The recent history of Apple (NASDAQ:AAPL) stock has been consistent — even if trading in AAPL stock has been anything but. Investors generally have followed the iPhone upgrade cycle. As the cycle nears, investors buy Apple stock. Once it passes, fears about the seemingly inevitable end of iPhone growth dominate the coverage of the stock — and AAPL shares fall.
Indeed, Apple stock fell sharply starting in late 2012 amid worries that the company couldn’t offer much innovation beyond that contained in the iPhone 5, which launched that year. It faded in 2015-2016 as investors grew impatient waiting for the iPhone 7. And AAPL shares fell in the fourth quarter last year, not long after the launch of the $1,000-plus iPhone XS seemed to cement the fact that the iPhone’s best days were behind it.
Apple stock of course has rallied again, gaining around 31% in 2019 alone. And the bullish focus has turned away from the iPhone, to services, wearables and other offerings.
But I’ve long believed that the company, and the stock, are at significant risk from potentially declining smartphone sales. That’s still the case. And with AAPL stock hitting technical resistance, and the news surrounding the company still not quite that impressive, recent levels may in retrospect prove to be another iPhone-driven peak — even if it doesn’t appear to be at the moment.
Why AAPL Stock Fell (Briefly) After Earnings
AAPL stock didn’t get much mileage out of its fiscal third-quarter earnings beat at the end of July. In fact, Apple shares actually lost 9% of their value over the following three sessions.
To be sure, tariff and Federal Reserve concerns played a role. But given that Apple’s numbers were nicely ahead of the Street earnings per share of $2.18 beating consensus by 8 cents and revenue increasing 0.7 points better than expected — it might have seemed like Apple gave enough to offset external fears.
Perhaps it did: AAPL stock has climbed steadily since tariffs were delayed through December. It’s now back to basically the same level at which it traded before earnings. That said, from here, Q3 earnings, despite the headline beat, look somewhat concerning.
The key reason is that Apple’s earnings actually were pretty good looking close. Services revenue grew 18% excluding the effects of currency and a one-time legal settlement boost in the prior-year quarter. Wearable sales, per the Q3 conference call, increased “well over 50%” year-over-year. Revenue in Greater China, which includes Taiwan and Hong Kong, after a nearly 25% decline in the first half of the fiscal year, bounced back to a 4% drop in Q3. According to the call, sales grew in constant currency.
Those are three of the key drivers for Apple’s growth going forward. Indeed, they are three of the pillars of the bull case for Apple stock. And yet, on a consolidated basis, revenue increased just 1%. Operating income declined 8.5% against Q3 FY18.
In other words, Apple did what bulls hoped it would do. Profits (both pre-tax and after-tax) still declined.
The Hardware Problem for Apple Stock
And so skeptics, myself included, might see the quarter — and indeed, year-to-date results — as validating the bearish thesis here. There’s no argument that Apple can and will grow its services business. The Apple Watch is a clear hit and long since has left the likes of Fitbit (NYSE:FIT) in the dust. AirPods are a winner, and even the iPad has made an impressive recovery, with revenue up 15% so far in fiscal 2019.
But this still is a company with a market cap of some $950 billion. Those products would be hits for any other company. For a company this size, they barely move the needle. CFO Luca Maestri said on the Q3 conference call that wearables on a trailing four quarters basis were now the size of a Fortune 200 company. The 200th company in the Fortune 500 (which measures companies by revenue) is General Mills (NYSE:GIS), with revenue around $16 billion.
$16 billion is less than seven percent of Apple’s trailing four quarter revenue. The profit contribution may be even smaller, given that services gross margins are roughly double those of products. Again, the business grew 50%+ in Q3 — and total revenue rose 1%. Profits fell.
This still is an iPhone story, which even with a 15% year-over-year decline has driven 55% of year-to-date revenue. (That says something about just how awe-inspiring that product is in sales and profits.) And that’s still a really, really big problem.
It’s likely unit volumes have peaked, as phones last longer. Models that run on the Android OS from Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) have much greater market share internationally and will catch up in quality over time.
There might be one more demand spike when the 5G model comes out. But over half of Apple’s revenue — at least, depending on the long-term health of the iPad and the Mac business — is in decline. Q3 shows just how difficult it is for Apple, even running on all cylinders, to offset that problem.
The Trillion-Dollar Curse
And so there’s been some reticence for the market to truly jump on board the Apple story over the past year-plus. It’s really only Microsoft (NASDAQ:MSFT) that has been able to avoid the so-called “trillion-dollar curse.” That market cap level has proven to be resistance for Apple stock — and may well do so again.
Technicals aside, the trade war still can buffet AAPL stock. Apple still needs to prove it can actually grow earnings if iPhone revenues are declining. It hasn’t done so yet. And until it does, history suggests that at some point hardware-related worries will return — and Apple shares will again pull back.
As of this writing, Vince Martin held no aforementioned securities.