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

Flat lay of different apple products on gray background.

Shahid Jamil

While we believe that Apple (NASDAQ:AAPL) will remain a very solid business for a long time to come, we are seeing increasing signs that it will be difficult to outperform the market going forward. There’s no question that Apple shareholders have done great things more than triple the S&P 500 in the last decade (SPY) returns, but we believe the company is unlikely to significantly outperform the S&P 500 over the next decade.

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Data from YCharts

A few years ago, the company stopped the quantities for devices such as iPhone, Mac & Co. Our interpretation is that growth would increasingly depend on price increases rather than selling more devices. While both strategies can result in significant sales growth, we believe that raising the price will result in less sustainable growth as, after a certain point, it will have a significant impact on the number of units sold. In other words, consumers only pay so much before switching to another brand.

A big source of growth in recent years has been its services business, which reached $19.2 billion in revenue and more than 900 million paid subscriptions in the September quarter. In the latest Result call Management went so far as to point out that it’s already the size of a Fortune 50 company and has nearly doubled in size over the past four years. However, growth is slowing as the business grew by just about 5% year over year. There was about 600 basis points of negative impact from exchange rates, so it can be argued that constant currency growth is closer to 11%, but even that growth rate isn’t that impressive.

Meanwhile, the previously high-growth wearables, home and accessories segment saw sales grow just about 10% year over year; The iPad was down 13% year over year. Overall, Apple’s revenue for fiscal 2022 was $394 billion, growing about 8% annually, and its diluted earnings per share grew only slightly faster, at about 9%. Adding to the relatively disappointing growth, the company chose not to provide revenue guidance for the next quarter, other than to say that the company’s overall revenue performance year-over-year will slow in the December quarter compared to the September quarter.

With the company’s growth slowing down and with a high valuation that we will consider in the following analysis, we believe that if the company fails to find a new disruptive innovation, it will very likely underperform the market , which can move the needle coming ten years.

finance

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

Apple ultimately benefited from Covid as travel, dining and other leisure activities were off the table and many people decided to spend their discretionary income on a new device like a new iPhone. This increase in revenue resulted in operational leverage, which is the main reason profit margins have improved.

While there may be some operational leverage going forward, this could be offset by rising component costs and other inflationary effects.

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Data from YCharts

growth

The impact of Covid can be seen quite clearly in the sales chart below, and it’s also clear that growth has started to slow down significantly. In terms of core product, iPhone growth slowed to just 10% in the most recent quarter, compared to a 39% overall growth in fiscal 2021.

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Data from YCharts

Growth has slowed significantly for the entire company, with ~8% revenue growth for 2022 below the company’s 10-year average. It can be argued that Apple has seen streaks of weak growth before, only to see growth revived. What has changed is that the revenue base is huge now, so moving the needle for any product or service is going to be incredibly difficult. In terms of inorganic growth, the company is already making numerous acquisitions, averaging about one per month in fiscal 2022.

There doesn’t appear to be any disruptive innovation in the pipeline, either, except perhaps the Apple Car, which admittedly could be important enough to make any meaningful contribution to growth.

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Data from YCharts

The Apple car or “Project Titan”

Our impression of Apple is of a company incredibly talented at delivering incremental innovation. Of course, it also has a history of disruptive innovation, with the iPhone probably being the best example. Still, it’s been a long time since the company introduced a brand new revolutionary device. In recent years, Apple seemed to be playing it safe, making incremental improvements to its existing product lines.

A potentially disruptive innovation that has garnered a lot of attention is the Apple Car, also 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. However, it doesn’t look like that’s going to happen any time soon.

Analyst Ming-Chi Kuo, who is a Call detailed disclosure of Apple’s plans for the product launch, says he wouldn’t be surprised if the Apple car doesn’t launch before 2028 or later, and that it might not even be a competitive product. it is get clear that Apple has so far had relatively little to show for this effort.

balance sheet

After all, Apple has a rock-solid balance sheet that gives it the flexibility to make interesting acquisitions or invest heavily in research and development. This is despite massive amounts of capital being returned to shareholders via share buybacks.

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

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Data from YCharts

valuation

If the starting valuation were low enough, Apple stock might have a good chance of outperforming the market, even if the company delivers relatively little growth. Unfortunately, the current valuation is relatively expensive with an EV/EBITDA of ~19x, which is well above the ten-year average of ~12.7x.

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Data from YCharts

The price-to-earnings ratio tells the same story, currently around 24x, much more expensive than the 10-year average of ~18.8x. By way of comparison, ten years ago you could buy stocks at around half their P/E ratio. Shareholders have benefited greatly from the multiple expansions and growth of the company.

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Data from YCharts

Other signs that valuation is much more sophisticated now include a dividend yield that’s less than half the 10-year average and a combined net distribution yield (including dividend yield and buyback yield) that’s about 2% below the 10-year average.

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Data from YCharts

If earnings growth were expected to accelerate, perhaps the high valuation could be justified. However, analysts have very low expectations for earnings growth over the next few years, as shown in the table below.

Apple EPS Estimates

Alpha wanted

risks

We believe Apple is a very solid company that certainly has an impressive balance sheet and very good profit margins, which mitigate risk. We believe the biggest risk for Apple shareholders is that they will lag the market due to a high starting valuation and slowing growth.

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

Conclusion

We see signs that Apple’s growth is slowing down and that new disruptive innovations are needed to re-ignite high growth and have a good chance of outperforming the market in the coming decade. The Apple Car could be one such product, but so far the company doesn’t seem to have much to show for the effort. Valuation-wise, the shares are trading at valuation multiples higher than the average over the past decade, and will also help the company’s shares struggle to significantly outperform the market in the decade ahead.

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