Why Is Apple Stock Falling: What's The Outlook?

Summary

• Both macro and company-specific issues have led to a decline in Apple stock.
• Apple is still a bit expensive relative to its historical P/E ratio.
• Investors who buy Apple today will probably do okay in the long run.
• Looking for a helping hand in the market? Members of Tech Investing Edge get exclusive ideas and guidance to navigate any climate. Learn More »

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Thesis

Apple (NASDAQ:AAPL) stock has been falling along with the rest of the market due to macro concerns and a mixed Q2 earnings report. Most of these concerns - like a recession weakening consumer demand - are temporary, and I expect Apple to deliver solid blue chip-like returns in the coming decade.

AAPL Q2 Earnings Review

Apple reported Q2 earnings a little less than a month ago on April 28th, beating by 4% on revenue and 6% on EPS. Since then, AAPL stock has fallen 16% while the overall market has fallen 9%. So, it seems like the market reacted negatively to Apple's earnings despite the top and bottom line beat. I've identified two issues with the recent earnings that may have caused the selloff.

The first is that Apple guided for a $4B-$8B hit from supply chain constraints due to a silicon shortage in the next quarter. Apple is the largest company in the world and thus the largest customer of virtually all of their suppliers, such as Taiwan Semiconductor (TSM) and Skyworks (SWKS). Normally, this gives Apple a lot of leverage in essentially bullying their suppliers into prioritizing their orders and giving them good deals. So, Apple having major supply chain issues was unexpected, and these issues will likely reduce Q3 revenue by a high single digit percentage. I estimate that they could reduce Apple's FY22 revenue by 2-3%.

Tech Investing Edge

The other issue was more subtle, and that is decelerating growth in the services business. The rapid growth of services has been used to justify AAPL stock's P/E multiple expansion in recent years, since companies with high margin recurring revenue tend to earn higher multiples. As shown in the chart above, services growth had already been decelerating for a few quarters, and that trend continued in Q2. Even worse, management guided that this deceleration will continue going forward. With 825 million active subscriptions, there simply may not be that much room left to grow.

Considering these two issues, I believe that investors were right to sell AAPL stock until it reached a lower P/E multiple. On the night of earnings, I warned members of my marketplace service Tech Investing Edge that investors might react negatively to these earnings, and that I would have a neutral rating on Apple until it got closer to 20 P/E.

Macro Concerns

In addition to issues specific to Apple's earnings, the whole market is already jittery due to issues like inflation, war, Covid, and a possible recession caused by the Fed raising interest rates.

Apple is often a considered a fortress stock that will be less impacted by these macro issues than other cyclical consumer brands. This is because Apple has a wide moat thanks to its strong brand and superior technology such as the M1 chip. Many Apple customers only want Apple products and won't settle for alternatives from companies like Microsoft (MSFT), Google (GOOG) (GOOGL), and Samsung - even if that means paying a higher price. This gives Apple strong pricing power, and as a maker of premium products their customers are well-equipped to absorb these higher costs.

Even so, no company is completely immune to poor economic conditions. Apple would be negatively impacted by a recession because it would mean that fewer people could afford to buy new devices and services, reducing Apple's revenue and growth rates. The full extent of this impact is difficult to measure because future economic conditions are not completely predictable.

But recessions come and go over time. For those who plan to invest for decades, the current macro issues should resolve themselves in the coming years. After that, the long-term story continues to look positive for Apple, since they are still very profitable, far from their cash neutral goal, and popular with younger generations.

Valuation & Factor Grades

Seeking Alpha

According to Seeking Alpha, Apple does very well when it comes to most factors. Considering that Apple is a slower growing blue chip, investors shouldn't expect market-leading growth from the company and should be satisfied with the C- growth score.

Thus, the main point of concern is valuation, since even after the recent selloff Apple gets an F. This score contradicts the average analyst price target of $190, which implies 39% upside from the current price. However, analysts have a wide range of targets; my favorite analyst Morningstar has a $130 price target, which is a few dollars below the current price.

Despite Apple's P/E falling sharply from 35 to 22 over the past year, it's still above the 10-15 P/E range that Apple traded at prior to Covid. For a company with single digit growth, the 10-15 P/E range is usually more reasonable, since investors often expect a company's P/E to match its growth rate. However, Apple is a very high-quality company with industry-leading margins and ROI, very shareholder friendly policies, and one of the widest moats around. I would argue that this means that Apple deserves a higher multiple, but whether the market will agree is a much more difficult question to answer.

Based on my own models, I estimate that AAPL stock could nearly double in the next decade, even if it experiences further multiple compression to 15 P/E. This assumes a 6% revenue CAGR, 4% annual shareholder returns through dividends and buybacks, and profit margin expansion to 28%.

However, Apple has delivered many growth surprises in the past. I think that Apple can manage 6% annual growth with only its current products. If they can re-accelerate growth with new segments like AR/VR, Apple Car, services, and/or a new idea, that could lead to higher returns. For example, at a 10% CAGR, I believe that AAPL stock could more than triple in a decade.

Conclusion

In my base case, Apple is a solid buy at the current price for investors looking for market average returns from a high-quality blue chip. In the bull case, Apple could re-accelerate growth and still deliver market-beating returns, although probably not to the same extent they did in the last decade.

There should be a place in most investors' portfolios for a company like this. Personally, while I've been a long time Apple shareholder, right now I'm not directly long the stock because I have enough indirect exposure through ETFs. For investors who don't already have a full position, I think that now is a good time to start buying Apple again.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.