Investing In Apple: The Risks and Rewards

In 2007, Apple, Inc. (AAPL) launched the iPhone to tremendous success. The vision of the company’s founder, Steve Jobs, came to fruition as Apple captured both mindshare and market share while redefining the hardware and software world. Along the way, it endeared itself to new generations of consumers.

The resultant impact on the company's stock was even more impressive. It started around $12 and continued its rise through a global financial crisis to land, eight years later, around $127. With no end in sight, the rewards of holding AAPL seem limitless, but are there risks ahead that investors may be dangerously overlooking?

Apple’s Rewards

If you had been lucky (or some may call it brilliant) enough to envision the impact the iPhone would have on Apple’s earnings and margins and invested in the stock a decade ago, you would be ecstatic over the rewards garnered from your position. And while the stock has continually ignored the direction of the markets by moving (for the most part) in an upward trajectory, the question remains: Do the future rewards outweigh the risks? Let’s consider four points:

1. Most analysts agree iPhone sales drive AAPL. Penetration into new markets, particularly the success of its venture in China, will largely determine if the company can produce strong year-over-year growth. The company can also explore new areas, such as game consoles, streaming services, watches, other “wearables,” and the TV/DVD/set-top box markets. And while these may produce avenues of future growth, they will not drive near-term (the next 18 months-two years) earnings growth like the expected growing domestic demand for the iPhone.
2. In April 2014, the company announced a large capital return program in the form of share repurchases and dividend increases that rewarded shareholders. The expectation is that will be another similar announcement in 2015, the impact of which will be felt into 2016.
3. Apple’s trailing price-to-earnings ratio is 17.1x (just slightly above the Standard & Poor’s valuation) with expected growth to outpace the market’s, making it an extremely attractive valuation.
4. A strong cash position on its balance sheet is cited by many as a catalyst for growth, or at the very least, continued share repurchases. 

Apple’s Risks

It is hard to compete with strong stock appreciation and anticipated continued strong growth, but there may be risks investors are overlooking.

Again the focus is on the iPhone for near-term risks. A slowdown in the growth and penetration of the smartphone market could be exponentially more painful for Apple, as over half its current revenues come from its iPhone products. A slowdown in any of the following could materially reduce Apple’s multiple and stock price: overall smartphone market growth, iPhone market share growth, or penetration into China. Considering that analysts’ predictions for iPhone sales are bullish for this year, next year could show negative comps or a year-over-year decline, which would effectively knock down the stock's multiple. 

Future growth is dependent on new product categories or on a product that would redefine a current category. Some skeptics wonder why the company is so keen on returning its cash via share repurchases and dividends instead of re-investing into research and development or making acquisitions. There is the risk that the company will be unable to sustain its “innovative” strategy in the future because it is not putting that cash to work today to discover the technology of tomorrow. 

The Bottom Line

Apple has been synonymous with growth and innovation, capturing all of a consumer’s technology dollars with its personal computing (Mac), smartphone (iPhone), and tablet (iPad) products, effectively raising switching costs to an undeniably high level. The risks lie in the company’s future ability to keep those consumers while drawing in new ones in more markets. New technology makes consumers fickle. They want the newest and best, and brand loyalty will be sacrificed to own the next greatest gadget. The risk is that Apple will not be in the running when the new wave comes rolling in.