Apple’s market value has almost doubled in the past year. For the first time since 2011, the iPhone maker’s price-to-earnings ratio has consistently outperformed the Standard and Poor’s 500 index for several months. This is in stark contrast to the past nine years, when Apple’s share price has been below market levels as investors worry about a lack of product innovation.
The shift in sentiment is due to Apple’s focus on developing an ecosystem of nearly 1.5 billion users to generate a steady stream of profits. Gene Munster, founder of Loup Ventures, says the growing contribution son to services such as iCloud storage and Apple Music is making Apple’s business more stable and therefore deserves a higher price-to-earnings ratio.
Apple’s earnings are expected to grow each quarter over the next three years, according to analysts’ estimates. The company expects profits to grow 10 percent in fiscal 2020 and maintain that growth for the next two years.
Despite two consecutive quarters of declines in Apple’s earnings last year, investors are willing to pay high prices for Apple’s stock, in part because the company is on track for steady growth. The stock is up 86 per cent in 2019 and is trading at 25, its highest level since 2008. By contrast, the Price-to-Earning Sable is 21.7.
The 2019 rally has helped Apple close the price-to-earnings gap with tech giants such as Facebook. But it still lags behind Alphabet and Microsoft, which trade at 31 and 32, respectively. Munster expects Apple’s price-to-earnings ratio to continue to rise as more investors embrace Apple’s expansion beyond smartphones.
Software companies typically trade at a higher price-to-earnings ratio because customers commit to buying services for a period of time, making sales more predictable. Apple-like spending is a similar recurring source of revenue for Apple’s vast user base.
However, Apple’s sharp rise in 2019 has also raised fears of a correction. Seven of the 49 Apple analysts gave a sell rating, the most in at least nine years. By Friday’s close, the stock was 10 per cent above Wall Street’s average target price.
At least half of Apple’s revenue is still dependent on the iPhone, another reason analysts are bearish. The price of the iPhone of up to $1,000 or more leaves the company vulnerable to a slowdown.
However, the iPhone’s share of revenue has been declining in recent years as smartphone sales slow and its service mix continues to expand. In addition to mainstream app store and AppleCare subscriptions, the company has also launched a TV-plus streaming service and an Arcade video game subscription service.
The market expects service revenue to rise to $54 billion by fiscal 2020, a fifth of the company’s total sales, up from 18 percent at the end of 2019.
Jensen Investment Management Inc. Kevin Walkush, portfolio manager, says the success of Apple’s portfolio and wearables such as AirPods and Apple Watch has made investors more willing to pay for Apple stock.
He said “there has been real progress in the service business” and that wearables were “growing very strongly”. “You’ll see all these different growth opportunities and the stickiness of the ecosystem that increases as a result of services. “