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Apple Stock: Services to Drive Margins Higher
Stock Analysis & Ideas

Apple Stock: Services to Drive Margins Higher

Few companies can compare to Apple (AAPL).

Apple is currently the world’s most valuable company, boasting a market cap of $2.4 trillion.

The company has been rewarding its shareholders consistently, with fat returns, while showing no signs of losing any momentum.

Apple recently unveiled the iPhone 13 and Watch Series 7 in its fall hardware event. While the phone itself shares many similarities with its predecessor, adding relatively few (though useful for professionals) new features, it should serve Apple greatly in the upcoming hardware cycle.

In my view, however, the more exciting catalyst for Apple going forward is the growth in its Services segment, which should expand its recurring revenues, expand margins further, and consequently, extend the bottom line.

I am bullish on the stock. (See Analysts’ Top Stocks on TipRanks)

Services: The Next Catalyst

By controlling the hardware part of the business, Apple has created a platform in which it is set to profit greatly from the Services section.

For Apple, it’s all about exclusivity, compatibility, and an all-in-one ecosystem. With a massive installed base of iPhones globally, the company can easily boost its financials by offering additional services to its users, and expanding vertically.

This includes the App Store, Apple’s cloud services, music, video, advertising, and payment services, and last but not least, Apple Care. Last year, total Services revenues amounted to $53.8 billion, an increase north of 100% since 2017.

To refresh your memory, back Apple had set a target in early 2017 to double its Services revenues by 2021, and the company has clearly succeeded in doing so.

In Apple’s latest results, Services revenues came in at $17.5 billion, 33% higher year-over-year.

Due to Services being a very scalable business model with little to no incremental expenses as it grows, gross margins from Services have steadily been increasing. They expanded from 60.8% in 2018 to 66% in 2020, and in Apple’s latest results, they further improved to 69.8%.

With the company set to flood the market with more devices as another cycle is upon us, a higher percentage of users are about to be subscribed to Apple’s services, once again boosting this metric.

Services will increasingly become a larger contributor to the bottom line, which along with the company’s massive buybacks, should result in consistently higher EPS.

Moreover, with services infiltrating into a larger chunk of the iOS user base over time, it’s increasingly unlikely that one will switch to the competition.

Once one is well-rooted in Apple’s ecosystem, switching to, say Samsung, becomes a drag; a counterproductive process.

Valuation

Over the past few years, Apple’s valuation multiple has undergone a significant expansion.

Some investors have argued that this is not deserved, considering that Apple is, after all, a hardware company, which inherently classifies its revenues as cyclical.

However, this is hardly the case. With a predictable cycle of new hardware and services involving recurring cash flows, Apple’s revenues have grown in quality.

For this reason, a premium is well-deserved, in combination with Apple’s other multiple qualities.

Based on EPS estimates for the year at $5.58, the forward P/E of 26.3 is well-justified.

Wall Street’s Take

Turning to Wall Street, Apple has a Strong Buy consensus rating, based on 19 Buys, six Holds, and zero Sells assigned in the past three months. At $169.86, the average Apple price target implies 15.9% upside potential.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

Disclaimer: The information contained in this article represents the views and opinion of the writer only, and not the views or opinion of TipRanks or its affiliates, and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices or performance.

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