Today's Opinions, Tomorrow's Reality 

Milking It

By David G. Young

Washington, DC, April 26, 2016 --  

Apple may have sagging phone sales and a lack of new products, but that doesn't mean it can't be profitable.

A few months after consumers camped out in lines to be the first to buy the new iPhone 6, Apple had the joyous opportunity to report its quarterly earnings. Numbers showed large increases in sales from the same quarter a year earlier, and that Apple accounted for half of all smartphones sold in the United States. The future was all Apple.

Fast forward 15 months, and quarterly reports aren't so rosy. Today, Apple announced the first decline in iPhone sales in the product's history -- 16 percent since the same quarter last year. Its shares dropped nearly 8 percent in after hours trading.1

Analysts offer plenty of explanations for this: nearly everyone in developed markets has already made the jump to a smartphone; Apple's latest iPhone models are merely incremental upgrades in the two year product cycle.

But perhaps the best explanation is that the huge increases in sales 15 months ago were a one-time fluke. Apple for years refused to increase the size of the iPhone's screen, despite obvious consumer demand. The company finally relenting at the end of 2015 with the iPhone 6. Those who wanted both a big screen and an Apple product lined up to get one. But this surge in new customers was a one-time change.

Apple will release its next generation iPhone 7 later this year, and while Apple fans will certainly be excited, markets clearly don't share that sentiment. Apple's share price has sagged by over 30 percent in the past year, with a price to earnings ratio (before today's numbers) of 11.16 -- less than half of the PE ratio of the broader S&P 5002. The fact that markets are willing to pay less than half as much for $1 of Apple earnings than most other stocks suggests investor's don't believe Apple can keep those profits going.

Given that iPhones account for two thirds of Apple's sales3, this quarter's numbers are indeed disturbing. Apple fans point to other disruptive technologies that may be coming: new features of Apple TV, a potential Apple Car, and other products we can't even imagine yet.

Maybe this will happen and maybe not. The Apple Watch was supposed to be one of these new disruptive products, but it has proven to be a financial dud. And given Tesla's difficulty in scaling its factories to produce its broad market-oriented Model 3, it's hard to imagine how a company as secretive as Apple could be anywhere close to building a vehicle for the broader market.

But let's discount Apple's new product pipeline for a moment. What if Apple has no new products up its sleeve? Are things for the company really that bad? In order to make Apple's shares buy the same amount of earnings as the S&P 500 as a whole, Apple's revenues would have to fall by half. Even with the reported decline in iPhone sales, that clearly isn't going to happen anytime soon. If iPhone sales do stagnate or slowly decline over the long-term, the company can still make plenty of money by milking its existing products for years.

Microsoft followed this model after its peak in the late 1990s. Years after its market share peaked, it still made plenty of money selling Windows and Office to folks who had to upgrade every couple of years. Selling upgrades may not be innovative, it may not be sexy, but it's plenty profitable.

Indeed, comparisons of Apple's profits to other tech companies are almost laughable. Rival Google, whose market capitalization briefly surpassed Apple to make it the world's largest public company earlier this year, has a PE ratio of over 314 -- meaning its share price is almost three times overvalued compared to Apple to buy the same amount of earnings. This is for a company that has a great track record of funneling money into R&D, but a terrible track record of making significant money off of anything besides their original product of search advertising.

Given much of Apple's past success has been based on consumers who are irrational slaves to fashion, it's hard to feel sorry for the company when investors take an equally irrational view as its stock falls out of fashion. But for those who care less about fashion than profits, Apple's future still seems plenty better than its rivals.

Full disclosure: David is an Apple shareholder who regularly carries an Android phone.

Related Web Columns:

A Welcome Resurgence, January 27, 2015

Learning to Be Boring, April 19, 2011


1. Reuters, Apple Posts Historic Drop in iPhone Sales; Forecast Disappoints, April 26, 2016

2. Google Finance, Apple Inc., as posted April 26, 2016

3. CNET, Apple Stares Down its First Ever iPhone Sales Slump, April 25, 2016

4. NASDAQ, Alphabet Inc. Analyst PE Estimates, April 26, 2016