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The Pros And Cons of Apple Stock

Apple stock - The Pros And Cons of Apple Stock

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Tech stocks were among the worst-performing names in the stock market during the correction of late 2018. And Apple (NASDAQ:AAPL) stock was one of the worst-performing tech companies during that period.

For AAPL stock, it was an autumn to forget. Apple stock, whose market cap had reached $1 trillion before the correction, in short order shed $300 billion of value as the shares plummeted from a high of $233 to just $142 per share at their bottom early this January.

However, like most of the market, Apple stock has found its footing again, as the shares have rebounded about 10% off their lows. The drop to $142 was almost certainly an overreaction. At its current level, is Apple stock still a good name to buy on weakness?

The Cons of Apple Stock

Revenue Warning: Apple started the year by shocking its investors. On Jan. 2, Tim Cook released a letter that included the following statement: “Based on these estimates, our revenue will be lower than our original guidance for the quarter, with other items remaining broadly in line with our guidance.”

At first blush, that may not seem like huge news. However, it’s important to remember that AAPL hadn’t issued a revenue warning since 2002. For all its ups and downs, it never missed so badly on a phone-upgrade cycle that it had to issue a revenue warning.

The recent shortfall didn’t come totally out of the blue. Apple’s decision to stop reporting unit sales last year was a clear indicator that things were starting to go dreadfully wrong for the company.

Furthermore, the size of the miss was dramatic. On last quarter’s earnings call, the company estimated that its revenues for its December quarter would be $89 billion to $93 billion. In Cook’s letter, the outlook was slashed to just $84 billion. This shows that Apple’s management had a terrible read on the outlook of demand for its products.

China Issues: It’s not hard to see what caused the miss. In his letter, Cook noted that all of the year-over-year decline in revenues were due to falling sales in China. Analysts have speculated that Apple would struggle in China for awhile now. Unlike in most other markets, Apple’s operating system is not a killer feature in China.

Rather, WeChat is the main attraction for China’s smartphone buyers, and it runs on any smartphone. As a result of this situation, Apple’s pricey phones are falling prey to cheaper competition.

Adding to the concern, on Friday Reuters reported that key Apple supplier Foxconn is cutting 50,000 contract jobs. It’s normal for Foxconn to lay off workers on a seasonal basis as demand fluctuates. However, its most recent layoffs came months sooner than usual.

Recently, it was reported that AAPL had asked its suppliers to prepare for a 10% decline in phone production. The layoffs by Foxconn confirm that speculation.

App Store Problems: Those who are bullish on Apple stock say that the growth of the company’s services revenue will boost the shares. Wall Street loves services revenue, as it tends to consist of subscription revenue or other recurring income. That is the case for AAPL; it earns tons of recurring money from its app store.

However, AB Bernstein analyst Toni Sacconaghi thinks that AAPL could lose some of this revenue.CNBC recently described Sacconaghi’s thesis:

As part of that regular Services revenue, Apple charges between 15 percent and 30 percent of monthly subscriptions for customers who buy software via the iOS App Store, a fee that’s come to be known as the “Apple Tax.” Any time a a user buys an iOS app, a digital item within an iOS app (e.g., an ebook) or initiates a subscription within an iOS app (e.g., a New York Times subscription), Apple takes a 30 percent cut for the first year and 15 percent for all subsequent years.

Unfortunately for Apple, more and more companies like Netflix (NASDAQ:NFLX) and Spotify (NASDAQ:SPOT) are trying to avoid paying this “Apple Tax”. Given the powerful position of some of these leading apps, they can credibly threaten to leave the app store if they don’t get a much better deal.

Apple’s services segment grew 18% last quarter, with the 30% app store “tax” driving nearly half of that revenue growth. If the tax revenue goes away, AAPL will have difficulty growing its overall services revenue.

The Pros of Apple Stock

Attractive Forward Returns: I’ve been bearish on Apple stock in the past. Last summer, for example, I suggested that Apple would be a victim of the Winner’s Curse. In other words, I contended that because AAPL was the largest company in the world, it would have trouble continuing to grow.

Since I wrote that column, Apple stock has tanked. More recently, in December, I estimated Apple’s 2023 earnings per share and derived a 2023 price target for Apple stock of $233. Since the price of Apple stock was  $175 at the time, I didn’t think that AAPL was a great investment.

With the price of Apple stock now $155, however, $233 is starting to look pretty nice. If AAPL stock ends 2023 at $233, a buyer of AAPL stock today will earn more than 8% per year from the appreciation of Apple stock price. Throw in the dividend, and the investor’s annual return rises to more than 10%. That’s not a home run, by any means, but it’s a very solid performance from a relatively conservative, blue-chip stock.

Discounted Valuation: Related to the previous point, AAPL stock finally looks compellingly cheap. I’ve long criticized the stock for being overvalued, given the minimal growth prospects of AAPL. After last year’s selloff of Apple stock, however, the market has finally priced in this reality.

Down here under $160 per share, Apple stock is selling at just 13 times AAPL’s trailing earnings and 12 times its forward earnings. Additionally, the stock’s price-sales ratio has fallen under three. Since 2010, the price-sales ratio of Apple stock has only fallen below three for two brief periods; once for a few months in 2014 and for one quarter in 2016. Both turned out to be fantastic buying opportunities.

Improving Macroeconomic Conditions: I still believe that we’ll get a resolution of the U.S.-China trade war fairly soon. Recent headlines suggest that President Trump is looking for a speedy resolution to try to boost the stock market and may make concessions to get there.

A thaw in the trade war would be great news for Apple, as its recent revenue shortfall was mostly caused by slowing Chinese sales, according to AAPL. On top of that, the recovery of the stock market and the strengthened economic outlook should help bolster both Apple’s revenues and Apple stock.

The Verdict on Apple Stock

Apple’s era of rapid growth has ended. I’ve been saying that for a long time, and the market has now come to that conclusion as well. However, AAPL stock can still make you money, now that it has firmly transitioned from a growth play to a value name.

I expect Apple stock price to head back over $200 over the next couple of years. The combination of the company’s  stock buyback, its dividend, and its stable, robust cash flows is great for conservative, income-seeking investors. While AAPL stock is unlikely to deliver spectacular returns again anytime soon, it can be a solid contributor to your portfolio.

At the time of this writing, Ian Bezek held no position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2019/01/the-pros-and-cons-of-apple-stock/.

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