Apple stocks close years of discount as earnings risk subsides

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(Bloomberg) – Apple Inc., the largest U.S. company by market value, has received little respect from equity investors. Until now.

For the first time since 2011, shares of the iPhone manufacturer have had a higher price-earnings ratio than the S&P 500 for months within a year in which the valuation of the share has almost doubled. This is a reversal from the previous nine years when concerns about lack of product innovation put the stock at a constant discount to the market.

This is due to the fact that Apple has focused on tapping into an ecosystem with nearly 1.5 billion users in order to generate a steady stream of profits. According to Gene Munster, a long-time Apple analyst and founder of Loup Ventures, the increasing contribution of services such as iCloud Storage and Apple Music makes the business more stable and therefore deserves a higher multiple.

"Investors are slowly becoming familiar with the concept that a company with a combination of software, hardware and services can be a reliable business," said Munster.

According to analyst estimates, Apple's earnings will increase from quarter to quarter over the next three years. Such an uninterrupted growth phase has not occurred since 2012, according to Bloomberg. Profits will increase by 10% in 2020 and will continue to grow at a steady pace over the next two years.

The prospect of steady growth is one reason investors are willing to pay for Apple stocks, even after earnings fell two consecutive quarters last year. After an increase of 86% in 2019, the share is trading at 25 times the previous year's profit, the highest level since 2008. In contrast, the S & P 500 is a multiple of 21.7.

The rally has helped Apple close the gap with technology giants like Facebook Inc. However, it still lags behind Alphabet Inc. (31x profit in the past 12 months) and Microsoft Corp. (32) Assume the company's expansion beyond smartphones.

Software companies typically have a multiple higher than that, as customers commit to purchasing services for longer periods to make sales more predictable. Apple Bulls argue that the large user base offers a similar recurring source of income.

The scale of the Apple rally in 2019 has raised concerns that the stock could be withdrawn. Seven of the 49 Bloomberg analysts who deal with Apple have sales ratings, the highest in at least nine years. At the close on Friday, the share was already 10% above the average target price on Wall Street.

Apple's continued confidence in iPhones for at least half of its sales is a bearish argument. Price tags of $ 1,000 or more make the company vulnerable to economic slowdowns. Profits declined again in 2016 and mid-last year, due in part to declining demand in China.

However, the share of sales of the iPhone has shrunk in recent years. This is due to the decline in smartphone sales and the steadily growing service portfolio. In addition to key products such as the App Store and AppleCare subscriptions, the company has launched the TV + streaming service along with subscriptions to arcade video games.

Revenue from services is expected to increase to $ 54 billion in fiscal 2020 and, according to Bloomberg, account for one-fifth of the company's total revenue, which was 18% at the end of 2019.

Apple's services and the success of wearables like AirPods and Apple Watch help make it easier for investors to pay for the stock, says Kevin Walkush, portfolio manager at Jensen Investment Management Inc., who owns Apple stock.

"The service business has really developed," and wearables "are growing very strongly," he said in an interview. "When you step back, you see all of these different ways to grow, but also to increase your ecosystem and the stickiness of that ecosystem due to services."

– With the support of Mark Gurman.

Contact the reporter about this story: Jeran Wittenstein in San Francisco at jwittenstei1@bloomberg.net

Contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Lu Wang

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