Apple Inc. designs, manufactures, and markets smartphones, personal computers, tablets, wearables, and accessories worldwide. It also sells various related services. In addition, the company offers iPhone, a line of smartphones; Mac, a line of personal computers; iPad, a line of multi-purpose tablets; AirPods Max, an over-ear wireless headphone; and wearables, home, and accessories comprising AirPods, Apple TV, Apple Watch, Beats products, HomePod, and iPod touch. Further, it provides AppleCare support services; cloud services store services; and operates various platforms, including the App Store that allow customers to discover and download applications and digital content, such as books, music, video, games, and podcasts. Additionally, the company offers various services, such as Apple Arcade, a game subscription service; Apple Music, which offers users a curated listening experience with on-demand radio stations; Apple News+, a subscription news and magazine service; Apple TV+, which offers exclusive original content; Apple Card, a co-branded credit card; and Apple Pay, a cashless payment service, as well as licenses its intellectual property. The company serves consumers, and small and mid-sized businesses; and the education, enterprise, and government markets. It distributes third-party applications for its products through the App Store. The company also sells its products through its retail and online stores, and direct sales force; and third-party cellular network carriers, wholesalers, retailers, and resellers. Apple Inc. was incorporated in 1977 and is headquartered in Cupertino, California. The company is publicly listed on NASDAQ under the ticker “AAPL”.
Our considerations
Apple Inc. is currently the largest company by market capitalization in the world, a giant in the tech industry, and one of the best known and established brands worldwide. The company has impressive numbers in terms of revenue, gross margin and growth. The management has a great experience, and it has always focused on innovation and development of products and services, and most importantly on building a well-established and trusted brand. Warren Buffett, one of the greatest investors of all time, has allocated over 46% of his entire portfolio in Apple stocks, confirming that the company is indeed a great one.
Apple has proved many times to be financially resilient. Recently in October, for example, the CEO Tim Cook said that supply chain issues cost Apple $6 billion in revenue during the quarter, but nonetheless managed to beat expectations on both revenues and income. Perhaps, even in the current economic environment, where the world is experiencing both a semiconductor shortage and high levels of inflation, the company will be able to thrive. On the other hand, Apple has huge income margins, which allow it to survive demand contractions, and an incredible market share, which allows it to raise its prices without damages.
Indeed, while competitors like Samsung and Xiaomi have income margins of, respectively, 14% and 9%, Apple has margins of over 26%, thanks to the extreme cult-like brand loyalty that makes customers pay high prices for its products. It isn’t random, though. Apple was able to create an “experience” with its products that is hardly reached by other players, and customers are more than willing to pay for it. Part of this experience is the cross-device synchronization, which pushes customers to convert all its devices to Apple’s, and the availability of multiple services under the same account, including streaming with Apple Music and Apple TV, cloud storage with iCloud, communication platform with iMessage and FaceTime, and payments with Apple Pay. The experience given by Apple products is often described as “it just works”, and puts the company in a good competitive position.
Indeed, Apple is the second-largest smartphone company in the world, with a global market share of 26.91%. Its main competitors are Samsung, with a global market share of 29.14%, Xiaomi with 10.02%, Huawei with 9.83% and Oppo with 5.02%. However, in the USA alone, Apple is the first smartphone company accounting for 61.07% of total market, while Samsung only 24.12%. A similar condition is visible in the United Kingdom too, where Apple the market leader with a 50.85% market share. In both countries, Samsung, Huawei and Xiaomi are its biggest competitors.
The PC market is slightly different, because Apple is only the fourth company worldwide, accounting for just 7.7% global market share, while its biggest competitors are Lenovo (24.6%), HP Inc. (21.1%) and Dell Inc. (19.5%). Finally, in the tablet market, Apple has 38% of the global market share, while Samsung and other competitors are under 15% of market share.
As the consumer electronics market became saturated, the company looked for other ways to increase its revenues, innovating itself and shifting a large portion of its revenues to services, such as the one mentioned earlier. Furthermore, Apple recently announced a possible release of the “Apple Car”, a totally electric and autonomous vehicle, on the likes of what already seen making by Tesla. The Apple Car, which is part of the “Titan project”, could be completed as soon as 2025: it is obvious, then, that we cannot estimate with certainty the future cash flows on this project, but we can be sure that if completed, it could probably compete with Tesla and other EV car manufacturers. Indeed, considering the over 1.2 billion Apple users worldwide, it is very likely that the possible revenue on the project would be enormous. In fact, the consumer, rather than choosing a traditional EV, could choose Apple’s vehicle because it interfaces with the iOS system and all other Apple devices and services, thus improving the “experience”.
While the company is solid, experienced great growth and huge revenues, it has some critical issues that are important to keep in mind. These problems arise, mainly, from the excessive concentration of supply in Asia. For example, Apple’s proprietary chips, the M1 and A-series processors, are manufactured by Taiwan Semiconductor Manufacturing Company, other tech components are manufactured in Vietnam and South Korea, assembly lines are located in China. This exposes Apple to geopolitical risks that are impossible to predict but, as investors, we should be aware of. There have always been rumors of China’s military claim of Taiwan, and the Russian invasion of Ukraine shows us that a war outbreak could be a possible scenario. A conflict in Asia would have devastating consequences for Apple, as it could no longer source and manufacture the basic components of its products. Tim Cook has announced, regarding this problem, that part of production will be moved to America.
