Apple to Hit $1 Trillion in Market Value in 2018
By Jack Hough
Photo: HitandRun for Barron's In August 2011, a couple of months before Apple was slated to announce the iPhone 4S, company co-founder Steve Jobs confirmed that his pancreatic cancer had returned. He ceded his CEO post to longtime Apple executive Tim Cook. Two days after the Oct. 4 unveiling, Jobs died. The phone, and the new personal assistant Siri, got mixed reviews, and the outlook wasn’t encouraging. But the 4S proved a hit. Fiscal-2012 earnings soared 60%, and the shares gained more than 80%.
That success created a problem of its own: the follow-up. The 4S sparked so much demand that it borrowed sales from the iPhone 5; profit fell in 2013, and the shares dropped 40% after the launch. The pattern was repeated with the iPhone 6 Plus and its bigger screen. That model was a massive seller, but was followed by another fallow period in which the stock price fell 25% from its peak.
It’s a good time to re-evaluate the stock (ticker: AAPL) because Apple could soon reach a milestone—the first U.S. company with a $1 trillion market valuation. (For a handicapping of the companies in the race, see “Apple’s Out Front, But Can It Be Caught?”) At $899 billion, Apple is easily the closest, and its iPhone X, along with a rising stream of service revenue, looks likely to get it there.
“You have to go back to Rockefeller and Standard Oil to find a company so dominant in a business so large,” says David Rolfe, chief investment officer at Wedgewood Partners, which manages $25 billion. “Other companies settle for unit sales or revenues, but in many quarters, Apple collects more than 80% of gross profit across the smartphone industry.”
One measure of its success: In its most recent fiscal year, Apple had $229.2 billion in revenue and $48.4 billion in earnings, roughly as much as the second- and third-most profitable U.S. companies, Microsoft (MSFT) and JPMorgan Chase (JPM), combined. Stock buybacks helped boost Apple’s earnings per share 11%, to $9.21.
After a 50% burst in the shares this year, will the $1 trillion figure mark a top? After all, the latest iPhone’s sales will fade next year, and the stock market is pricey. Many of the best smartphone markets look saturated or, in China’s case, tightly contested. Apple is also capable of self-induced stumbles, as Barron’s pointed out just last week (“Software Problems Bug iPhone Users”). For those who look for historical precedents, there’s Apple’s sumptuous $5 billion campus, bringing to mind ambitious buildings from Woolworth, Chrysler, and Sears that foreshadowed an eventual fall.
We don’t think the peak is near. Apple seems to be escaping its product supercycle peaks and troughs to post more-consistent year-to-year growth. That could have a lasting effect on the stock’s valuation, based on what Wall Street pays for other steady growers. Barron’s has backed Apple shares in recent years, starting at $76, split-adjusted, ahead of the move to plus-size phone screens (“For Apple, Bigger Is Surely Better,” March 22, 2014). The shares have returned 147% since then, versus 56% for the Standard & Poor’s 500.
“Apple isn’t just selling you a phone,” says David Pearl, co-chief investment officer at Epoch Investment Partners, which manages $48 billion, including a $900 million position in Apple begun 10 years ago, around the launch of the original iPhone. “It’s selling you the easiest, most elegant experience for mobile communications and computing, and its services revenue is growing faster than its products.”
Twenty years ago, things could hardly have been more different. With Microsoft Windows–based personal computers dominating the market, Apple had slumped to a 12-year trading low and was on a path toward bankruptcy. Jobs, ousted in 1985, had returned as interim CEO, promising innovation, but he badly needed cash. Microsoft chief Bill Gates, under scrutiny by antitrust regulators, stepped up with a $150 million lifeline. At the time, Apple was valued at $1.7 billion, about 1% as much as Microsoft.
The comeback that followed was astonishing. In 1998, Apple introduced the iMac, an all-in-one desktop computer with a reasonable price and eye-catching design. In 2001, the iPod music player launched, showcasing new software for organizing songs, albums, and playlists—called iTunes. That same year, the company unveiled the first of what is now 500 Apple Stores. In 2003, came the iTunes store and with it, a new business model for music: download songs for 99 cents apiece. Apple also made iTunes available to Windows users. The following year, unit sales of iPods topped those of Mac computers. If iTunes made Windows users curious about trying a Mac, Apple’s move in 2006 to Intel chips and software that would run Windows programs on Apple’s operating system got them to buy. Mac sales soared.
In January 2007, Jobs took the stage at Macworld in San Francisco to unveil “three revolutionary products,” really a single product, called iPhone, combining a touch iPod, phone, and full internet browser.
The results speak for themselves: Apple’s market value now tops Microsoft’s by more than $200 billion.
Today, Apple has an estimated 900 million customers. Many are buying services that include music streaming, movie rentals, applications, online storage, extended warranties, and digital payments. Apple’s recent purchase of Shazam, a service for identifying music clips, shows how Apple can add features to subscription services like Apple Music. Growing 23% in the past fiscal year, services account for 13% of Apple sales—and an estimated 20% of gross profit.
IPhone generates 60% of Apple’s revenue; there are an estimated 800 million active devices that provide a vast and growing base for services. A recent UBS survey of smartphone users in five key countries shows that retention rates have been climbing and stand at 85% for iPhone, versus 71% for Samsung and 78% for phones that use Android software. In other words, switching services isn’t common, but when it occurs, Apple generally wins.
Average time between iPhone upgrades has settled at two years or so for U.S. customers. The top reasons that users give for buying new iPhones are a preference for the brand and a fondness for the iOS operating system, combined with a desire to upgrade their existing models to something faster and more efficient.
