Apple stock dropped from $705 to $663 over the past five days, or 5.5%, due to apparent disappointment that Apple sold only 5M iPhone 5s on the first weekend of sale. Once that “concern” started hitting the stock, other bears starting piling on with other "issues." One side effect of having a stock that has performed so well over the past ten years is that those who have been naysayers all along are waiting for their time to come. Despite recent price movements, the time of Apple’s demise is not yet here. Take this opportunity to buy at a 5% discount, because when December quarter numbers are released, the stock may not see the $600s again.
Here are Five Bear Arguments, and the reasons why Apple remains an attractive investment, particularly with the stock price dip.
“Apple only sold 5M iPhone 5s in the first weekend.” Five Million is a superb number. Had Apple been able to meet demand, the number would have been even higher. The possibility of supply constraints surfaced earlier in the summer when key semiconductor suppliers were warning of potential product shortages later in the year. At that time, some speculated that these supply constraints would prevent Apple from bringing the iPhone 5 to market, but Apple delivered. On top of that, the new touch screen met with supply constraints as well. For investors when demand exceeds supply, this called a “happy problem,” particularly with a brand as strong as Apple. Customers will wait for the product they want and pent-up demand bodes well for the following quarter. For the past three product upgrades, iPhone unit sales have increased 41%, 66% and 117% over the quarter previous to the product release. And, the pattern for pent-up demand on iPhone releases has intensified over time. The launch of iPhone 4 sold 91% more units than the launch of iPhone 3S; and the launch of the iPhone 4S sold 163% more units than the launch of the iPhone 4. To put th iPhone 5 in context: In the December quarter last year, Apple sold 1.7M iPhone 4S in the first weekend, and went on to sell 37M in the quarter. The iPhone 5 sold 5M in the first weekend, which, if the historic trend remains in tact, the iPhone 5 could sell 50M units in the upcoming quarter. The iPhone 5 had a stellar launch.
“Demand for the iPhone is saturated.” Demand exceeds supply for iPhones, yet again. And, the demand was greater, faster and stronger than Apple has previously experienced. Even compared to other iPhone launches, the iPhone blew out previous records. Consider: the iPhone 5 sold out 2M in 24 hours, compared to the iPhone 4S that sold 1M in 24 hours. For pre-order, the iPhone 5 sold out within one hour (as measured by those orders that could be immediately filled on the website), compared to the iPhone 4S that sold out in 22 hours and the iPhone 4 which also sold out in a day (and took down AT&T’s website with it!). The day after the iPhone 5 went on sale on the website, fulfillment would take 3-4 weeks compared to 1-2 weeks for the iPhone 4S and 8 days for the iPhone 4. The iPhone 5 is arguably the most successful launch of a consumer electronic yet.
“The products are maturing.” Hardly. Let’s look at the facts. Apple participates in three segments: smartphones, computers and tablets.
- Smartphones: IDC predicts that cell phone unit sales will increase from 1.7B to 1.8B this year. While this is nothing to write home about, smartphone units sales will grow at 38.8%. Within the smartphone market, the market share numbers have bounced around yet Apple has tended toward 20% or so of that market. With the launch of the iPhone 5, Apple will most likely see its smartphone market share hit 25%, even in consideration of all the new product announcements by other manufacturers. Smartphone market growth of 38.8% growth is not a sign of a mature market.
- Computers: Admittedly, the PC market grew at 2% in this last quarter, one sign of a mature market. However, Apple’s Mac sales grew at 15%. So while the overall industry is mature, Apple’s product sales behave as a growth industry.
- Tablets: Gartner has forecast sales of 118M tablets will be sold in 2012, a 100% increase over last year. Moreover, Gartner also predicts that there will be 665M tablets in use world wide by 2016, almost a 6-fold increase in 4 years. Moreover, Apple currently has 70% market share in this category. Apple is a dominant player in a growth industry.
More on this topic can be found in Apple: Product Commoditization?
“Carriers will reduce subsidies.” This argument has been around for some time and carriers have not reduced subsidies. While carriers would have the incentive to cut costs in any area, it is extremely unlikely that they will cut off Apple products because iPhones draw in new customers, create customer loyalty, sell higher-priced data plans and utilize valuable bandwidth more efficiently than the competition. Apple drives revenues (more and higher-paying customers) at lower operating costs (more efficient network usage) making Apple a very valuable relationship for carriers. And to drive the point home, bears have been making this argument for years yet not one announcement has been made that a carrier has reduced its subsidies to Apple. See Within Apple Earnings Report, Seven Positive Trends to Consider and Apple's Recent Stock Price: Explanations.
“Apple maps is not as good as Google maps.” There is a great deal of discussion on the internet about Apple versus Google maps and many iPhone users apparently would like to see Google maps on their iPhones. The resolution is to download the app from the Safari browser, drag the icon to your screen and the problem is solved. It is unlikely that potential customers will not buy an iPhone because maps are no longer pre-loaded. iPhone users have the highest loyalty of smartphone users, and are more likely to buy another iPhone than any other smartphone. When the reasons for iPhone loyalty are examined, it is styling, ease of use, abundance of apps, etc, but not linked to specific apps. A UBS study last year pegged iPhone loyalty at 89% and a Piper Jaffray study this summer showed that 94% of iPhone owners planned to buy another one.
