Apple stock is up 2x in the last year, which is spectacular for a company with an almost two trillion dollar market cap.
Given I’ve already analyzed other FAANG names, I thought it would be interesting to look at what assumptions are required to justify the current stock price and to determine if it’s a good investment at current levels.
TLDR: I think the stock is worth $118, which is just below today’s price. I’ll purchase a half position for the fund, with the hope of adding more on declines.
Apple’s Business Segments
Let’s look at the Apple’s businesses in more detail below. The numbers in brackets represent their share of 2019 revenue.
iPhone (55%)
This is by far the single biggest contributor to Apple’s revenue, so having a view on how iPhone sales evolve over the next 10 years is critical to valuing the company. A few factors to consider –
1. Upgrade cycles seem to be getting longer - currently at about 4 years. It would not surprise me if we get to five years soon.
2. The average selling price for iPhones is slowly rising, which will likely offset the revenue decline from the longer upgrade cycle.
Here’s how I think about modeling iPhone revenues going forward.
Active iPhone users have grown by about 100mm per year since 2017 and there are now about 1B active iPhone users. Assuming, they’ve been upgrading every 3.5 years, that’s 240mm people buying a new iPhone each year at a cost of about $600 per phone. This maps to the roughly $145B in iPhone revenue per year from 2017-2020. It seems reasonable to me that in 10 years, there will be about 1.5B active iPhone users. If they now upgrade every 5 years, at an average cost of $660, that translates to a steady state iPhone revenue of about $165B in 2030.
You could argue its conservative to model only 50mm additional users going forward when the last few years have trended at 100mm users, but like any mature product, I think the high growth phase eventually ends. Adding 500mm new users over 10 years is still a solid outcome.
Mac (10%)
2020 was as strong year for Mac sales (up 10% YoY). However, I expect that people who needed to buy new computers given they’re working from home have now already done so, and sales will be down YoY in 2021. Beyond 2021, I expect Mac sales to grow at 2%/year on average.
I use a Macbook Pro that’s over 5 years old and I don’t expect to upgrade for another few years at least. The days of most people (not gamers / artists) needing a new computer every 3 years are gone, so I don’t see this being a high growth area for Apple.
iPad (8%)
iPad sales were also up strongly in 2020, but like with Macs I expect a decline in 2021 followed by very low growth (2%/year) over the next nine years. While I’ve bought iPads in the past, I don’t ever expect to buy a new one. There will be some population of people that like and continue to buy iPads, but I expect this to be relatively static.
Wearables, Home and Accessories (10%)
While this only represented 10% of revenue in 2019, it has grown 39% on average over the last two years and grew 25% in 2020. I expect the strong growth to continue, with the Apple Watch driving the bulk of the sales. There are currently 1B active iPhone users and about 50mm active Apple Watch users. Given the newer Watch models are significantly more useful than older models, I wouldn’t be surprised if there are 200mm active Watch users in 10 years. Of course, 4x the current users doesn’t necessarily mean 4x the revenue in 10 years, but about 3x revenue seems reasonable to me.
Services (18%)
This is Apple’s 2nd biggest segment after the iPhone and has grown an average of 18% over the last two years and 17% in 2020. The bulk of the revenue here comes from Apple taking a cut of sales generated by apps. There have been two prominent lawsuits in the last year brought by Fortnite and Spotify, claiming that Apple is using its position as a gatekeeper to extract an unfairly large percentage of app developer’s revenues. There is now a Coalition for App Fairness.
While these lawsuits have some merit, it’s unclear to me that Apple will be forced to change their pricing strategy. The bulk of the smaller developers seem to have no problem sharing revenues with Apple to get access to their users. It’s only once apps get to a massive user base like Fortnite and Spotify, that it hurts to share millions of dollars with Apple. In the case of Spotify, Apple has a competing product in Apple Music, so Spotify has an axe to grind. It’s entirely possible Apple introduces some tiered pricing for larger apps that pacifies them. While this would obviously hurt revenue growth, it would also reduce the likelihood of further lawsuits and future regulatory challenges.
The big wildcard for this segment is the roughly $10B that Google pays Apple each year to be the default search engine on its devices. This amount goes straight to Apple’s bottom line. If the U.S. DoJ forces Google to stop making these payments, Apple’s market cap should drop ~200B (at a 20x multiple to free cash flow).
Perversely, this should be a win for Google given most users would use it as their default search option anyway, so Google should see a marginal decline in ad revenue, while adding $10B straight to their bottom line. Obviously, the reality is not this simple or Google would have figured out it shouldn’t be paying Apple so much, but this is a real issue investors in both companies should consider.
I’m going to ignore the Google wildcard for the purposes of my growth assumptions and model services growth of about 7% on average over the next nine years, which essentially leads to this business doubling in size.
Margins
Apple’s product margins have declined form 36% in 2017 to 32% in 2020. This seems to be mostly from the mix of products sold (fewer iPhones which have higher margins than Mac, iPads etc). I expect this decline to stop going forward, and model steady state margins of 32% on products.
Services margins have increased from 55% to 67% in the last three years and I model steady state services margins of 70%.
Valuation
Based on these revenue and margin forecasts, a discount rate of 3%, and a terminal value multiplier of 20x, I arrive at a per share value of $118. This is just below today’s share price of $122. While I’d ideally like to buy the shares at a discount to my calculated value, my assumptions are fairly conservative, so I’m ok buying a half position for the fund at the current price. I hope there will be declines over the next couple of years that allow me to add to my position.
As always, the model is available here if you’d like to input your own assumptions.