Bigger iPhones and Minor Tweaks Won't Change Apple's Fortunes

Apple can keep making money by tweaking its product line, but real growth will happen only if it comes up with another blockbuster product.

Jan 30, 2014 at 7:00PM

With Apple (NASDAQ:AAPL) shares falling more than 7% Tuesday due to a seemingly weak growth forecast from CEO Tim Cook, it is becoming increasingly obvious that the company needs innovation beyond tweaking its existing products. It's been losing share of the mobile market to Google's Android (NASDAQ:GOOGL) and now it may have a resurgent Microsoft (NASDAQ:MSFT) to compete with, as well.

Apple, of course, remains a financial juggernaut. In the final quarter of fiscal 2013, Apple generated $9.9 billion in cash flow from operations and returned $7.8 billion in cash to shareholders through dividends and share repurchases. The numbers were similar for the first quarter of 2014, where the company posted record quarterly revenue of $57.6 billion and quarterly net profit of $13.1 billion.

Looking good?
On the surface, the company's guidance for the second quarter of 2014 seems pretty promising. But investors and Wall Street don't treat Apple like other companies. Apple predicted revenue between $42 billion and $44 billion, gross margin between 37% and 38%, and operating expenses between $4.3 billion and $4.4 billion. What Apple did not predict, however, was an exciting new product line that would create huge growth opportunities.

Cook did hint at new releases and product lines, but the lack of anything specific likely led to the decline in stock price.

"We're working on things that you can't see today," Cook was quoted in USA Today. "We have zero issue coming up with things we want to do that we think we can disrupt in a major way. The challenge is to focus on the few that deserve our full energy."

Minor tweaks are just that
While investors seem desperate for Apple to enter a new category -- perhaps with its long-rumored TV or some new product nobody has considered -- the company has spent the past few years tweaking existing product lines. The iPad got a better screen, and a smaller version was created. The iPhone got faster and shinier, and a cheaper, plastic version was created. All of these minor moves kept Apple chugging along.

However, Forbes reported in June that more than than half of Americans have smartphones. According to the Forbes article, "In the 18-34 demographic, penetration is 80% and the limiting factor is mostly money. For those earning $75,000 and up, 90% have a smartphone already." And, while there is more room for growth in tablets -- ZDNet reported in June that one third of U.S. adults have tablets -- the ceiling is not high.

Apple is unlikely to completely wipe out its competitors or gain significant market share by tweaking and maintaining its current lineup. For example, rumors that the company is going to introduce larger screens to compete with Samsung's popular phones and "phablets" that run Google's(NASDAQ:GOOGL) Android operating system have been met with a ho-hum reaction from investors. It's not that a bigger iPhone won't be cool and people won't buy it -- it will be, and they will -- it's that these are defensive moves designed to maintain market share or eke out slight gains. They're not deal changers. Most likely, Apple will slowly lose share to cheaper Android phones, and perhaps to Microsoft's Windows 8 phones eventually.

Apple needs a game changer -- again
For Apple to regain the explosive growth of a few years ago, it needs another blockbuster. The company might have beloved products, steady revenues and huge profits, but without innovation, the company risks investors perceiving it in the way many see Microsoft -- (NASDAQ:MSFT)steady and boring with its best days behind it.

Of course, there are worse places to be than having billions in profits and a steady, dull, but positive long-term outlook. But slow and steady won't send Apple's stock climbing again. For that to happen, the company needs the next "iWhatever," be it a TV, a toaster that can do your taxes, or some sort of magic we have yet to think of.

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Fool contributor Daniel Kline is long Microsoft. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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