Can Apple’s service performance hold up $1.4 trillion in market value?

Apple will report fourth-quarter results today after the close, and investors will be looking for new evidence that the iPhone maker has a highly profitable subscription service. Apple’s share price hit $1.4 trillion and its price-to-earnings ratio is at a 10-year high. Apple’s share price has doubled in the past year, despite a decline in sales of the iPhone and other smartphone markets around the world.

Can The price-to-earnings ratio be a 10-year high, and can Apple's service performance hold up $1.4 trillion in market value?

Apple Chief Executive Tim Cook has been pushing to turn a loyal customer base into a stable source of revenue, including streaming video and credit cards launched last year in partnership with Goldman Sachs.

Another factor supporting Apple’s share price is that demand for the iPhone will eventually pick up with the introduction of 5G wireless technology, and the market is excited that low interest rates have contributed heavily to the stock market’s rise.

Apple shares closed down 2.9 per cent from their all-time high yesterday as worries about the economic impact of the outbreak hit Wall Street. Analysts will hear comments on the impact on Apple’s manufacturing operations in China on a quarterly earnings conference call after the market opens Tuesday.

On Wednesday, Apple’s market capitalisation briefly exceeded $1.4 trillion for the first time, but the company has yet to close at that level in one trading day.

Some investors worry that Apple’s rally and soaring price-to-earnings ratio may have gone too far.

John Conlon, chief equity strategist at People’s United Advisors, said: “Apple’s share price is worrying and I wouldn’t be surprised if there is a small correction in the near future.” He added that Apple’s service business had become the main reason he held Apple shares.

After the recent rally, Apple’s share price is now 23 times expected earnings, the highest multiple since 2010, according to Refinitiv. Over the past decade, Apple has averaged about 14 times earnings, lagging behind other high-growth companies in recurring revenue, reflecting apple’s single reliance on iPhone sales and its reliance on persuading consumers to upgrade their phones each year.

Salesforce.com and Netflix, which rely on recurring revenue, trade at more than 55 times earnings. Intel and Cisco Systems, technology hardware sellers, are expected to trade at about 14 times earnings.

Apple, which is on track to meet its target of $48.7bn in service revenue by the end of fiscal 2020, is now focusing on selling high-margin subscription services to its user base. Many investors are increasingly optimistic about the company’s earnings outlook, a trend reflected in the company’s soaring price-to-earnings ratio.

In addition to existing services such as cloud storage, the App Store and music, Apple last year launched an ambitious video streaming service, as well as credit cards, subscription news apps and video game services.

Apple has also stepped up its focus on appleCare, which extends its warranty program. For example, the iPhone’s Settings now includes reminders to encourage people to buy or update their AppleCare plans.

Apple said its service revenue reached $12.51 billion in the September quarter, beating analysts’ expectations of $12.15 billion. Service revenue accounted for 20 per cent of total revenue in the quarter, up from 17 per cent a year earlier.

Apple also released cost-of-sale data showing that gross margins in its services sector rose to 64% from 61% a year earlier. That’s well above Apple’s gross margin of about 38 percent in recent years.

For one of Wall Street’s most closely watched companies, however, Apple offers limited details.

Apple’s quarterly report revealed sales of iPhones, macs and iPads, but has so far not released details of sales of service products.

‘Fund managers are buying Apple stock to avoid underperforming the benchmark, continuing Apple’s recent strong stock price performance,’ Cowen analyst Krish Sankar wrote in a client note last week.

Analysts on average expected service revenue to grow 19.7 percent to $13 billion in the first quarter ended Dec, according to Refinitiv. Overall quarterly revenue is expected to grow 5.0 percent to $88.5 billion, and adjusted net income edged up 1.5 percent to $20.3 billion, or $4.55 per share.