This article was written by Talia Shakhnovsky, a Financial Analyst at I Know First.
“The combination of negative investor sentiment, the potential for a services acceleration in June, and a low bar for September guidance keep us positively biased into earnings.”
– Morgan Stanley equity analyst Katy Huberty
Summary:
- Recession risk is increasing due to trade tensions and consumer pullback.
- Within the Technology Sector, Apple stock is stable and efficient compared to competitors.
- Apple’s settlement with Qualcomm, potential purchase on Intel’s modem-chips, and 5G investments are key steps towards further growth.
- Apple’s financial statement supports a long-term bullish outlook, with a potential share-price of $246 in one year’s time.
Market Overview: Recession Fears
Growing possibility of a recession is influencing current market trends. According to the New York Federal Reserve, there is a 33% chance of an economic downturn within the next year, the highest risk level since the Great Recession. Morgan Stanley’s chief U.S. economist Ellen Zentner concurs: “For now, the path to the bear case of a U.S. recession is still narrow, but not unrealistic.” She explains that escalating trade tensions and tariffs combined with tighter financial conditions may cause pullback from consumers. As a result, “Corporates may start laying off workers and cutting capex as margins are hit further and uncertainty rises.” To combat these worries, the Federal Reserve is expected to cut interest rates by a quarter of a percentage point as “insurance” against a recession.
For investors, a recession may decrease stock prices, especially in the auto and tech sectors. In this concerning stock market environment, Apple (AAPL) is a bullish long term investment. Along with being an icon of innovation, it is a leader in market share – 80.4 million Apple smartphones are in the U.S. market alone or 46% of the U.S. market. As a result, investors should look to AAPL which can succeed in a recession due to its strong competitive position, recent business updates, and secure financials.
Apple Competitive Position in Technology Sector
Apple belongs to the technology sector within the consumer electronics industry. Relative to both its sector which averages PE of 17.6x and the U.S. market which average a PE of 17.9x, Apple has good value based on earnings with a PE of 17.3x. Furthermore, Apple’s return showcases its strong position. Over one year, Apple’s return was 8.1% outperforming the U.S. technology sector’s return of 3.4% and the U.S. market’s return of 3.3%. Apple’s return on assets is 16%, compared to the technology average of 6.2% emphasizing that Apple uses its assets more efficiently than the technology sector as a whole. Finally, Apple’s expected return on equity is 96.7% vs. the technology average of 9.20% – Apple demonstrates outstanding use of shareholder funds. As a result, compared to its sector, Apple is a stable and efficient investment.
Apple’s Business Growth Analysis
Apple Inc. was founded in 1977. It designs, manufactures, and markets products including smartphones (iPhones), tables (iPads), and personal computers (Macs). It also sells services like iCloud which provides cloud storage, Apple Pay which provides cashless payment, and Apple TV. Along with recent releases like the July 23rd, 2019 operating system update and improving iPhone sales in China, Apple’s settlement with Qualcomm, upcoming purchase of Intel, and 2020 product lineup will continue to drive its growth.
After a multi-year patent dispute, Apple entered into a settlement agreement with Qualcomm, a semiconductor and telecommunications company. Qualcomm’s Q2 earnings reveal that it received at least $4.5 billion from Apple. Throughout Apple’s struggle with Qualcomm, Apple exclusively used Intel’s modems. However, Apple decided that Intel’s modems would not be ready in time for a 5G, the next generation of high speed wireless, iPhone. As a result, Apple bought a six-year patent licensing agreement with Qualcomm to secure Qualcomm’s services as a parts supplier.
Furthermore, Apple is in talks to buy Intel’s smartphone-modem chip business in a deal valued at $1 billion or more. Smart-phone modem chips are the technology that allow phones to connect to wireless data networks. This purchase also includes Intel’s development research for 5G chips. Apple intends 5G chips to differentiate its technology from the rest of the market as global smartphone sales plateau due to phones lasting longer. Apple has also hired engineers, including some from Intel, and announced plans for an office of 1,200 employees in San Diego as part of its 5G development process. Apple expects to launch these 5G iPhone models in 2020. Raymond James analyst Chris Caso upgraded Apple shares to market outperform because he believes that Apple will offer 5G models across the price spectrum which is a “compelling” reason for upgrades at a time when Apple is increasingly selling “legacy” devices. By settling with Qualcomm, Apple ensured that it is on track to launch 5G next year.
