Apple Draws Strength From Mac

Yes, there's the iPhone, but investors should take a look at the Mac for growth.
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Investors are betting that Apple's iPhone will be a hit with consumers.

But if the device somehow fails to live up to all the hype, what will keep the company's sales afloat -- and stock price rising -- is, in a word, computers.

Apple's increasingly

popular Macs served as a ballast for sales and earnings growth in the last quarter as iPod sales took a breather.

Desktop and notebook sales can likely carry the company through short-term volatility in sales of iPhones as well as other products such as iPods and its new television set-top boxes.

Also, if the iPhone launches on June 29 as planned, Apple can begin shifting engineering resources back to its delayed Leopard operating system, further shoring up its Mac business.

"Apple's computer business gets lost in the iPhone buzz," says Richard Parower, a portfolio manager at J.W. Seligman, which holds Apple shares. "Investors have to keep in mind that there's a lot more going on at the company."

Apple shares rose 8%

when the company unveiled the phone in early January and have tacked on an additional 34% since mid-April, as analysts release lofty forecasts of the device's sales.

Despite a third day of heavy selling on Wall Street, Apple's shares closed trading up Thursday 43 cents, or 0.35%, to $124.07.

Conservative figures peg iPhone shipments between 2 million and 5 million this year and more than 10 million in 2008. That's well below the nearly 100 million phones that No. 1 handset maker

Nokia

(NOK) - Get Report

sells each quarter, but that could match or exceed

Research In Motion's

(RIM)

BlackBerry sales.

Some of these predictions are based on the fanciful notion that the $500 and $600 iPhones will be swept up in the luxury-goods craze along with ritzy handbags from

Coach

and jewelry from

Tiffany

.

Apple has tried to manage investors' stratospheric expectations for the iPhone. In April, the company said it had shifted engineers from

its Leopard project to the iPhone development team to ensure that the iPhone's launch wouldn't be delayed.

But investors' true skittishness surfaced in May when Apple's stock plunged 3% after a Web site floated a rumor that technical glitches would hinder the device's debut.

Even if the iPhone hits store shelves on time, there's still the risk that consumers won't pay breakup fees to ditch their current cellular service contracts to sign up with

AT&T

(T) - Get Report

, which has exclusive rights to sell iPhone service for five years.

What's more, there are always risks that users will experience problems in the device's functionality, which could deter others from paying Apple's premium price.

But offsetting these risks is Apple's growing share of the computer market. Mac sales leapt 36% last quarter from a year ago, exceeding most analysts' forecasts and tripling overall industry growth.

This helped lift revenue 21%, despite a growing proportion of sales from cheaper iPod models. Apple's bottom line benefited from falling prices on memory devices for computers and iPods.

As a result, gross margins swelled 5 percentage points to 35% from the same quarter a year earlier.

Computer sales should benefit from several tailwinds, including back-to-school shopping and the release of the Leopard operating system. The new Macs come with souped-up

Intel

(INTC) - Get Report

processors that enable users to take advantage of enhanced audio-video tools available on

Adobe's

(ADBE) - Get Report

latest version of its Creative Suite software.

This could spur Mac purchases by graphic artists and general photo enthusiasts.

"I see Apple as a long-term play on the growth in consumption and production of digital-video content," says Fati Naraghi, director of technology and telecom research at Newton Investment Management, a unit of Mellon Financial. Several Newton funds hold Apple shares.

"The amount of video traffic people create and consume will continue to grow as broadband penetration increases across the globe," Naraghi says.

Naraghi expects Mac sales to be strongest outside of the U.S. The iPod has brought Apple into homes across the world, she says, especially in developed European markets where the company is expanding its number of stores.

"Apple's longer-term growth story is predicated on mainstream consumers buying Macs as people get used to the iPod and see Apple stores opening everywhere," Naraghi says.

Though Apple's stock has gotten "ahead of itself" on iPhone expectations, Naraghi believes that the stock is very attractive on a three-to-five-year time horizon, given the trends toward consumers downloading and producing digital music and videos.