What do Apple's iPhone Sales Mean to Investors?

Recently, Apple (NASDAQ: AAPL  ) announced a new record for opening weekend sales of iPhone – 9 million units were sold globally, with most versions of the new iPhone 5s sold out by Saturday. 

The 5c is basically last year's iPhone 5 dressed up in bright plastic and moved down $100 in price. The 5s is this year's new model featuring a new A7 processor and the TouchID fingerprint sensor. 

Additionally, Reuters reports:

Apple tweaked its financial forecast to reflect the higher sales, an unusual move for the company... It said gross profit margin would come in at the top of its previous forecast of 36 percent to 37 percent.  

Finally, the adoption rate of the new iOS 7 is phenomenal – over 32% of users upgraded in just 48 hours. Now it is over 50%. For comparison, Android OS from Google  (NASDAQ: GOOGL  )   version "Jelly Bean," released 14 months ago, is still running on only 45% of Android devices.

Why the year-long price contraction?
The simple answer is contracting margins. A more elaborate answer is more complex. To begin with, we should note the company's recent earnings history.

In Apple's most recent earnings release (July), while revenue increased slightly year-over-year, income fell sharply – almost $2 per share to $7.47.  Margins fell from 42.8% to 36.9%. However, surprisingly strong iPhone sales reported in July (31.2 million) gave a lift to the company's stock, driving it up over $500 before it slipped back to $450. It has since recovered to the $490 range.

Driving this are two investor fears:

1. Apple no longer innovates.

2. Competition from Google's Android and Microsoft's Windows Phone 8 from Microsoft (NASDAQ: MSFT  )   drives prices and margins down.

Both of these have just been proven false.

For point No. 1: the 5s is seen as being very innovative. The new A7 processor has jumped to 64-bit processing, a move no one expected. The 5s is the first and only smartphone with a 64-bit processor.

Reuters continues (referring to:

Daniel Ernst, an analyst with Hudson Square Research, said iPhone sales show Apple still has a deep connection with its customers.
"The critics have told you Apple lost its magic," he said. "Customers are telling you something very different."

Competition
On point No. 2:  Google's Android has taken over the low end of the smartphone spectrum. That move has pushed the operating system to almost 80% world wide share. Even Microsoft's Windows Phone 8 has grown, moving to 4% globally. Nokia's Lumia line has been very popular. 

This has not changed iPhone prices, however. The 5s was added at the same price as previous flagship models, and the 5c did not drop below the usual price of $99 (with contract), which is something that many were looking to see. While this does not completely address falling margins, it does show that we are not seeing a pell-mell race to the bottom.

It should be noted that BOM costs of new models has risen slightly over the years, while price has remained constant. According to iSuppli, the 4s model cost about $188 to build, but last year's iPhone 5 cost $198. With the addition of a totally new component – the TouchID fingerprint reader – the 5s cost is still only $199. 

The real reason for dropping margins is the increasing mix of lower priced units. In July's earnings report and conference call, it was said that older iPhone models were making a higher proportion of the mix than expected. Additionally, the popularity of the iPad Mini lowered the overall margin mix. The iPhone 5c has met this challenge by using a plastic casing, saving $42 per unit.

Conclusion
Apple is celebrating – and should be. The response to the new iPhone 5s is spectacular. It's clear that – in spite of what pundits and detractors say – Apple still knows how to innovative.

Additionally, we can look forward to a new iPads soon. Most likely they will include the new TouchID , but probably only on the full-sized models. This will be a strong differentiator, pulling up the ASP for that product line.

Still, there must be continued concern for margins. To me it is likely that the change in product mix has evened out to some degree. The lower-priced older products, and the iPad Mini, have begun to stabilize as a percentage of units sold.

Overall, things are looking positive. The year-long slump may be over. Factors that indicate this include:

  • Apple is repurchasing
  • Carl Icahn is purchasing
  • New iPhones are well designed
  • iPhone release was spectacular
  • iOS 7 upgrade is spectacular
  • Margins appear to be stabilizing

Overall, the perceptions of Apple in the investment community are high. Surely, baring some unforeseen disaster, the company's stock price will soon push over the $500 mark. I think that by the end of the year it will be at $600, and a good end of the year quarter will send it back over $700. (assuming Congress resolves the budget crisis!)

To get over $700 will take a good holiday quarter. I think that we can extrapolate from the opening weekend's sales-about 80% over the iPhone 5 intro.

If we half that to plus 40% on iPhones, and figure roughly the same for iPads, but not so well for other lines,  then this gives us a 24% earnings per share growth year-over-year. If we project that ahead over the trailing twelve months EPS of $40.11 then we get almost $50. At the new level of growth, the price-to-earnings ratio should rise somewhat to 14, and this would give us $700.

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Read/Post Comments (6) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 15, 2013, at 12:53 AM, Jmers wrote:

    I like the fool but you need to get your facts straight. There were phones that had a 64-bit architecture before this phone, this is pure marketing fluff and the market noted that on day of release with a huge lump to their stock.

    Please stop drinking the apple kool-aid and be objective. Yes, they have a huge profit margin, but its because their products are over-priced once reasonable consumers realize this, its game over.

  • Report this Comment On October 15, 2013, at 1:08 AM, SimchaStein wrote:

    All old news - Still good points. Apple has plenty of upside, no downside and will increase dividends by 2 bucks in 6 months.

    The 64 bit chip will be in an iPad soon giving Apple a 12 to 24 month tech lead in the phones and tablets.

    The iPhone 5S Camera is enough to drive upgrade sales.

  • Report this Comment On October 15, 2013, at 1:12 AM, fauxscot wrote:

    jmers.... you seem to be the only one out there that thinks there were 64-bit phones.

    let's have some model numbers, manufacturers and prices to go with your comments. handheld, battery powered, phone size 64 bitters? where?

  • Report this Comment On October 15, 2013, at 1:39 AM, makelvin wrote:

    @jmers, "...There were phones that had a 64-bit architecture before this phone..."

    If you are going to make a statement like this, you have to follow up with more details. Otherwise, it only makes you look like the ignorant idiot that just like to make things up when you have no clue what is truly going on.

  • Report this Comment On October 15, 2013, at 12:39 PM, Bravadu wrote:

    @jmers

    So where could the average customer buy a 64-bit phone before the iPhone 5s?

    I'm referring to phones that made it out of the research lab and prototype phase.

    Please tell us - we're dying of anticipation.

  • Report this Comment On October 17, 2013, at 5:40 PM, CharlesClarke3rd wrote:

    This article is so laughable! They improved thier initial release plan. Instead of going country by country, they rolled everyone out day one. Thats how they broke thier "record." This just means everyone that wanted one got one the first weekend instead of being sprawled out over months. Its not a sign of increased demand. Innovation? Don't make me laugh! How stupid is it to go to 64 bit instead of quad-core? VERY! dumbest thing ever. Its technically equivicable... but in reality its the dumb thing to do. smartphones are being depended on to do so many things at once that not offering quadcore on a phone is ridiculous. Anywho, 64 bit ARM is coming but its coming after quad core for everybody with half a brain cause Apples marketing way of differentiating themselves is STUPID. You're a dumb person author. You're dumb, dumb, dumb. The S4 only had 1 month of being a best selling device, I'm guessing the iPhone 5S will have that first weekend. Thats it. Windows Phone will take over the market as with Windows 8 and tablets. iPad is yesterday's news.

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