What should we expect from Apple stock in the face of inflation? And in the face of a recession?

  • Investors have never seen a mature Apple operating in a negative macroeconomic environment.
  • Next year will probably be a very real test.
  • A further pullback from the highs suggests investors are worried about this test – and a still-high valuation.

One of the biggest questions about Apple (NASDAQ:) is how the company will perform in a weaker macro environment. And one of the difficulties in judging AAPL stock right now is that we don’t really know the answer.

To be sure, we don’t really know the answer to key questions about most stocks. This is precisely what makes investing difficult, enjoyable and hopefully fruitful. But in Apple’s case, we don’t even have much evidence to base our answer on. We just haven’t seen this version of the company overcome significant external difficulties.

It seems likely that will change. Inflation is a global issue, and economic concerns are growing in markets like China and Europe. Apple is an American company, but more than half of its revenue and profits come from abroad, which means it is exposed to a number of potentially difficult markets. With the stock still reasonably expensive, investors need to be confident in Apple’s ability to perform well in any environment to consider owning shares, even after the recent downturn.

Source: Investing.com

Take a step back from Apple stock

Clearly, Apple has been through recessions before. But, again, it wasn’t that version of Apple.

Remember that the first iPhone didn’t go on sale until June 2007. That was several months before the global financial crisis hit. The iPhone has sold incredibly well: revenue from the product and “related products and services” was $1.84 billion in fiscal 2008 (which ended in September), and $6.75 billion the following year. But given the ubiquity of the iPhone and its revolutionary nature at the time, the economic climate outside probably wasn’t as dissuasive as it is today.

However, we can look at the smartphone leader of the time. This is Research In Motion, now known as BlackBerry (NYSE:). RIM weathered the crisis very well: its revenues nearly doubled in fiscal year 2009 (which ended in February) and grew another 35% in fiscal year 10.

We came very close to having a concrete example of what inflation could mean for Apple. In 2019, President Donald Trump imposed 25% tariffs on Chinese imports and threatened to go further. Since many Apple products are assembled in China, the company was in danger.

The additional tariffs were never implemented, but one analyst estimated a hit to annual earnings of about 50 cents to 75 cents per share. Based on Apple’s stock count at the time (4.5 billion; the stock has since split and Apple has also repurchased shares), this suggested an annual decline of $2-3 billion. . Over the past four quarters, Apple has made nearly $100 billion in net profit.

This time, is it different for Apple?

The track record we have suggests that Apple should be able to handle macro headwinds. But this conclusion is far from definitive.

When BlackBerry was the dominant product and Apple was the newcomer, the smartphone itself was new enough that it might have trumped other economic considerations. More importantly, even BlackBerry was far from the market saturation that Apple experiences today. At the end of fiscal 2010, BlackBerry had 40 million subscribers. There are now over a billion active iPhones.

Today, the iPhone, at least to some extent, is a luxury item. It’s definitely a better product than almost all phones running Alphabet’s (NASDAQ:) Android operating system. But for most consumers in most markets, Android phones are far cheaper and likely at least in the “good enough” range.

Even for iPhone loyalists, budget pressures can impact choices. Customers can opt for the lower end, or postpone replacements for a few months. And since the iPhone still accounts for more than half of Apple’s sales, small changes can stunt the company’s growth.

The risk also exists outside of the iPhone. Apple’s impressive, high-margin services business relies on consumer spending on apps within its ecosystem. And, somewhat quietly, the iPad has once again become a contributor to growth: sales increased by 50% between fiscal year 2019 and fiscal year 2021. Even if the iPhone is too important for consumers to run out of breath give it up, the same may not be true for the rest of the company’s product portfolio.

Is AAPL too expensive?

What’s interesting about this discussion is that it echoes the bearish trend in AAPL stock that has prevailed over the past decade. The risk invoked at the time was known as “commoditization”. Smartphones, the theory goes, were no different from any other form of electronics. At the time of their release, they were expensive; over time, the quality improved and the price fell, eroding profit margins.

Obviously, this theory did not hold true. In fact, Apple has consistently raised prices over the iPhone’s 15-year history at a rate above inflation.

Even with these price increases, Apple’s gross margins hadn’t budged much until recently. It is the services activity which is at the origin of this peak; at 72% in the first three quarters of FY22, gross margins in this category are almost double the 37% posted for products.

So the question is: What if Apple can’t raise prices? Margins take a hit – and that hit would be amplified by rising input costs.

To be sure, these concerns are mostly on the fringes of the investment case. The bears who predicted commoditization severely undervalued Apple, and investors shouldn’t make that mistake today.

Nevertheless, there is a risk that, in a more negative external environment, Apple’s earnings growth may come to a halt. This is why AAPL stock has been so sensitive to macroeconomic fears, and why there is a real risk in paying a still high earnings multiple at this time.

Disclaimer: At the time of writing this article, Vince Martin does not hold any positions in the securities mentioned.

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