Rare Apple Downgrade And The Bearish Case
One sell-side analyst has finally taken the plunge. On Wednesday, Merrill Lynch’s Wamsi Mohan changed his rating on Apple from “buy” to “hold”, in what has been the first downgrade of the stock in the past year at least.
Today, I look at the points raised by the analyst in order to better understand some of the counterpoints to the overwhelming bullish stance on Apple seen around Wall Street nowadays.
What has turned the bull skeptical
- Highest valuation premium to the S&P 500: this is probably the main risk to investing in Apple today, or at least what investors seem to fear the most. The graph below illustrates Mr. Mohan’s point. Apple’s trailing P/E has breached the 30x mark and continues to head higher. This is the first time since early 2012 that Apple’s multiple has exceeded the S&P 500’s.
- Gross margin pressure from 5G iPhones: I also expect that the next phone’s bill of materials will be inflated. Some estimates suggest that the chipsets to support 5G devices cost 50% more than the comparable ones for 4G models. On the other hand, higher product costs get offset, at least partially, by higher device prices. Take Samsung as an example: the Galaxy S20 5G is priced around 30% higher than last year’s S10 lineup. Also, over time, I always expect technology costs to decrease, making margin headwinds front-end loaded.
- Tough comps and margin pressures in the App Store: I share this concern with Merrill’s analyst. I estimate the App Store to be the most important piece of Apple’s services segment, from a revenue perspective. However, I also estimate that the App Store’s growth rate had been decelerating at an annual pace of at least ten percentage points between 2016 and 2019. This year, the business will likely experience a boost from the stay-at-home economy, but the tailwinds will probably be much less meaningful in 2021. In addition, I wonder if developer backlash and government scrutinty could cause Apple to revisit its App Store commission policy.
Explore more data and graphs
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