trailed the S&P 500 in recent years as well.
Limits to Growth
There are several factors that tend to hold back mega-cap companies. For one, size becomes its own limiting factor. A company whose revenues consistently increase 20% per year will double its revenues every four years. That’s not too hard when the top line is increasing from $1 billion to $2 billion, and $2 billion to $4 billion and so on. But once you hit Apple’s size of $250 billion per year in annual sales, even increasing them by 10% becomes a massive challenge. Businesses that generate annual revenue of $25 billion don’t grow on trees.
Apple simply can’t ride its dominant iPhone all that much farther and remain a growth company. It needs a major new revenue generator to support the next $1 trillion of market cap, which is why talk of Apple’s moves into cars, healthcare, finance, and other fields broadly separate from its core business seem so appealing.
But then there’s the matter of leadership. Many times, one visionary or masterful leader carries a company to greatness. Once that person’s time at the top ends, it can be hard for the new leadership team to keep the winning streak going. Companies become resistant to change over time as large organizations become more and more stuck in their ways. An organization like IBM (NYSE:IBM) – another fallen former market cap leader – finds it hard to keep up with smaller, more pioneering competitors. Even acquisitions often don’t help, since the young talent at the companies that have been acquired don’t want to join a behemoth where there is less room for personal advancement and life-changing stock option payouts.
What’s the Next Big Thing for Apple?
So far, Tim Cook has demonstrated competence as Apple’s leader, but not much beyond that. There’s no clear sign that Cook will be able to lead Apple into broad new growth categories.
Sure, Apple has built an appealing revenue story with its services. Wall Street is enamored with recurring revenue streams right now, and for good reason. Hardware traditionally is a brutally difficult business, while selling apps, software subscriptions, and the like leads to much more stable profits.
But services are still a small piece of the pie at Apple, and will remain that way for the foreseeable future. From 2015 to 2017, the giant’s services revenue jumped from $20 billion to $30 billion. That’s good, but its iPhone sales exceeded $140 billion. Even a 50% jump in services over two years amounts to a less than 5% increase in Apple’s overall $250 billion revenue base. And meanwhile, iMac sales have been flat in recent years, and iPad sales continue to trend downward.
AAPL Stock May Seem Cheap, But Its Best Days Have Passed
If AAPL stock is going to continue putting up great returns, it needs a big new product category. It appears to be trailing badly in smart speakers, the watch wasn’t a game changer, etc. Since Steve Jobs passed, what new revolutionary product has Apple launched?
AAPL stock should still make people some money. The stock isn’t particularly expensive, and it is in fact cheaper than it looks due to the massive cash balance. For investors such as Warren Buffett who are looking for safe places to park billions of dollars of excess capital, AAPL stock can get the job done.
But the era of life-changing returns from AAPL stock has ended. Going forward, the company is likely to produce something along the lines of 5%-7% annualized total returns, with the dividend and share buyback responsible for much of that. Without major new revenue streams – services aren’t large enough to count – there simply isn’t an easy path to ongoing double-digit returns. Apple still has a fortress balance sheet and a great brand. But without more innovation, it, too, is likely to succumb to the winner’s curse that has plagued previous stocks which achieved the largest market caps.
At the time of this writing, Ian Bezek owned IBM and XOM stock.