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Is the Worst Over for Apple?

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It wasn’t all that long ago that Apple (AAPL - Free Report) became the first US corporation with a trillion dollar market cap and that they could do no wrong. Huge institutional ownership of shares and big weights in the major indexes seemed to assure for a while that the value of Apple would continue to trend upward as long as the broad markets did.

Even when other big-cap tech stocks like Amazon (AMZN - Free Report) and Facebook (FB - Free Report) began to show weakness, Apple kept climbing, eventually hitting an all-time closing high of $232.07/share on October 3rd.

That’s when things started to get rough.

On November 1st, Apple’s fiscal 4th quarter results spooked investors for a few reasons. Even though overall revenues and earnings surpassed expectations and the Services business unit enjoyed its best quarter ever, unit sales of Apple’s flagship iPhone products were essentially flat. Apple’s curious decision to announce that they would no longer be breaking out unit sales figures in future reports further stoked fears that Apple’s sales of popular products had peaked.

Subsequently, several of Apple’s parts suppliers warned of lower revenues and though none of them mentioned Apple by name, the markets surmised that Apple had been cutting back on future orders for components in expectation of continued sluggish sales.

In prior periods, Apple has been able to compensate for sluggish unit sales growth by raising average selling prices and because of their innovative and desirable product mix, consumers kept buying anyway. Unfortunately, there’s some maximum price customers are willing to pay for phones, tablets and computers before demand suffers and it appears that Apple may be getting close to saturating those markets at the current price points.

The effect of current and future tariffs, a lawsuit with Qualcomm that threatens Chinese sales and a US federal lawsuit about Apple’s pricing policies for apps in the Apple store all threaten to harm the company’s performance, though the potential effect of each is difficult to quantify.

Though it’s been a rough couple on months for most stocks, Apple shares have bee punished worse than most, down almost 26% since the old highs.

The Bull Case

When the market starts looking for bad news, even basically innocuous details start to look sinister.

Flat Sales (Even though you’ve had spectacular sales for years)? Sell it.

Potential exposure to the trade war or US – China relations? Sell it.

Lawsuit that won’t be decided for months or years (and may well never produce any significant fines or sanctions)? Sell it.

All that selling now has Apple shares priced at a forward P/E ratio of just 12.7X, and Apple still has plenty of gas in the tank.

Analyst estimates for this quarter and FY 2019 have been relatively stagnant lately, earning Apple a Zacks rank #3 (Hold).

The accessories business is still going strong. It’s easy to focus solely on phones, but don’t forget about earbuds, watches, Apple TV, home internet routers, etc. Sales in the Services division – like Apple music, storage and third party apps - continue to grow at double digits, up 17% YoY in the most recent quarter. Those sales come at high gross margins with marginal infrastructure costs.

Finally, Apple has always been good at surprising the world with new products that no one had any idea they even wanted until they needed them.

(What’s your recollection of what a cell phone was like before the debut of the iPhone in 2007?)

Though we’ve seen several product cycles the past few years that have been incremental improvements of existing products, it would be foolish to discount the possibility of another groundbreaking product currently in the works. Automotive products are the most often predicted next breakthrough and Health Technology is always on the table, but with Apple, there’s always the possibility of something no one’s even imagined yet.

Time and time again, Apple has rewarded stalwart investors with great products and even better financial results. It’s definitely too early to count them out now.

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