On the other hand, here are Four Catalysts why Apple remains a solid investment for the foreseeable future:
Profits, Profits, Profits. Apple’s gross margin has averaged 45% in the three quarters of FY12. Recent tear down analysis of the new iPhone 5 estimate that the cost to build the iPhone 5 at $207 to $238, depending on the size of memory. With retail prices (unsubsidized) of $649 to $848, Apple makes $442 to $611 per phone, or 70% on average. It is estimated that Apple makes about 51% gross margin on its 4G iPads. To put this in context, Apple’s gross margins are almost double of other product companies: 22% (Dell), 23% (HPQ), 29% (NOK). It has been articulated that Apple earns more on its smartphones than the sum total profits of the other participants in the industry. Over time, these profits have accumulated to a $117B war chest of cash, short and long term investments.
Other potential new products. Apple will most likely, sooner or later, introduce an iPad mini and an new Apple “television.” An iPad mini is anticipated to be announced in October, available by the holiday shopping season. It is expected to be a 7” screen and be priced somewhere between $199 and $299, the mid-point being most logical. Last holiday season, Amazon’s Kindle Fire was an attractive alternative to the iPad for some customers due to its lower price point ($199 versus $399 for the least-expensive iPad) and smaller size. With that, Amazon reached close to 17% market share with the Kindle Fire and 54% market share of the Android products. An iPad Mini, priced around $249, would substantially soften Amazon Kindle Fire’s price advantage and would negate any size advantage. And relative to Android offerings generally, Apple has an edge with content. Google has a limited number of apps designed for the 7” tablet, while Apple has over 250,000 apps designed specifically for the iPad. Apple also still leads in media content over Google and Apple has an entire ecosystem around AirPlay and iCloud that would enable all other Apple products to work with the new iPad Mini. And while little has been said about an Apple television-like device, the potential of such is looming. Apple introduced the Apple TV, a digital media receiver, originally in March 2007 and has updated it twice in September 2010 and March 2012. Most agree that Apple "doesn't have hobbies" and this will eventually turn into another growth product category for Apple. Apple has ample room to improve the user experience, expand its Ecosystem, further integrate consumers' media collections, and has proven its ability to disrupt industries before (music, cellular). See Four Reasons Why Apple Could Revolutionize Television.
China. China is an enormous market, and Apple products are very popular there. Apple's "iPad" name dispute was recently resolved allowing Apple to begin selling iPads in China. Demand was so exuberant for the iPhone 4S, lines formed overnight and crowds had to be calmed. The iPhone 5 will be available at China Telecom and China Unicom in December, and there are rumors that Apple and Qualcomm are working on a chip that will work on China Mobile's unique communication standard. China has become Apple's fastest growing market, and is expected to soon become Apple's largest market. Moreover, Apple has not yet been adversely affected by economic conditions in China as have other high-end retailers, perhaps because Apple is in such high demand yet relatively hard to get, with only fives stores in the country.
The potential of iPad. Researchers already acknowledge that the tablet category will surpass the computer category by 2016. Furthermore, the iPad has the potential to be much larger than the iPhone. The iPad revenues reached $28.5B in two years; it took 3.5 years for the iPhone to achieve the same metric. iPad can be freely purchased and used with out the distortions created by carrier associations, pricings, promotions and specifications. iPad adoption in the enterprise has been unprecedented with almost all of the Fortune 500 adopting. And, the iPad has virtually no competition, yet. NPD predicts that Apple will have 72% market share in tablets in 2012 and, as stated above, the tablet market is expected to grow 6-fold in four years. With the dominance of the iPad, the market potential and the associated margins, the iPad could double Apple's market capitalization in three years. To read a detailed analysis of iPad potential, see The iPad Will Mirror iPod’s Market Dominance. Here’s Why and Why it Matters.
Apple is an attractive stock. Five million iPhones sold in its first weekend, limited only by supply constraints, is a stellar start. Whenever there is a window of opportunity to call Apple's demise, the bears will take the shot. The issues raised about the stock, as cited above, just don't make sense when looking at the data, consumer behavior or pent up demand. On the other hand, Apple has many catalysts on its runway, particularly going into the fourth quarter. See Apple: Seven Reasons iPhones and iPods Boost December Quarter - Quantified. Take advantage of headlines that may not make sense but may affect the stock to continue to build a position at attractive prices. At today's $681 price, Apple still trades at a Price to Earnings Growth ratio (Price (less cash) Earnings over Growth Rate) of less than 1.0, meaning investors can buy growth at a discount, very attractive metrics for a growth stock. And, currently, Apple still makes great products that consumers want at great margins. All that for an attractive stock price.
