It has been an impressive year for Apple (AAPL) - Get Report. The stock climbed from a 52-week low of roughly $150 per share at the end of 2018, hurt dearly by the fourth quarter bear market, to reach nearly $300 apiece only a year later. Not even monetary policy uncertainty and fears over the US-China trade war, the hot topics of 2019, were enough to stop Apple from rising almost uninterruptedly by more than 80% over the past 12 months.
Given the recent market value gains and unprecedented valuation expansion, many fear that Apple might be ripe for a pullback, or a period of stock price malaise at best. However, considering the fundamentals of the business, I would argue that shares continue to look attractive at current levels, and that Apple could still be one of the best-performing large cap stocks of 2020.
Higher Margins, More Predictable Revenues
To understand the bull case, one must realize that Apple is far from being the one-trick pony that enabled it to prosper in the late 2000s, following the highly successful debut of the iPhone. Because analysts and experts often dwell on quarter-to-quarter smartphone shipment projections to assess the company's prospects, it is easy for investors to miss the forest for the trees.
This is not to say that iPhones have or will soon become irrelevant for the consumer electronics giant. But as the graph below depicts, Apple's revenue composition has changed noticeably in 2019. As smartphone sales struggled throughout the year in important markets like China, two segments stepped up to the plate and picked up the slack: wearables and services.
The former, propelled by the success of the Apple Watch and Air Pods, grew sales at a dizzying pace of more than 40%. Segment revenues reached a respectable $24.5 billion, about as much as companies such as Dollar General (DG) - Get Report and Macy's (M) - Get Report were able to produce in the last fiscal year.
But services has perhaps been the most important story of the past several quarters. Apple is well on track to surpass its original goal of doubling fiscal 2016 services sales by fiscal 2020. The success of the App Store and the expansion of services such as Apple Pay can be credited for revenues that have risen by an average of 24% annually for the past three years.
Unlike the sales of phones or tablets, service revenues are typically recurring, which leads to more top-line stability and predictability. Even better, services carry margins that are about twice as high as those of products, suggesting that sales growth in this segment should result in even more pronounced earnings increase. The combination of smoother sales growth and the operating leverage effect from higher margins should be enough to justify the recent spike in the stock's valuation multiples.
What Goes Up Need Not Come Down
Yes, Apple had an extraordinary 2019. And yes, it will be hard for the stock to top its recent performance in the year ahead. But it would be too simplistic to assume that "what goes up must come down", and that Apple will necessarily undergo a period of mediocre returns in the new year as its stock price reverts to the mean.
More reasonable, in my view, is that Apple will continue to post solid results in 2020, supported by the upcoming 5G cycle and its impact on iPhone sales, growth in the wearables segment and the revenue mix shift towards more profitable services. Valuation should remain stable because "the new Apple" commands higher multiples, likely puzzling analysts that continue to expect the stock to trade at its historical average P/E of about 15 times compared to its current multiple of about 25.
This being the case, I believe Apple is more likely to continue its climb in the new year, even if at a less dramatic pace.
The author has a long position in AAPL.