Apple: Justified or Overpriced?

Lasting 11 years, the longest bull market in US history ended in March 2020 as markets began to plummet while investors withdrew their capital amid fears of a global pandemic. Many would’ve predicted that markets would not begin to recover anytime soon as the pandemic does not look to improve anytime soon with a lack of vaccine in sight. However, this is not exactly how it has played out: Q2 2020 saw the greatest quarter for the stock market in US history while markets began to make a recovery. The NASDAQ index has rallied nearly 50%, yielding a gain of around 12% YTD, with tech stocks seemingly a safe bet preferred by investors.

One company which has appeared a favourite amongst investors is Apple. Apple's share price has increased over 120% (over 1 trillion USD) since its low in March and has recently become the first non-state company to reach a market capitalisation of 2 trillion USD. It took Apple up until 2018 to exceed a 1 trillion-dollar market capitalisation; it has more than doubled in the two years since. For perspective, the whole UK stock market capitalisation is just over 2.16 trillion USD. This achievement was a historical milestone due to coming at a time where much of the U.S. economy is currently shut down and has come to a standstill. Some of the economic effects of the pandemic are yet to be seen, with the current excessive monetary and fiscal stimulus unable to be sustained for a long period of time. It remains uncertain how markets will react once this stimulus stops or once a vaccine is released to end the current pandemic. This, however, hasn’t stopped technology companies like Apple from growing and preventing the current macroeconomic climate from hindering its prospects. Apple’s revenue has grown to 59.7 billion USD in Q2 2020 (an 11% rise from Q1 2020), beating analyst expectations of 52.6 billion USD (which would’ve given a 2% decline from Q1 2020). This demonstrates the ability for Apple to succeed regardless of the current market conditions or economic climate, owing to the significant strength of the fundamentals and financial position of Apple.

Many believe Apple (as well as other tech stocks) is overvalued stocks due to the uncertainty surrounding the pandemic and future earning prospects. However, with the robust demand for its products, it is easy to build a strong argument justifying its valuation. Usually, with premium technology products, brands and products go through cycles between being popular and unpopular, and profit margins get smaller as competition increases. However, this hasn’t occurred with Apple’s products such as their iPhones, with prices continuously increasing and never falling out of favour. Since Tim Cook has taken over as CEO, he has diversified the company into other markets: namely, wearables and services which now account for 550 million USD of recurring revenue. This is why Apple will remain strong for the foreseeable future as the large cash pile of over 200 billion USD that Apple maintains can continue to provide a safety net and can help with other investments such as R&D and possible strategic buyouts.

However, there are some reasons to be cautious. For example, Apple’s price to earnings ratio of 35 is its highest since 2007, suggesting a ratio this high may not be sustainable. This high price to earnings ratio reveals complete investor confidence regarding the company, and the current financial fundamentals brand this confidence warranted. However, there is not complete certainty regarding the future political situation surrounding the company: the big tech companies have come under increased scrutiny amid concerns regarding market dominance. Apple is being criticised for charging 30% commission for consumer purchases through its App Store. This commission fee brings significant profit to Apple whilst limiting profits for developers as a result of the price elastic nature of App Store purchases. Due to the recent scrutiny regarding this high fee commission, Apple may decide to lower this in the future as developers such as Epic Games (developer of Fortnite) have raised complaints concerning Apple abusing its power. With Apple’s services stream (inclusive of Apple Store) being more than its Mac, wearables and iPod revenue combined, this could hurt the profitability of this major revenue stream if this commission fee declines over time. Additionally, the current US-China trade war is extremely unpredictable given the protectionist policies implemented by President Trump. Trump is attempting to ban certain Chinese-developed applications such as the widely used social media platform TikTok and Chinese messaging app WeChat. This trade war could escalate and ultimately affect production plants in China offering attractive profit margins for Apple products.

It appears the business model of Apple is now incredibly strong with the new diversification of revenue and increased concentration placed on its subscription-based revenue. Additionally, given the cash balance of over 200 billion USD, Apple could sustain large losses for a very long time. Apple is profitable all over the world, and with this generous cash balance, even if the political decisions are made which could be detrimental to Apple, the resources required are available to Apple to find solutions around external policies and come up with new and innovative ways to continue appearing as a market leader. Hence, the true intrinsic value of Apple is difficult to calculate, but the presence of Apple in the future is much easier to argue given Apple’s history and desire to revolutionise and dominate markets into the future.

By Josh Davies