Apple Stock Projection: Financial Position
Apple’s financials demonstrate why it is likely to be a bullish long-term investment. Apple’s expected earnings growth is 2.9%, exceeding the low risk savings rate of 2.7%. Moreover, year on year earnings growth has been positive over the five years with one-year earnings growth (7.3%) exceeding the five-year average (6.3%). Current annual income from dividends is 1.49%, and this value is also expected to increase to 1.53% by next year.
Apple’s balance sheet indicates the health of this investment. Dividends paid are well covered by earnings (4.1x coverage) as are dividends after three years (expected 4x coverage). Apple earns more interest than it pays, so coverage of interest payments is not a concern. Furthermore, debt is well covered by operated cashing flow. Coverage exceeds 20% of total debt, at a high 63.8%. Apple is also able to meet its short-term commitments with holdings of cash and short term assets. Overall, Apple has a low level of unsold assets and debt is covered by short term assets with assets at 1.1x debt.
Analysts agree that Apple is a safe investment. Morgan Stanley equity analyst Katy Huberty expects third-quarter services revenue growth to accelerate for the first time since March 2018 which is “a key catalyst for regaining investor confidence.” Huberty is also bullish about the 5G iPhone cycle, describing it as “a more meaningful impact on iPhone shipment growth as compared to the iPhone X, which was launched at a time when replacement cycles were lengthening due to the shift away from handset subsidies.” In total, 11 analysts rated Apple as a strong buy, 21 rated Apple as a buy, and 6 rated Apple as a hold. Apple’s current price is $207.74; analysts have Apple at an average price target of $213.41 and a high of $250.
Conclusion: Apple Stock Projection & Valuation
Apple is currently trading at $207.74 a share, approaching May 3rd’s year-to-date high of $211.75. While the markets as a whole including the Technology sector may struggle as recession fears rise, Apple’s 5G innovation will secure its growth.
At a share price of $207.74 and 4.6 billion outstanding shares, Apple’s current value is $956B. 58% of Apple’s total revenue over the past year came from iPhone sales, followed by services (17%), Mac sales(10%), iPad sales (8%), and finally wearable/home/accessories sales(7%). Consequently, Apple’s total revenue increases when it sells new products (83% of revenue) or increases subscription to its services (17% of revenue). J.P. Morgan expects technology sales to increase by 8.33% due to the new features on Apple’s 2020 iPhone. Services are Apple’s fastest growing sector, with 24% year-over-year revenue growth; if services continue to grow at the same rate, sector revenue may increase by approximately 24% over the next year. Based on the relative growth rates of Apple’s sectors, its total revenue growth rate may approximately be modeled by 0.83*1.08 + 0.17 * 1.24 = 1.1072, or roughly 11% revenue growth over the next year to reach approximately $287 billion.
With a net income margin of 22.4%, net income will be approximately $64.288 billion. Earnings per share equals net income divided by the number of shares – assuming number of shares stays consistent, Apple’s EPS in a year may be 13.98. Finally, Apple’s current PE ratio is 17.6 – estimated share price equals earnings per share times the PE ratio. In a year, Apple’s share price may reach $246. Thus, I predict Apple will continue its growth with an expected share price of $246 in one year, in accordance with I Know First’s bullish forecast.
Post Earnings Release Update
On July 30th, 2019, Apple Inc. published its Q3 Earnings Release. Investors should note that net income fell 13%, while Q3 revenue grew 1% year over year. Moreover, iPhone sales continued to decline, becoming less than half of Apple’s revenue for the first time since 2012. On the other hand, Apple recorded gains in services (up 12.7% YoY) and wearables (almost 50% YoY). Mac and iPad revenue both increased as well, jumping near half a billion each. Globally, Apple continued its global growth in China (17% revenue growth YoY) – but not due to iPhones sales which dropped 12% globally . CEO Tim Cook also announced the upcoming August release of the Apple Card in the US in a call about the Earnings Release. Overall, CFRA Research Angelo Zino concludes that Apple “essentially beat fairly low expectations.” Apple stock grew 4% after Apple’s Q3 Earnings Release.
Current I Know First Apple Stock Projection
I Know First’s machine learning algorithm has a positive outlook for AAPL. Apple stock is bullish over the 1 month, 3 months and 1-year horizons. For the 1-year horizon, the signal is strongest at 191.25 with a predictability indicator of 0.7.
Past I Know First Success – Apple Stock Projection
On March 11, 2019 I Know First published a bullish forecast for AAPL. Since then, Apple stock price has risen 20.14%, highlighting another success of I Know First’s algorithm.
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