In conclusion, a long-term investor should definitely consider this company, but a good investor should pay attention to the risks and rewards we mentioned. In addition to the geopolitical systemic risk, another possible risk is the slowdown in sales, but even in this case we must rely on what the state of the economy is, even if we think Apple will not be heavily impacted. Finally, a good investor should consider above all the fair value of the company to decide whether to invest or not. We don’t think the company is, in that sense, a good investment right now, but this could obviously change in the future.
Business
The Company designs, manufactures and markets smartphones, personal computers, tablets, wearables, and accessories, and sells a variety of related services. For reporting purposes, the company divides its revenues into two segments: products and services.
The product segment is divided in other subsegments:
- iPhone, that is the Apple’s line of smartphones based on its iOS operating system. In 2020, the company released iPhone 12 series, while in September 2021 the company released iPhone 13 series.
- Mac, that is Apple’s line of personal computers based on its macOS operating system. The segment includes MacBook Air, MacBook Pro, Mac mini, and 14/16 inches MacBook Pro powered by M1 chip.
- iPad, that is Apple’s line of tablets based on its iPadOS operating system. The segment includes iPad Air, iPad Pro, powered by M1 chip, and the updated iPad and iPad mini.
- Wearables, Home and Accessories. This subsegment includes AirPods, Apple TV, Apple Watch, Beats products, HomePod, iPod touch and accessories.
The services segment is also divided into other subsegments:
- Advertising, that includes various third-party licensing arrangements and Apple’s own advertising platforms.
- AppleCare, that offers a portfolio of fee-based service and support products.
- Cloud Services, which store and keep customers’ content up-to-date, and synchronized across multiple Apple devices and Windows personal computers.
- Digital Content, as the company operates various platforms that allow customers to have access to applications, books, music, video, games and podcasts.
The company also offers digital content through subscription-based services: Apple Arcade, Apple Music, Apple News+, Apple TV+ and Apple Fitness+.
Payment Services, as Apple offers payment services such as Apple Card, co-branded credit card and Apple Pay.
Revenue and margins between segments varies a lot. In 2021, Apple’s revenue from Products segment was $297,392 million, or 81.3%, while Services segment revenue was only $68,425 million, or 17.7%. However, the Services segment presented a way higher gross margin, 69.7% compared to Products’ 35.3%. Even though Products gross margin seems lower, we have to keep in mind that these numbers are impressive for such a huge company. Furthermore, in 2021 most of Apple’s revenue came from iPhone sales, that alone accounted for 52% of total revenues.
Competitors
The markets for Apple’s products and services are highly competitive and characterized by price competition and related downward pressure on gross margins, introduction of new products and services, short product life cycles, improvements in product price and performance, and price sensitivity on the part of consumers and businesses. Apple’s closest competitors seek to compete through aggressive pricing, low cost structures, and by imitating its products by infringing its intellectual property. The company’s ability to compete successfully depends heavily on ensuring the continuing and timely introduction of innovative new products, services and technologies to the marketplace.
As explained before in Business section, Apple is focused on creating and marketing smartphones, personal computers, tablets, wearables, accessories, and services. The company faces substantial competition in these markets from companies that have significant technical, marketing and distribution skills, and other resources, as well as established hardware, software, and service offerings with large customer bases. More specifically, Apple faces competition from:
- Other smartphone and tablet producers, such as Samsung Electronics Co., Xiaomi Corporation, Motorola Solutions Inc., Huawei Investment & Holding Co. Ltd. and LG Electronics Inc.
- Other PC, hardware and accessories producers such as Microsoft Corp., Dell Technologies Inc, Samsung Electronics Co., Logitech International S.A., Lenovo Group Limited, and HP Inc.
- Other software services such as Microsoft Corporation, Adobe Inc., and Zoom Video Communications, Inc.
- Other subscription services in the entertainment and media business, such as Netflix Inc., The Walt Disney Company with Disney+, and Alphabet’s Google with its Play Store.
- Other web services, such as Alibaba Group, Oracle, Microsoft Corp., Amazon.com, International Business Machines Corporation and Alphabet.
Our valuation
We evaluated the company using our discounted cash flow model. The model relies on the past 15 years worth of financial statements data in order to estimate the future growth of the company. Each company is valuated in a slightly different way, and in this specific case we estimated the future free cash flows for the next 10 years by estimating line by line each of the three main financial statements.
We made some assumptions in order to valuate the company:
- The terminal growth rate is 4.00%;
- The total shares outstanding are 16,406.40 millions;
- The effective tax rate during the forecast period will be, on average, 14.44%;
- The United States 10-year treasury bond yield will reach 2.70% by the end of 2022;
- The risk premium is 6.00%;
We used those assumptions to model the weighted average cost of capital, which resulted equal to 9.43%, and to estimate the future revenue growth and free cash flows. We estimated a fair value of $147.05, meaning that according to our valuation there is a possible downside in the stock price of 6.72%. Therefore, we give the company a “hold” rating. A lot of factors could influence the valuation, including but not limited to economic policies, markets development and real economic growth: therefore, we will update this valuation at the start of the next quarter.
