Apple Stock Downgraded: What You Need to Know

After Apple gets over the iPhone 8 hump, concerns will mount.

Rich Smith
Rich Smith
Jun 12, 2017 at 2:35PM
Technology and Telecom

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Apple (NASDAQ:AAPL) stock is proving Newton right today, as gravity (and analyst commentary) have pulled shares down 3.6% as of 2:31 p.m. EDT.

As tells us, Citigroup just issued a new report predicting that Apple's new iPhone 8 will feature "significant enhancements" over previous iPhones. Problem is, if Apple tries to cram too much new tech into the product (a fingerprint sensor integrated into its OLED screen, for example), suppliers could have difficulty producing sufficient units to support a lot of iPhone sales early on.

And that's just one of the worries. On top of Citi's report, StreetInsider (requires subscription) notes that a second analyst, Mizuho Securities, this morning went ahead and actually downgraded Apple stock to neutral ahead of the iPhone 8's arrival. Fears of "initial supply constraints due to complexities around product ramp," says StreetInsider, are one of the concerns that Mizuho cited -- but that isn't the only thing that has Mizuho worried. Here are three more things you need to know.

Apple basket

iPhone-picking season will soon arrive. But is Apple's basket half full or half empty? Image source: Getty Images.

1. iPhone 8 will astound

Like Citi, Mizuho is pretty sure that Apple's iPhone 8 will be a hit, and initiate "a strong iPhone cycle" this year. What worries Mizuho, though, is what happens after the initial wave of iPhone 8 buying has passed.

Mizuho sees the potential for "pull-in of demand" for iPhones -- buyers who might ordinarily buy iPhones in 2018 buying them in late 2017 instead. While this will likely give Apple stock a big sales boost at the end of this year, it could also produce a head fake for investors if initial enthusiasm for the iPhone 8 fails to sustain sales momentum next year.

2. But Apple fanboys may not be enough

A second reason Mizuho is nervous is because, in its view, Apple's iPhone sales are "driven primarily by [existing iPhone owners buying replacement phones] vs. net new customers" switching to the iPhone from Android and other models. So long as iPhone sales remain largely limited to Apple "fanboys" (and -girls), this will prevent Apple from growing its "installed base" of iPhones on the market.

3. Price is still an object...for phone buyers

And even then, Mizuho hasn't run out of reasons to worry about Apple. Rumor has it that Apple is planning to charge upwards of $1,000 per unit for its 10th-anniversary iPhone. On the one hand, this implies that the new model could drive beaucoup revenue to Apple, and drive beaucoup profits to the bottom line -- but only for iPhone 8 units that actually get sold.

Muses Mizuho: "potentially higher ASPs for high-end SKU" iPhone could test the limits of "demand elasticity" even among Apple's most loyal customers. Translated into English, this means: If the price is too high, folks might not buy.

Granted, there are Apple fans out there who will pay any price to own the hottest new iGadget. But Apple didn't introduce a cheaper iPhone SE model last year just on a whim. It did so because Apple recognizes that even its fan base does not possess unlimited income. There's a real risk, then, that if Apple gets too aggressive in reaching for profit margin, it will scare off some would-be iPhone 8 buyers and limit the new phone's attractiveness.

Final thought: Price should be an object for investors, too

How much should these risks worry Apple stock shoppers? Here's how I look at it.

Right now, Apple stock is selling for about 17 times trailing earnings, but only 14.6 times trailing free cash flow. Optimistic analysts quoted on S&P Global Market Intelligence see Apple potentially growing earnings at as much as 14.7% annually over the next five years, and if they're right, then that might be fast enough to justify at least Apple's price-to-free-cash-flow ratio. On the other hand, though, the average consensus earnings growth target for Apple on Wall Street is closer to 9% annual growth over the next five years.

If that growth rate proves accurate, then it's hard to see how paying 14.6 times FCF or even 17 times earnings for Apple stock is justified. Bear in mind, too, that the analysts coming up with the 9% growth projection see Apple's iPhone 8 driving earnings per share to $8.95 this year, and $10.51 next year. Mizuho, on the other hand, is projecting only $8.79 per share this year, and only $9.16 next year (4% year-over-year growth).

Long story short: If Mizuho's estimates are anywhere near accurate, investors have good reason to be worrying about Apple stock today. I know I am.