Apple stock is undervalued as the company is moving to a mature one. Is the Market missing something here?
- Why is Apple stock trading at such low multiples compared to its tech peers?.
- Is there something the market is not seeing?.
- What are the industry trends that showcase Apple's upside despite a poor 2016?.
Apple Inc. (NASDAQ:AAPL) is the largest company in terms of market capitalization, but AAPL stock is also the cheapest among the top technology stocks in terms of price multiples. After dropping sharply during the first half of the year Apple recovered nicely during the second half, thanks to the iPhone 7 launch and a favorable response from the industry. But despite the recovery, Apple is still trading at less than 15 times earnings and 3 times sales.
Why is this, and does it present an upside to investors looking to increase their positions?
Of the top four tech companies in the world (by market cap), Apple sells the most, earns the most and has the highest operating margins of them all, yet still trades extremely close to Amazon.com (NASDAQ:AMZN), the retail giant that operates with wafer thin margins, in terms of price to sales ratio. Even from a price to earnings multiple point of view, Apple commands a much lower valuation than Alphabet Inc (NASDAQ:GOOG). What is really surprising is that the company is selling at half the P/S of Microsoft (NASDAQ:MSFT), a company that is still on a recovery path. (See also: Apple Inc. Cuts iPhone Production, Time To Sell AAPL Stock?)
The root cause for such low valuation for AAPL are the growth expectations the market has assigned to all these other companies. Alphabet’s revenues are still growing at double-digit rates and the company’s closest competitor in the advertising industry is many times smaller than them. Microsoft’s cloud business is also growing at double-digit rates for the last two years, and will soon overtake earnings from Windows-based business streams. Amazon’s top line is still growing at double-digit speeds despite the company crossing over into the 100-billion-dollar revenue territory. Apple, in comparison, saw its revenue decline by 8% this year, and the forecasts aren’t really promising.
Let’s take a closer look at Apple’s revenue streams to understand if Apple really warrants such low valuation multiples from the market.
Apple’s lead earner is the smartphone segment, obviously, with iPhone sales accounting for nearly 63% of their overall revenue in 2016. Apple sold 211 million iPhones in 2016, 8% lower than the 231 million iPhones the company sold in 2015. As a result, net sales from iPhone dropped from $155.04 billion in 2015 to $136.7 billion in 2016.
Sales from iPad, iMac and Services were all in the $20 to $24 billion range, much smaller in size when compared with iPhone sales. The problem for Apple is that sales of all their devices sharply declined this year, and 'services' was the only segment that reported strong growth.
But Apple is not the only company to face a sharp decline in smartphone sales this year, as it is a worldwide phenomenon. The days of strong double-digit growth are essentially over for the smartphone industry. According to Comscore, there were 198.5 million smartphone users in the United States, while PewResearch center says “64% of American adults now own a smartphone of some kind, up from 35% in the spring of 2011.”
That leaves about a third of the population yet to bite the smartphone bullet, of which 42.6 million are senior citizens - 14.5% of the population - who aren’t likely to keep refreshing their smartphones frequently even if they do use one.
As developed markets move out of the growth equation, companies will naturally turn their focus towards developing nations. But even that is not going to help Apple much.
Smartphone penetration in a country can never be higher than the internet penetration in the region. China’s internet penetration has just crossed over 65%, and smartphone usage has already reached 58%. India is at an abysmal 22% internet penetration, with a 17% smartphone penetration level.
As a premium luxury segment product, iPhone’s potential market size in these countries is already small, with not much room for explosive growth. (See also: Microsoft Corporation: Is MSFT Stock A Better Buy Than AAPL Stock Now?)
The best bet for Apple now is to hold its sales numbers in developed markets, expand a little in developing markets by adding a few more phones at the bottom end of the price range and keep product refresh cycles as tight as possible to show stable iPhone sales growth over the next several years. The days of double-digit growth are over and Apple may have to play defense in the smartphone market during the next decade.
Mac and iPad Sales
Barring a miracle during the fourth quarter, 2016 will be the fifth consecutive year of PC sales decline.
Apple sold 18.48 million Macs in 2016, resulting in $22.83 billion in sales. As a premium segment player, Apple should be able to hold its market much better than other players and new product launches will be key to future worldwide sales.
The story isn’t much different for the tablet market.
Worldwide tablet shipments are expected to decline for the second straight year in 2016, dropping 9.6% compared to 2015 volumes, according to a new International Data Corporation (IDC) Worldwide Quarterly Tablet Tracker forecast. The tablet market in totality has seen its peak and will face down years in 2016 and 2017, followed by a slight rebound in 2018 and beyond driven by detachable tablet growth. Right now the detachable category only accounts for 16% of the market and IDC expects it to reach 31% in 2020.
Though the segment may not show strong growth, Apple’s premium positioning of its product should help the company eat market share and keep sales moving during the next decade.
The Nearly Invisible Upside
As you can clearly see Apple is facing an extremely tight market in all three of its device segments. This has immensely affected the market sentiment, leading to a gross undervaluation of the company.
Despite the tightening market, Apple still remains the most profitable smartphone maker in the world accounting for more than 90% of the industry’s profits. This is not the same for other manufacturers, who are facing sustained losses as they compete for market share, and that’s already showing up as consolidation and shutdowns in China this year.
Due to its high profitability advantage, Apple is the only company with a high degree of stay-ability in such a brutal market.
Apple is grossly undervalued by the market because the company is merely moving from a strong growth phase to a mature growth phase. But the market is discounting the stay-ability factor of the company.
As more companies find the going difficult in such market conditions and start dropping out of race, Apple will keep expanding its reach either through its devices or through its services portfolio.
Our recommendation is to buy AAPL stock while it’s cheap because the market will realize its folly sooner than later. Looking to invest in technology companies? Here are our latest Top Stock Picks which have outperformed the NASDAQ by over 110%.