Going sour on Apple over doubts for future growth

8 May 2013

Once upon a time buying Apple stock was a no-brainer - the share price just kept going up and up as iPhone followed iPod and iPad followed iPhone. But judging by the near-40% fall in the share price over the year to date, the party looks well and truly over. It begs the question: are Apple's best days behind it?

The fundamentals appear to be solid enough. Last year it was the highest-earning company in the US. The most recent earnings report, in January this year, showed revenue of $42 billion (£27 billion) for the first quarter of the 2013 financial year, which ended on 29 December 2012, producing a net profit of $13 billion. Its phones and tablet computers are still market leaders, and trading on a price/earnings ratio (P/E) of 10.2, Apple is a cheap stock, even if it costs you around $420 to buy a share.

Add to this the 70% of total smartphone profits that it rakes in on a profit margin of 38%, and it's perhaps hard to understand why some are writing off the company. Nevertheless, Apple's shares fell 10% after the financial first-quarter results and are now down 40% from the $705 all-time high. Wall Street was not looking forward to the second-quarter report on 23 April.

Why is the market mood souring on Apple, especially given that the company is still growing? For example, sales of its iPhones stood at 47.8 million in the last reported quarter, up 29% on the same time the previous year. Record figures indeed, but sales of phones running Google's Android smartphone operating system accounted for 69% of the smartphone market, doubling its share in a year, with Samsung out in front as the leading vendor. Apple didn't lose share, but it didn't gain either, staying at 19%.

Wall Street analysts worry that Apple's growth story is over. There's fear that developed markets, where Apple is strongest, are saturated and the growth opportunities will be in the emerging markets where Apple is weak. Consumers in India, China and Brazil certainly want smartphones, but not at Apple's prices. Apple has always positioned itself as a premium brand and that has served it well in developed markets, but it is not working so well elsewhere.

Analysts, from being overwhelmingly bullish on Apple, are now putting out more 'sell' notes or scaling back their price targets. Chief among their concerns are not just those saturated developed markets, but also the poor emerging markets penetration, the high prices of its products, the threat from Android phones and the range of models available on that platform, in particular the bigger screen sizes, and lastly the lack of visibility on new products to drive growth.

There are other issues too that could be thrown in, such as the impact of the loss of the leadership of former chief executive Steve Jobs, dubbed a visionary by industry pundits, who died more than a year ago, and the lack of communication by the company, a trait once seen as a virtue.

The most recent high-profile analyst to go sour on Apple is Goldman Sachs' Bill Shope. He worries about products: "The most recent product cycle has not driven the market share and new user growth we had anticipated." Shope removed Apple from Goldman's Americas Conviction List in April, although he still rates it a 'buy', for now. He expects to see the company addressing some of the issues it faces by introducing a low-cost iPhone, adding a larger-screen model to the product range and substantially increasing the dividend.

Emerging market weakness

Analyst Peter Misek at US stockbroker Jeffries & Co focuses on Apple's weakness in emerging markets, although it should be noted that China is the company's second-biggest market after the US. He contends that iPhone profits "peaked" last year and says a future "low-cost iPhone priced at $350-$450 may be too expensive" for emerging markets. Smartphones from India's fast-growing local firms Karbonn and Micromax sell for as little as $66.

Lowering iPhone prices to chase market share holds the danger of narrowing profit margins, which is likely to have been the case with the introduction of the smaller and cheaper iPad tablet - the iPad Mini - as its popularity cannibalises sales of the original higher-margin iPad. Misek sees Apple as vulnerable to "good enough" smartphones at attractive prices to higher-end units with compelling designs and features". This is the problem that Apple ran into in the PC market, where its more closed and expensive approach lost out to Microsoft's Windows operating system.

Many technology funds have sizeable Apple holdings and the AXA Framlington Global Technology fund is no exception, with the US giant accounting for 5.3% of the portfolio. Manager Jeremy Gleeson doesn't think Apple is about to make the same mistakes again and end up as a niche player. "I believe Apple knows its strengths better than it did 30 years ago," says Gleeson.

"If it needs to become less closed at some point, I believe it will, if and when it is in the interests of users." He agrees there is pressure on margins, citing Apple's lower guidance for its second quarter, but doubts "there is a correlation between its gross margins and its share of industry profits" as "there are a lot of players in the industry not making any money", and he struggles to "visualise how they will suddenly turn this around".

Gleeson admits the falling share price has "had a negative impact" on his fund's performance, but adds that "the stock has contributed significantly to returns over time". His fund is up by only 2.5% over a year and a healthier 40% over three.

Halo effect

Gleeson says Apple is a good long-term buy because, although there will be near-term volatility until there's more clarity "on what impact lower price devices have on its business model", the "halo effect will continue and the success of introducing a new generation of consumers to their products will deliver further hardware sales". He also points out that Apple is even cheaper than its 10.2 P/E if you factor in its $137 billion cash balance.

Tony Cripps, an analyst for consultancy firm Ovum, is also positive on Apple. He says the shares price collapse "shouldn't be seen as a surprise". He continues: "Explosive growth was always going to be followed by a slowdown at some point. Markets and analysts have reined in their expectations."

He's not too worried on the product cycle front either. "Apple has always been very good at staggering the introduction of products in different markets. It has always gone for this ratcheted approach and does it very well," he says. He does think Apple needs "to make a splash in the home environment" but is cool on the idea of a cheaper iPhone. He concedes that "it will be difficult for Apple to maintain its margins over the long run" but he "can only see a cheaper iPhone happening if it serves topline growth".

California-based Walter Price, manager of the RCM Technology trust, is dismissive of the naysayers, but understands that Apple can't stand still. "There's no doubt that Samsung's got some attractive alternative devices for people that want a bigger screen, for example, or for women that like the Note [halfway between a tablet and a phone that makes calls and uses a stylus], while in Asia it is popular because it is easier to enter characters."

Could Apple go the way of Nokia?

Apple must meet the challenge, he insists: "Apple need to have more models. In my view the iPhone 5 [Apple's most recent phone release] is nice but they need to have a wider-sized phone." Nokia was once dominant in mobile telephony but is struggling in the smartphone market.

Could Apple go the way of Nokia? "In the case of Nokia you had a shift from hardware to software. With software you have more lock-in and loyalty, a user interface that's familiar plus all the content. So it is stickier and more durable than you might think looking at history because of the ecosystem," Price replies. He thought the share price was vulnerable to a weak reception for the iPhone 5 and was right, and he says Apple needs to stay focused on making premium products while still addressing more market segments.

Apple at these prices looks like a buy for traders, although the shares may fall further after the fiscal second-quarter results.

Long-term investors while comforted by the fundamentals, may need to keep a keen eye on the product cycle to make sure Apple is still innovating.

If Apple starts to consistently raise its dividend over the next few years, it could even start to look like an old-fashioned value proposition.

What's in the pipeline?


A smartwatch could include ways of interacting with other Apple devices. It could also monitor your body to produce biometric data such as how far and fast you've walked and blood pressure.


Steve Jobs mentioned having "cracked" TV in the official biography by Walter Isaacson released after his death in October 2011. An Apple TV, in addition to connecting to the internet, could be voice-controlled.

Low-cost iPhone and bigger screen model

A cheaper iPhone with a larger screen to sell in the emerging markets and compete with Android devices.


Apple may be about to launch a streaming music service similar to Spotify.


Apple has a large number of games in its app store and might move into full-blown gaming, disrupting the businesses of current hardware and software providers.

iPhone 5S

The next iPhone may use fingerprint technology.

Add new comment