Disclaimer: The content below represents my opinion and in no way should be mistaken for investment advice.
Yesterday after the market closed, Apple released its earnings for FY2016 Q2 (Fiscal Year 2016, second quarter). Here are the headline numbers, with additional thoughts further detail below:
Revenue: $50.6B vs Wall Street expectation of $52B
Net Income: $10.5B ($1.90 EPS)
Guidance for Q3: $41B – $43B
Dividend: Increased from $0.52 to $0.57 per quarter ($2.08 to $2.28 per year)
Share Buyback Authorization: Increased from $140B to $175B
Initial Stock Reaction
As a result of these figures, the stock traded down about 8% after hours yesterday, and today pared those losses to about 6.3%. It remains to be seen how the stock will trade over the next few months as this quarter’s results and next quarter’s guidance are digested by institutions and individual investors.
As a long term shareholder I don’t worry as much about the stock price fluctuations, instead focusing on whether the overall story is playing out according to my own expectations. As I mentioned in yesterday’s post, my investment in Apple is based largely on the cash flow being generated and returned to shareholders through dividends and buybacks. The dividend pays investors who stick with the stock, while buybacks help reduce the shares outstanding, making each remaining share worth more in terms of EPS (earnings per share). All while the stock trades at a discount to the overall market.
Anyone who has followed Apple the past few years knows that the iPhone is the product that generates the lion’s share of the cash. With the smartphone market finally showing signs of saturation and the iPhone showing its first year-over-year unit decline this quarter, some are worrying that Apple has peaked. It is my personal belief that while market saturation is approaching, the smartphone is the one product that almost every person carries with them at all times. It is possible that the replacement cycle is moving from 2 years to 3 years, but at the same time 4G LTE penetration in China and India are on the rise which should bring new users to the Apple ecosystem. So long as Apple is still viewed as the premium smartphone maker and people aren’t leaving the ecosystem whenever they decide to upgrade the cash should continue to pour in.
Areas to Watch
Nevertheless, it makes sense to continually look for holes in your investment thesis. In my opinion, the two major worries for me are a complacent management team at Apple and the possibility that the next hit product won’t come any time soon.
Listening to conference calls, you constantly hear CEO Tim Cook tell investors how “thrilled” and “optimistic” he is about Apple’s current performance and future product lineup. While it isn’t unusual for management to sound upbeat, it would be nice to hear Cook acknowledge relative underperformance by the iPad line in recent quarters rather than insist things are great. Certainly the company is big enough that admitting one product line isn’t meeting internal expectations won’t be mistaken for a downbeat forecast for the company overall. Cook also indicated last quarter that Q2 should be the trough for the company, but Q3 guidance says otherwise. While Cook can’t be expected to see the future, he does have access to a lot of data that outsiders do not, in addition to knowing pipeline rollout schedules that others do not. It isn’t unreasonable to expect his vision 3-6 months out to be more accurate than Q3 guidance suggested.
As it relates to new products, this is very tough to gauge. Apple has a history of creating hit products like the iPod, iPhone, and iPad, but this doesn’t mean it is an easy task. CapEx (capital expenditure) seems to indicate that there is some real effort going into something, but given Apple’s famous secrecy as an investor you are forced to either have faith or not.
Overall, my investment thesis remains intact. The company continues to throw off incredible amounts of cash, even in down quarters. Some of this cash is being returned to shareholders, while the majority of it piles up for future R&D and/or acquisitions. The (relatively) low iPhone sales don’t bother me at all, as we are in the final 2 quarters of an S cycle, so it should be expected that many people will wait for the iPhone 7 in September. Comparing the size of the current user base to when iPhone 6 was released in 2014 reveals steady growth in the company’s main product line (which still enjoys close to 40% gross margins).
I will reassess again in July when Q3 earnings are released and Q4 guidance is given. My expectation is that I will continue to hold Apple shares for many years into the future but may trim my position from time to time since it has grown to make up an outsized portion of my investment portfolio.