Apple: Unlikely to outperform the market in the future (NASDAQ:AAPL)

Shahid Jamil

Although we believe that Apple (Nasdaq:AAPL) will continue to be a very strong business for a long time, we see more and more signs that it will struggle to outperform the market going forward. There is no doubt that Apple shareholders have been good over the past decade, more than tripling the S&P 500 index (TO SPY), however we believe the company is unlikely to outperform the S&P 500 by any significant amount over the next ten years.

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YCharts data

The company has already stopped disclosing the number of units for devices like iPhones, Macs, etc. some years ago. Our interpretation is that it meant that growth would always come more from increasing prices than from selling more devices. While both strategies can generate significant revenue growth, we believe higher pricing results in less sustainable growth, as it starts to have a significant impact on unit sales at some point. In other words, consumers will only pay so much before switching to another brand.

A big source of growth in recent years has been the services business, which achieved $19.2 billion in revenue and more than 900 million paid subscriptions in the September quarter. He even pointed out in his most recent earnings call run how it’s already the size of a Fortune 50 company by itself and has nearly doubled in the past four years. Its growth, however, is slowing, with the business growing only about 5% over the previous year. There was about a 600 basis point negative impact from foreign exchange, so you can argue that constant currency growth is closer to 11%, but even that growth rate isn’t that impressive.

Meanwhile, the previously hyper-growth segment of Wearables, Home and Accessories saw revenue grow only about 10% year-over-year; the iPad was down 13% year over year. Overall, Apple had revenue of $394 billion in fiscal 2022, which equates to about 8% annual growth, and its diluted earnings per share grew only slightly faster at about 9%. In addition to relatively disappointing growth, the company has opted not to provide revenue guidance for the upcoming quarter, other than to state that the company’s total year-over-year revenue performance will experience a slowdown during the December quarter compared to the September quarter. .

With growth slowing for the company and with a rich valuation that we will consider in the analysis below, we believe that unless the company can find a new disruptive innovation that can move the needle, much will likely underperform the market over the next ten years.

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We don’t think there’s much room for margin improvement for Apple. The company was even showing a trend of declining operating margin before the Covid crisis.

Apple finally benefited from Covid as travel, dining and other leisure activities were out of the question and many people decided to spend their discretionary income on a new device, like a new iPhone. This increase in revenue has led to operating leverage, which is the primary reason we’ve seen profit margins improve.

While there may be operating leverage in the future, it could be countered by rising component costs and other inflationary impacts.

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YCharts data

Growth

The impact of Covid can be seen quite clearly in the revenue chart below, and it’s also clear that growth has started to moderate significantly. As for the core product, iPhone growth slowed by just 10% in the recent quarter, compared to overall growth of 39% in fiscal 2021.

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YCharts data

Growth has cooled markedly for the company as a whole, with revenue growth of about 8% for 2022 below the company’s 10-year average. It can be argued that Apple has seen bouts of weak growth before, only to see growth rekindle. What has changed is that now the revenue base is huge, so any product or service is going to have an incredibly difficult time moving the needle. As for inorganic growth, the company is already making numerous acquisitions, averaging about one per month during fiscal 2022.

Also, there doesn’t seem to be any disruptive innovation in the pipeline, other than perhaps the Apple Car, which certainly could be important enough to really contribute to growth in a meaningful way.

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YCharts data

The Apple Car or “Project Titan”

Our impression of Apple is that of a company incredibly talented at delivering incremental innovation. Of course it also has a history of disruptive innovation, with the iPhone arguably the prime example. However, it has been a long time since the company introduced a revolutionary new device. Apple seemed to be playing it safe in recent years by making incremental improvements to its existing product lines.

One potential disruptive innovation that has been making a lot of noise is the Apple Car, otherwise known as “Project Titan.” If successful, we believe this is the kind of innovation that could actually allow Apple to reignite growth and outperform the market. It doesn’t look like that will happen anytime soon, however.

Analyst Ming-Chi Kuo, who has a reputation for accurately disclosing Apple product launch plans, says he wouldn’t be surprised if the Apple car doesn’t launch until 2028 or later, and that it might not even be a competitive product. It’s becoming clear that Apple has relatively little to show for this effort so far.

Balance

At least Apple has a rock-solid balance sheet that can provide the flexibility to pursue attractive acquisitions or invest heavily in R&D. This is despite huge amounts of capital being returned to shareholders via share buybacks.

Apple ended the quarter with $169 billion in cash and marketable securities and $120 billion in total debt. As a result, net cash was $49 billion at the end of the quarter as the company continues to make progress toward its goal of becoming net cash neutral over time.

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YCharts data

Assessment

If the initial valuation were low enough, perhaps Apple’s stock would have a good chance of outperforming the market, even if the company offered relatively little growth. Unfortunately, the current valuation is relatively expensive, with an EV/EBITDA of ~19x, significantly higher than its 10-year average of ~12.7x.

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YCharts data

P/E ratio tells the same story, currently around 24x, much more expensive than the 10-year average of ~18.8x. For comparison, a decade ago stocks could be bought at about half the p/e ratio. Between the multiple expansion and growth of the company, shareholders have reaped great benefits.

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YCharts data

Other signs that valuation is now much more challenging include a dividend yield that is less than half the 10-year average and a net common payment yield (which includes dividend yield and repurchase yield) about 2% lower than the 10-year yield. average.

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YCharts data

If earnings growth was expected to accelerate, the high valuation could perhaps be justified. Analysts, however, have very low expectations for earnings growth over the next two years, as can be seen in the table below.

Apple EPS estimates

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Risks

We believe Apple is a very strong company, and it certainly has an impressive balance sheet and strong profit margins that mitigate risk. We believe the most important risk for Apple shareholders is that they may underperform the market due to a high initial valuation and slowing growth.

It also has significant competition that shouldn’t be dismissed outright and that could take market share away from the company. In particular, we believe investors should keep an eye on Samsung Electronics (OTCPK:SSNLF) and Xiaomi (OTCPK:XIACY).

Conclusion

We’re seeing signs that growth is slowing at Apple and that new disruptive innovations will be needed to reignite high growth and have a good chance of outperforming the market over the next decade. The Apple Car could be one such product, but so far it seems the company doesn’t have much to show for the effort. In terms of valuation, the shares are trading at valuation multiples above the average for the past decade and will also help make it difficult for the company’s stock to significantly outperform the market over the next decade.

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