“When you get down to where we are in the iPhone cycle, I don’t care,” says John Barr, manager of the Needham Aggressive Growth fund (NEAGX) and an 11-year Apple holder. “The smartphone isn’t just a product. It’s an indispensable platform for its users’ lives, where Apple continues to add value with software and services.”
This year, while not promising Siri-like gains, should be lucrative. The iPhone X brings significant new features and a different look, and so is expected to drive a better year for unit growth. Although projections have come down since the smartphone was introduced in early fall, Wall Street consensus puts iPhone sales at 242 million units, up 12%. That’s solid growth—just not the 37% leap Apple saw during its last iPhone boom in fiscal 2015. And pricing this year looks particularly strong.
Apple’s wireless AirPod headphones sold out their holiday consignments last week at the company’s retail stores and aren’t available again until January. Their popularity should drive accessory sales for Apple, which is also introducing a wireless charging pad for the iPhone, AirPods, and Apple Watch in 2018. Such “other products” generated $12.9 billion last year, up 16% and making up 5.6% of sales. Overall, Wall Street sees Apple revenue jumping 20%, to $274 billion, and earnings per share rising 24%, to $11.43, in this fiscal year.
APPLE COULD GET TO $1 TRILLION in market value over the next year because of its changing investor appeal. Its rising earnings predictability makes Apple look less like a hit-or-miss gadget maker than a seller of consumer staples, which tend to fetch high valuations for their safety and income.
Kraft Heinz (KHC), for example, trades at 20 times forward earnings estimates. It carries long-term debt equal to 28% of its stock market value—the reverse of Apple, which holds cash and investments equal to 30% of its market value. Earnings estimates for Kraft have been falling of late, while Apple’s have been rising. Food is a safer bet than electronics, or is it? Consumers have been shifting from packaged food to fresh, giving indigestion to Campbell Soup (CPB), General Mills (GIS), and others, but those same consumers are staring into their smartphones as intently as ever. Statistically, Apple’s earnings have been smoother than those of Kraft in recent years (see the table).
At the rate Apple has been gobbling its own shares, its share count could fall to five billion in a year. To reach $200 a share over that same period, or $1 trillion in market valuation, Apple’s forward price/earnings ratio must rise from 14.7 times to 16.6. It would then be priced on par with Campbell, whose outlook calls for a fourth-straight year of revenue declines. That assumes Apple will merely meet earnings estimates: It has beaten them in 19 of its past 20 quarters.
What are the risks? The most obvious is a broad stock market correction. In a recent look-ahead for investors, Bank of America Merrill Lynch recommended overweighting technology and noted that sentiment on stocks has shifted from skepticism to optimism, and could reach euphoria early next year, driving more gains but potentially setting up a decline later in the year as inflation picks up and interest rates rise. A recession could make matters worse, cutting into revenues and profits. On the other hand, few companies are better-positioned than cash-stuffed Apple to put money to work in the next downturn.
China is a wild card. The country has lower smartphone penetration than the U.S., making it a key growth opportunity. Domestic brands, led by Huawei and Xiaomi, are battling for share. There are signs they are winning, at least at lower price points. According to data from market researcher IDC, iPhone’s share of smartphone shipments has been trending lower this year, while that of Chinese brands has been rising. Wall Street predicts Greater China revenue growth of only 15%.
Morgan Stanley analyst Katy Huberty is much more enthusiastic. She analyzed data from Jiguang, which tracks messaging services in China, and concluded Apple’s share of active smartphone shipments in China is rising, not falling, this year. The difference between shipment data and usage data comes down to inventories and upgrade cycles, according to Huberty. A surge in shipments of local brands reflects rising store inventories, but it overstates end demand. At the same time, Chinese users of inexpensive local phones tend to upgrade them more frequently than users of pricey iPhones, so different unit-sales rates don’t necessarily reflect a shift in customers.
As a result, Huberty puts Apple’s China growth this year at closer to 70%, fueled by a large base of users who are due for upgrades. That’s enough of a difference in China to put her estimate of Apple’s EPS at $13 even, a 41% rise from last year, much more than the Street is expecting. If Huberty is right, Apple could get to her $200 price target on a burst of growth, even without much of a rise in its P/E.
Another upside source got less theoretical this past week with the passage of a sweeping corporate tax cut. Apple sits on more than $250 billion in cash and investments held overseas as a tax dodge, about a fifth of the total for all U.S. companies doing likewise. To bring that money home for dividends or stock buybacks, it would have had to pay the top corporate tax rate of 35%. The new law cuts the top rate to 21%; imposes a mandatory, one-time 15.5% tax on overseas cash and equivalents; and switches to a territorial tax system to reduce offshore avoidance.
For shareholders, the cake is the tax savings; the icing is that Apple loses its incentive to hold cash overseas. The second helping of cake with icing is that Apple has already booked enough to cover anticipated tax charges. Epoch’s Pearl reckons Apple could get a mid-single digit boost to ongoing earnings from the lower tax rate, and as much as a 7% increase from bringing home cash and buying back stock.
Apple’s next leg up doesn’t depend on a hot new product category, but one is certainly possible in coming years. The shift toward self-driving cars and connected homes could turn Apple’s CarPlay software and coming HomePod voice-controlled speaker into launching points for bigger businesses. Cook has gushed about the potential for augmented reality, a key focus of the iPhone X. Current applications are few, but future ones, to the extent that users pay for them in the App Store, will bring Apple a cut of revenue.
There are surely many more clever ideas than these. But investors who study patent filings or track rumor sites for signs of Apple’s next breakthrough are overcomplicating matters. Watch instead the $14 billion in yearly research spending, the smoothing out of earnings, and the still-modest stock valuation. Watch Cook, who might lack the showmanship of Jobs but has quietly presided over $450 billion in market value creation. And watch Apple prove the skeptics wrong again.
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