Apple Inc (NASDAQ:AAPL) stock is up 60% in the last one year and could continue to outperform in future.
We have remained bullish on Apple Inc (NASDAQ:AAPL) stock for a while now. Apple stock has been part of our top stocks to buy portfolio (which has outperformed the Nasdaq Composite by over 160%) for several quarters. Apple continues to deliver strong results and churn billions of dollars in free cash flows. Over the past one year, shares of the tech giant have soared by over 60% on the hopes of an iPhone Supercycle and the stock is nearing the trillion dollar market capitalization milestone. However, the recent rally has also pushed Apple's valuation multiples higher and a strong iPhone X sales appear to be already priced in. Given this, should Apple stock continue to find a place in your portfolio for the coming quarters? Yes, we think so. Below are our reasons.
Other hardware products like iPad will deliver growth.
It is not just the iPhone which is doing well for Apple. Other hardware products like iPad, Mac and Apple Watch are seeing improved performance. After declining for several quarters, iPad sales are beginning to show resilience. For the second consecutive quarter, iPad sales showed YoY growth. Apple sold 10.3 million iPads in the fourth quarter, 11% higher than last year. iPad revenue grew by 14% YoY. Though on the sequential basis, both the unit sales and revenue declined. Previous quarter (2017 Q3) was the first time in three and a half years that iPad sales started to increase. According to NPD, iPad's share in U.S tablet market jumped from 47% last year to 54% in the fourth quarter.
This segment is likely to continue seeing strong growth as demand from emerging markets like India and China remains strong. According to Apple, among people planning to buy tablets, purchase intent for iPad was over 70% for both consumers and businesses. Mac sales are also picking up. This was the best year ever for Mac, with the segment reporting highest annual revenue in Apple's history. It was also the best September quarter ever, with Mac revenue growing by 25% YoY. According to Apple, growth in Mac revenues was driven by notebook refreshes we launched in June and a strong back-to-school season.
Apple Watch is also seeing strong traction with customers. For the third consecutive quarter, unit sales grew by over 50% YoY. Apple recently launched Apple Watch Series III with cellular connectivity, which is also enjoying strong sales, according to Apple CEO Tim Cook. Apple's wearable segment which includes Watch and Air Pods grew by 75% YoY. Apple will also launch its HomePod, the $349 voice-activated speaker next month. The voice-activated speaker is still nascent but is seeing rapid growth. According to Arthur Liao, an analyst at Taipei-based Fubon Securities, Apple could sell up to 4 million HomePods next year alone. And this market is expected to grow at a fast pace over the next few years.
Services segment will be the main growth driver for Apple Inc.
While hardware segment including iPhone and iPad are likely to show strong performance going forward, the services segment will be the main growth driver in the medium term. The services segment includes revenue from AppleMusic, AppleCare, Apple Pay, licensing and other services is already the size of a Fortune 100 company, but is still growing at a rapid pace. Over the last five years, the services segment has grown at a CAGR of over 23%.
Last year, Apple had set a target of doubling this segment revenue by 2020 to $48 billion, requiring the service segment revenue to grow at a CAGR of 19% over the next four years. However, in the fourth quarter, Services segment revenue growth came in a tad higher at 34% YoY growth, with segment revenue reaching a record high of $8.5 billion in the September quarter. In fiscal 2017, the company had generated $30 billion in revenue from this segment. The App Store set a new all-time record.
It not just the growth of the service segment, but also the strong margins which will be key to driving Apple stock higher from here. According to an estimate by Piper Jaffray, the services segment has a gross margin of around 60%. With Apple Pay and Apple Music continuing to deliver strong growth, this segment will be a growth driver for Apple. Apple music saw paid subscribers grow by 75% YoY while transactions on Apple Pay grew by a massive 330%. These segments will continue to deliver strong growth.
Apple Inc has a strong capital return policy.
Another reason why Apple stock should make it to your portfolio is the company's strong capital return program. Since 2012, the company has returned over $233 billion of capital to shareholders. This includes $166 billion in stock buyback and $60 billion in form of dividends. Apple has increased its dividend payment from $0.38 in 2012 to $2.18 in 2016, a compounded annual growth rate (CAGR) of 54.8%. While this is likely to moderate in future, given the comfortable payout ratio, high profitability, free cash flow and cash balance the company could continue to grow its dividend for a long period of time. Apple CEO Tim Cook has vowed to keep increasing the stock's dividend payment every year. In 2017 the company had a payout ratio of 26% and return on equity of 36.6%. So Apple's sustainable rate of dividend growth (roe*(1-payout ratio)) is around 27% per year.
So, in the long run, Apple stock seems to be a good bet, even for dividend investors, given Apple's track record in growing dividends and its potential. In the short run, Apple stock price will be driven by iPhone X sales. It is imperative that Apple delivers on its 2018 guidance. Apple stock remains a good buy. We rate Apple stock 4.2 out of 5 given its strong balance sheet and growth drivers.
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