Thursday, March 28

Apple Stock: I’d Rather Buy The SPY (NASDAQ:AAPL)


Nikada/iStock Unreleased via Getty Images

Investment Thesis

There’s no denying the incredible success of Apple (NASDAQ:AAPL) as a company and as an investment. Indeed, Apple even enticed investing legend Warren Buffett, who typically stays away from technology stocks, to take up a billion-dollar position back in 2016. But, as many of us know, the larger a snowball gets the harder it is to roll, to the point where it’s so large it can’t be rolled at all. With a near $2.5 trillion market cap, Apple is an enormous snowball. To put it in perspective, Apple is the size of 25 PayPal’s (PYPL). It takes an enormous amount of money to move Apple, whether that be revenue, earnings, or investors.

Apple has an impressive track record of innovation with products such as the Apple Watch, Air Pods, Apple TV, and Apple Pay. But how many more homeruns could be left in this behemoth? Just as important a question, how far outside the park must Apple hit these homeruns to have a meaningful impact on revenue and earnings?

I’m not betting against Apple’s ability to innovate. I’m betting against their ability to replicate past success in a manner that’ll grow EPS well above the S&P 500. In my opinion, Apple is a snowball that’s just too hard to move. Because of this, I think investors are better off buying the SPY.

Where is Future Growth Coming From?

I think most of us will agree Apple has pretty well saturated the smartphone market in the US. As of 2021, data shows Apple had 46.9% of the US smartphone market with share gains growing at a very slow pace. I see no reason to believe iPhone share gains will be any better than the recent past.

Screenshot from Statista

iPhone Market Share (statista.com)

Apple’s second-largest market is Europe where they hold a 32.3% share. Apple holds a microscopic edge over Samsung as a market leader. Share gains in Europe have also moderated in recent years similar to the US.

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Screenshot from statcounter.com

Apple Market Share – Europe (Statcounter.com)

Perhaps China can save the day? Apple recently reclaimed the number one spot as a smartphone provider in China. Apple overtook competitor Huawei after Huawei was negatively impacted by US sanctions. So, one could argue Apple’s 23% leading market position is somewhat artificial.

Either way, with saturated markets in the US and Europe and a fierce competitive environment in China, I don’t see market-beating returns coming as a result of increasing iPhone sales which are the backbone of the company.

So, where will Apple turn to produce the +15% per year (or approximately $15 billion in year one) earnings growth investors are accustomed to?

Share Repurchases

Over the past 10 years, Apple has spent an astonishing $467 billion on share repurchases, reducing the total number of shares outstanding by 4.4% annually. Share complaints have been a foundation of Apple’s annual EPS growth and I fully expect this to continue in the future. While I’m a fan of shared repurchases, I don’t prefer when they’re the primary form of EPS growth.

Screenshot from Quickfs

Shares Outstanding (Quickfs.com)

To put it in perspective, share repurchases accounted for the following percentage (approximate) of annual EPS growth for Apple:

  • 2017: 47% of YOY EPS growth
  • 2018: 21% of YOY EPS growth
  • 2019: Not measurable because EPS growth was negative
  • 2020: 62% of YOY EPS growth
  • 2021: 9% of YOY EPS growth

Prior to 2021, share repurchases often accounted for a significant portion of EPS growth. I view 2021 as an outlier due to the amount of fiscal stimulus injected into the economy, which drove up revenue for many companies, including Apple.

Products & Services

Apple has numerous products and services of which I am a satisfied customer. These include the iPhone, iPad, Apple Watch, Air Pods, AppStore, Apple Pay, and Apple Music. I greatly enjoy each of these and believe they offer excellent value.

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Apple’s fastest growing categories are Wearables, Home & Accessories and Services. Over the past 5 years, Wearables, Home & Accessories has grown revenue at a 31.5% CAGR while Services clocks in at 20.3%.

Here’s what’s included in each per Apple’s 2021 10-K filing.

Wearables, Home and Accessories net sales include sales of AirPods, Apple TV, Apple Watch, Beats products, HomePod, iPod touch and accessories.

Services net sales include sales from the Company’s advertising, AppleCare, cloud, digital content, payment and other services. Services net sales also include amortization of the deferred value of services bundled in the sales price of certain products.

excel screenshot

Revenue by Category (Author’s personal data)

As seen in the table above, iPhone, Mac, and iPad sales have been fairly lumpy whereas Wearables, Home & Accessories and Services have been steadily increasing.

Using this information, I can make an educated guess on future revenue growth for Apple. In the table below, I de-rated the revenue CAGR for each category to reflect a more modest expectation of growth.

excel screenshot

Forecast Revenue by Category (Author’s personal data)

Valuation

Using the market multiple approach, I arrive at a 2026 target price of $197 for Apple, which includes share repurchases but excludes dividends. I assumed revenue growth of 10.3% (table above), net margins of 23.2% (5YR avg), a long-term PE of 20, and reducing shares outstanding by 4.5% annually.

  • 2026 revenue estimate = $593 billion
  • Net income = $593 billion x 23.2% = $137.6 billion
  • Shares outstanding reducing from 16.9 billion in 2022 to 14.0 billion in 2026
  • 2026 EPS estimate = $137.6 billion / 14.0 billion = $9.83
  • Fair value = 20 (PE) x $9.83 = $196.60

With today’s price of $154 per share, a target price of $196.60 would constitute a 5-year CAGR of 5%. Not exactly a market-beating return in my opinion.

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From a DCF perspective, I show an intrinsic value of $156, which doesn’t offer an acceptable margin of safety. I used an 8% discount rate and 2.5% terminal growth rate. I assumed Apple will continue reducing total number of shares outstanding by 2.5% annually and grow FCF by 7.4% annually (below the 10 YR CAGR of 10.8%).

excel screenshot

DCF Valuation (Author’s personal data)

Aren’t There Risks To The SPY?

Of course, stocks and ETFs aren’t called risk-assets for nothing. In the current macro environment of rising interest rates, sky-high inflation, and a looming recession, investing anywhere is risky. To quote Mr. Buffett:

Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.

History says 10 or 20 years from now, the market will be higher than what it is today, so it’s important to keep a long-term perspective. In the current environment, dollar-cost averaging may be the best approach. And if you find yourself stressed about unrealized losses in 2022, that’s probably a good sign you’re invested too heavily, either in general or in an individual position. How well you sleep at night is often a good gauge of portfolio health.

Conclusion

Apple is a phenomenal company with a bright future, but I find it hard to believe it’ll offer market-beating returns in the coming years. At its current share price, Apple appears to be fairly valued and doesn’t offer an acceptable margin of safety. Investors looking to 5x their money in the next 5 to 10 years likely won’t be able to do so owning Apple. It’s simply too large a snowball. Because of this, I think investors are better served buying the SPY where they’ll get indirect exposure to Apple, de-risk their portfolio, and have a decent chance of outperforming Apple in the long term.

Readers interested to learn more about my view of the S&P 500 index should check out the article: Equity Risk Premium: A Profound Revelation, But Not Really.


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