Apple Inc. (NASDAQ:AAPL) has long been a darling of both growth and value investors alike, but maturing growth and valuation relative to the growth on offer suggest the stock is looking similar to International Business Machines Corp. (NYSE:IBM). Once dominant, both have products and solutions that seem ubiquitous to their fan base, but lost ground in fast-growing emerging technology trends.

The stock is still touted as a growth story by the bulls and the argument is forgotten about weakness in iPhones today. The real long-term story is high growth offered by the services segment, wearables, and Apple Card down the road; businesses that carry much better margins and cash flows. Add to that the company can continue to use the cash flow generated on lenient buybacks like those seen over the last 5 years that resulted in shares outstanding declining by 24% since 2015.

We believe as the premium attached to blue-chip stocks dissipates after the lockdown, the market will be forced to reassess growth catalysts for Apple in an environment that will be dogged by increasing competition for the product businesses and services business that is not large enough to drive growth for the whole company.

Ask any old-timers in the tech industry, they will attest that IBM was the cutting edge once. Investors should avoid getting caught in when large FAANG loving institutions rotate out. Without top-line growth or margin expansion, the story is largely multiple expansion and buybacks, rarely a good place to be for a tech investor.

Please note that we talked about Apple Inc. in our weekly list of stocks for the week as well.

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This Apple is turning stale

Apple Inc.
2015 2016 2017 2018 2019 1H 2020
Revenue Growth -8% 6% 16% -2% 6%
As % of revenue
Gross Profit 40% 39% 38% 38% 38% 38%
Research and development 3% 5% 5% 5% 6% 6%
Sales and marketing 6% 7% 7% 6% 7% 7%
Operating Margin 30% 28% 27% 27% 25% 26%

Ask your friendly value investor, would you assign 30 times earnings, 21 times book, and more than 6 times sales to a business that grew sales by 10-11% over the last 5 years while gross margins and operating margins declined during that time frame?

The key question is if it’s not growing and too rich for value investors, why are you here, unless you are index hugging Long-only shop that relies on asset gathering alone.

Segment % of total revenue Growth profile
iPhone 57% Low
iPad 7% Negative
Mac 8% Negative
Services 17% High
Wearables and others 11% High

Academic exercise for Purnha’s internal use only.

Amid all the hype about services and wearables, the market sometimes forgets to focus on rest of the majority of the revenue sources that are barely growing or declining.

Growth % of revenue Long-term growth
Low to negative 73% 3% 2%
High growth 27% 15% 4%
Total 6%

Academic exercise for Purnha’s internal use only.

As the chart above shows, if we assign a respectable 3% long-term growth to low and negative growth businesses and 15% long-term growth to high growth businesses, consolidated revenues are expected to grow around 6%. These low and negative growth businesses declined by 7% over the last 5 years, 2015-2019.

Next Yr. PE Growth PE/ Growth
Apple 25 6% 4.2
IBM 12 2% 5.8
Facebook 31 20% 1.6
Netflix 75 18% 4.2
Alphabet 37 19% 1.9
Amazon 138 20% 6.9

Academic exercise for Purnha’s internal use only.

And when we compare the company’s growth profile to that of other constituents of the FAANG, it doesn’t fit. Instead, the company looks more akin to IBM.

The rot that cannot be ignored anymore

Besides the poor growth prospects of the businesses, other major risks that are largely ignored by the Street so far,

  • China factor, both from demand and supply standpoint
  • Service and other growing businesses lag product businesses
  • Margin trend, can it reverse?

The China factor

The stock market rally of the last few months may have made investors forget that Apple was among the first companies to warn of weakness when China entered lockdown back in March, highlighting the importance of China for Apple.

China that makes up close to 15% of the total revenue has not grown for the company over the last 3 years and shrunk as a percentage of total revenue.

Yes, shrinking China as a market is no news, but this is the only big market that is out of the lockdown yet, suggesting expect market share losses for the company. The role of China in the supply chain is even more significant in light of the recent political tensions with the U.S.

Service and other growing businesses

Apple Inc.
Growth 2017 2018 2019 1H 2020
Product 15% -5% 3%
Services 22% 16% 17%
Gross Margins
Product 36% 34% 32% 33%
Services 55% 61% 64% 65%

Purnha’s data source: SEC Filings

We agree the services segment is doing great, with strong top-line growth and expanding gross margins. Indeed, the whole Apple story is hinged on services businesses right now. Even though average revenue per paid subscriptions across the services seems to go down given paid subscriptions grew 32% over last year, but services revenue grew by merely 17%.

What we doubt is the ability of the services business to sustain growth if the product revenues do not turn the corner in a meaningful way, since shrinking product sales will negatively impact the size of the Apple ecosystem. In essence, service revenues are a lagging indicator.

This is why declining ASPs of iPhone may not scare away the bulls, but if the units (which the company stopped sharing with the shareholders) don’t grow meaningfully even with falling ASPs, bulls may be forced to run for the hills soon.

Like services, wearables are also dependent upon the success of the primary driver of the Apple ecosystem – iPhone units.

Margins, can they grow again?

As the charts above show, margins for the company have been under pressure over the last few years. Products gross margin declined again last quarter, almost 380 basis points sequentially, due to loss of leverage and unfavorable mix.

Ideally, increasing service business should have brought the consolidated gross margin higher, but the service business is still not big enough to offset the decline caused by a declining margin in the product business and given the ASP pressure on the iPhone, stability in product margins may elude the company for a while.


Yes, almost all the improvement in EPS over last five years has been due to the shrinking shares outstanding and now that the market cap is almost $1.6 trillion, the company would need $400 billion to purchase another 25% of the shares outstanding over the next five years.

Can they do it with net cash of more than $100 billion and a free cash flow of more than $50 billion? Yes, they can but do you want to pay 25 times for those types of earnings in a 0% interest rate environment?

Disclosure: This is purely an academic exercise for our internal use and we are NOT recommending buying or selling based on these projections.

Original post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.