Why Apple's 10% Gap Up Is Just the Beginning

Apple's iPhone sales figure is the key headline, but capital allocation and iTunes are what could drive the stock to new highs.

Apr 24, 2014 at 6:00PM

Apple (NASDAQ:AAPL) blew away expectations for quarterly results with revenue of $45.6 billion on the strength of iPhone sales and iTunes-related revenue. The quarter was expected to be weak for the company, as it's after the Christmas season yet before the launch of the iPhone 6, but the company really delivered on both results and capital allocation. The stock is gapping up almost 10% at $570, but with the iPhone 6 release coming later this year, it is very likely that this is just the beginning.

The iPhone number was good, but don't ignore iTunes.
iPhone sales figures were impressive, with 44 million phones sold into the channel, but iTunes revenue of $4.6 billion was up 11% year-over-year and is growing at twice the rate of the overall top line. To put this in perspective, the lower-margin Mac business was virtually flat, selling 4.1 million units in the quarter compared with 4.0 million units a year ago. iTunes is a derivative of the hardware business, but is now even more important from a profit standpoint because those profits are higher-margin. Apple previously announced that it operates the iTunes business at breakeven, but with just the $4.6 billion in revenue from iTunes software and services, the company's entire operating expenses structure is covered. It seems unlikely that this is running at breakeven.

Massive capital allocation plan scares away shorts
Apple announced changes to its capital allocation plan that will send short-sellers running for the hills. The buyback is being boosted by $30 billion, up from $60 billion to $90 billion. However, the company is doing three additional things: it is raising its dividend by 8% to $3.29, it will raise the dividend annually going forward, and the stock is being split 7-for-1. The stock split, theoretically, does not increase the value of the company, but in practice, stock prices tend to rise after a split announcement.

iPad numbers weren't as bad as they seem at face value
When selling products through resellers, companies have an opportunity to manage earnings results by stuffing the channel with product. However, when channel inventory is reduced, the numbers look ugly, and this was the case with iPad figures in the quarter. Last year, Apple sold 19.4 million iPads into the resellers distribution channel, which subsequently sold about 18 million, thereby increasing channel inventory by 1.4 million units. This year, Apple sold 16.4 million units into the channel, and the channel sold 17.5 million units to consumers, effectively decreasing channel inventory by 1.1 million units. So, the real sell-through decline was only 3%.

10% gap up is just the beginning
The iTunes business is probably higher-margin than hardware, and growing much faster than the top line, because there are back-half product catalysts. Today's gap up is probably just the beginning. Apple managed to produce massive upside amid concerned investors, while also deploying capital in several shareholder-friendly ways. It would have been nice to hear about wearable computing products or electronic payments, but considering the sheer number of announcements and the strength of the results, maybe it's better to save a few press releases for a rainy day.  

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David Eller has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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