Later today, Apple (NASDAQ: AAPL ) will announce earnings. While the Street awaits with bated breath, it is important as individual investors to understand what analysts are looking for. Investors in the know understand there is one number that analysts are looking for.
More than just earnings
Earnings announcements are more than just earnings; anybody that's seen an investment drop like a rock after beating consensus earnings estimates can tell you that. Earnings are a rare opportunity to get a glimpse into company operations and see if they are addressing analyst concerns. Right now, the main concerns for Apple investors are lack of innovation and "iteration fatigue." Nowhere is this more apparent than in Apple's gross margin percentages.
|Gross Margin Percentage||47.4%||42.8%||40%||38.6%||37.5%||36.9%|
As you can see, Apple's gross margins have fallen over a thousand basis points, or roughly 22%, since the second quarter of 2012.
What's behind this drop?
The story behind the drop is often that Apple is losing its innovation edge against competitors, notably Samsung (NASDAQOTH: SSNLF ) and other competitors using Google's Android OS. Samsung recently reported its flagship phone, the Galaxy S4, has sold 40 million units and recently wrestled away the title as the most profitable smartphone maker from Apple. Regardless of the product, the fear is that Apple cannot continue to price its products at premium pricing and maintain high sales figures.
Also, concerns about Apple's innovation gap persist. The familiar refrain is that while Apple is incrementally improving its products with each new iteration, would-be buyers are not seeing the benefit and are instead looking at previous year, lower-cost versions. This results in a downward drag on gross margins. The most apt analogy here is a gas station; it would prefer you not to spend your money on low-margin gas, and instead spend your money on higher-margin convenience items.
Why is the number 37 so important?
Apple can answer this criticism by reporting the number 37. That is $37 billion in revenue and 37% gross margins. First, it would be a powerful signal that Apple can continue to price its products at premium levels. Plus, it would be an increase in revenue over last year's quarter and sequentially, 4.7% and 2.8% respectively. The September quarter is typically a slow quarter for Apple, but beating both comparables will instill confidence.
In addition, Apple would really give investors a reason to cheer by hitting or exceeding 37% gross margins. As the above-referenced visual shows, investors are looking for Apple to reverse the gross margin slide that had dogged the company for the greater part of two years.
Here's how it will do both
Apple responded to its amazing iPhone 5c and 5s launch by issuing an update on its guidance for both revenue and gross margins. The company now expects for revenue to be on the high end of its $34 billion-$37 billion guidance and that margins will be at the high end of the 36%-37% range.
That's understandable. Apple continues to command a large gross margin from the iPhone and sold a whopping 9 million units in its first weekend. Also, lost in the negativity concerning the 5c's sales figures was this gem -- the case saves Apple nearly $42 and the bill of materials is 12% less expensive than the model it replaced. So you can see how in both revenue and margins, these are fantastic developments.
Foolish final thoughts
This quarter it is important for Apple to change the narrative. It had a successful iPhone launch that should aid this quarter in both revenue and gross margins. Reporting 37% gross margins and $37 billion in revenue will reassure investors leading into the busy December quarter.
Margins and revenues are only one part of the story
It is imperative to understand how products play into Apple as an investment. It's time to learn how Apple continues to innovate in the face of increasing competition. Read about the future of Apple in the free report, "Apple Will Destroy Its Greatest Product." Can Apple really disrupt its own iPhones and iPads? Find out by clicking here.