Why You Should Ignore Apple, Inc.'s Q4 Guidance

On Tuesday afternoon, Apple, (NASDAQ: AAPL  ) reported solid earnings for Q3 of its 2014 fiscal year. However, investors have a tendency to look past earnings numbers for the seasonally weak June quarter, instead focusing on guidance for the upcoming quarter.

Photo: The Motley Fool

On one level, this makes sense, as Apple has released new iPhones during the September quarter for the last two years -- and is expected to do so again in 2014. However, Apple's Q4 guidance is meaningless in terms of projecting demand for new products like the iPhone 6. Investors would be better off ignoring the guidance and waiting for more solid information.

Apple's guidance
Apple's Q4 guidance calls for revenue of $37 billion-$40 billion, compared to $37.5 billion in Q4 of FY13. Gross margin is expected to be 37%-38%, compared to 37% in Q4 last year. Based on the midpoints of these projections and the other parameters Apple provided, EPS would work out to approximately $1.22.

That's almost 10% below the average analyst estimate for Q4 EPS, which is $1.34. Even if all of the parameters came in at the favorable end of the guidance ranges, EPS would amount to about $1.32, still a bit shy of what analysts are expecting.

Uncertainty: the small caveat
One reason why investors shouldn't put too much stock in Apple's guidance is that Apple has not yet revealed the iPhone 6 launch timeline. (Indeed, it's possible that Apple hasn't nailed down a firm schedule internally.)

The exact timing of the iPhone launch matters a great deal. Last year, Apple sold 33.8 million iPhones during the September quarter -- of which more than 9 million were sold on the launch weekend for the iPhone 5s and iPhone 5c. Those two phones were on the market for just nine days during the September quarter, but likely accounted for about one-third of Apple's iPhone sales.

Early sales of the new iPhones will depend on launch timing and supply availability (Photo: The Motley Fool),

If Apple manages to accelerate the iPhone launch by a week, it would provide a big boost to revenue and earnings this quarter. On the flip side, if the launch slips by a week, Apple would only have two days to sell the new iPhone in Q4, pushing a lot of sales into the December quarter. It's also unclear if Apple will be launching a "phablet"-type phone in the September timeframe.

Thus, Apple's revenue and earnings for this quarter depend heavily on the timing of the iPhone 6 launch, and initial inventory levels. Creating projections for Q4, therefore, involves a lot of guesswork on Apple's part.

Last year, Apple's revenue came in above the high end of the initial guidance for Q4. Gross margin reached the high end of the guidance range, while operating expenses came in somewhat below expectations. It's quite possible that the guidance Apple just provided is equally conservative.

Supply vs. demand: the big caveat
An even bigger reason to take Apple's Q4 projections with a giant grain of salt is that it doesn't provide any information about projected demand -- let alone real demand -- for Apple's products. As noted above, in recent years, new iPhones have arrived near the end of Apple's Q4, and the same is likely to be true this year.

Apple's iPhone 5s was in short supply for almost 3 months (Photo: The Motley Fool).

These iPhone launches are routinely characterized by supply/demand imbalances. Last year, the iPhone 5s was in short supply as late as December. Apple is expected to introduce larger screen sizes with the iPhone 6, which many customers have wanted. This has led to widespread expectations that the iPhone 6 launch will drive an especially strong upgrade cycle.

However, Apple's September-quarter results will bear little or no relation to demand for Apple's new products. Even if demand were uncharacteristically low, Apple would still probably face shortages of its new products within a few days of the launch. Instead, supply will be the key constraint on sales this quarter.

Supply constraints won't have much of an impact on long-term sales, though. People who have waited years for a big-screen iPhone aren't likely to defect to a different brand just because they have to wait an extra month or two due to initial shortages. Apple has consistently shown in the last few years that it can boost production rapidly to meet demand within a quarter or two of a new device launch.

Thus, Apple's September quarter performance will be determined primarily by supply issues, whereas its FY15 results will depend on demand for its new products. Investors are going to have to wait a few more months to get a better sense of what these new products will be, and how well they will sell.

Foolish wrap
Apple investors are sure to pick through the company's recent guidance for hints about its future earnings trajectory. However, this is a hopeless cause. Apple faced a high level of uncertainty in putting together a Q4 forecast, because so much depends on the timing of the iPhone 6 launch, and initial supply.

Most importantly, Apple's Q4 sales will be heavily determined by supply constraints, whereas demand will be the main determinant of sales in the following year. As a result, investors will need to be patient, and wait for more information to understand how Apple's new products will impact its financial results.

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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 July 23, 2014, at 1:55 PM, mds wrote:

    AAPL knows a bit more what guidance should be for Q4 than outside speculative manipulators of the stock.

    Their guidance continues to be more aggressive and they continue to impress. So the street sets targets just above in an effort to disappoint when they have no case for it.

    The guesses of course change as time goes on to save-face.

  • Report this Comment On July 23, 2014, at 2:42 PM, Wingsy wrote:

    "Investors would be better off ignoring the guidance and waiting for more solid information."

    While I mostly agree with the premise of the article, that Apple guided on the low side, my eyes rolled 360 degrees with the 2nd part of that statement. "More solid information", from where exactly? Analyst projections?

  • Report this Comment On July 23, 2014, at 2:43 PM, Wingsy wrote:

    MDS: I didn't see your comment until I posted mine or I would have left it at that.

  • Report this Comment On July 23, 2014, at 4:53 PM, TMFGemHunter wrote:

    Thanks for the comments.

    @Wingsy: More solid information would include: 1) Apple's next product announcement, so investors will know for sure what is coming; 2) Apple's report on first weekend sales (it usually does this); 3) iPhone lead times during September and October; and 4) Apple's December quarter guidance.

    On top of that, there's also the more subjective customer buzz that could give hints about Apple's FY15 sales potential.

    Adam

  • Report this Comment On July 23, 2014, at 5:45 PM, mds wrote:

    APPL's performance is not subjective to consumer buzz. Consumers and investors are entirely different. Buzz, or hype, is mostly lies & speculation. There is no way to predict 2015 unless you are Tim or one of his top team.

    I-Phone lead time is down to two weeks production thanks to Tim's investments in factories and equipment dedicated to AAPL; which is also increasing margins. Not to mention 99% sell through on what they ship.

    This is not channel stuffing Samsung. What they make you will buy; weather you know it now or not.. AAPL creates markets, it does not follow.

  • Report this Comment On July 24, 2014, at 3:41 AM, McBobb wrote:

    That's well put:

    "What they make you will buy"

    The end of quarter dates are 4 arbitrary lines in the sand, dictated by accounting and filing schedules. Does anyone really think that the overall sales of iPhones to the end of year will be that much different if the iPhone 6 launches at the end of Sept vs the beginning? Not really. Different product mix of v5/v6, different margin (we can't be sure how different yet though!), but I would guess roughly the same number of sales overall. Just timed differently, that's all.

    So why worry what Apple execs, speculating analysts, or even random commenters think will sell by these quarter end dates? It all comes out in the wash, so if you're a long term investor, don't sweat it. Just sit back and watch the inevitable rain of cash flood in, and the obvious value be reflected in the share price eventually.

    Now that's Foolish.

  • Report this Comment On July 24, 2014, at 4:46 AM, CraigWPowell wrote:
  • Report this Comment On July 24, 2014, at 8:17 AM, Mathman6577 wrote:

    @mds said it best. Wall Street sets (mostly) unrealistic goals for Apple stock. In the meantime, companies like Amazon that do not make any money get a pass.

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