As the overall market rebounds, shares of Apple (NASDAQ:AAPL) have not only bounced back but have also roared to a new all-time high above $350. Investors have cheered the company's ongoing transformation to a business model that is less dependent on product sales and more so on higher-margin services offerings.
Here's a look at the stock's valuation and its underlying business as investors consider whether the iPhone maker's shares are a buy, sell, or hold.
Apple's growth story for 2020 and beyond
10 years ago, Apple's growth story essentially boiled down to one product: the iPhone. But the narrative for Apple stock is much different in 2020. While the iPhone is extremely important to Apple's overall business, investors aren't planning for sales of the device to grow substantially from here. On the other hand, Apple's growth in this decade will likely come primarily from services.
Today, Apple has an installed base of more than 1.5 billion active devices, creating a massive opportunity for the company to sell services to this large user base. The company is doing that in two main ways: launching and selling its own services and profiting from its share of other services sold through its app store.
Highlighting how important Apple's services segment has become to the company's overall results, fiscal 2019 services revenue grew 16% year over to $46.3 billion, accounting for 18% of total revenue. But here's the kicker: services has a much higher gross margin than Apple's products sales do, making the segment more important to the company's performance than it seems on the surface. In fiscal 2019, services gross margin was 64% compared to products gross margin of 32%. In addition, services gross margin is expanding; it increased from 60.8% in fiscal 2018 to 63.7% in fiscal 2019.
Apple's offerings in its services segment have been growing recently as management capitalizes on the opportunity in front of it. Last year, the company rolled out four new services, including a news subscription service, a streaming gaming service, a streaming TV service, and a new credit card. This builds on other important native Apple services including Apple Pay, Apple Music, iCloud, and AppleCare. Further, Apple benefits from sales of apps across its operating systems and from particularly strong growth in third-party subscriptions. Third-party subscription revenue increased 30% year over year in Apple's fiscal second quarter (the company's most recent quarter), management said in the company's earnings call for the period. Total paid subscriptions, including both third- and first-party subscriptions, were 515 million in fiscal Q2 -- up 125 million from the year-ago quarter. In fact, these subscriptions increased 35 million sequentially, marking the most significant sequential growth in subscriptions that Apple has ever seen.
Wearables is a key catalyst, too
Looking beyond iPhone, Apple's Mac and iPad segments have been holding their own. Mac revenue rose 2% year over year in fiscal 2019 to $25.7 billion and iPad revenue jumped 16% year over year to $21.3 billion.
But there's one area of Apple's products business that investors should be particularly excited about: wearables, or sales of Apple Watch, AirPods, and Beats headphones. The segment that includes sales of wearables, called "wearables, home, and accessories," saw revenue surge 41% year over year to $24.5 billion in fiscal 2019, fueled by strong growth in AirPods and Apple Watch. While this segment is still much smaller than Apple's services segment (which is second in size only to iPhone), it's growing faster than services -- making it an important catalyst for Apple.
iPhone is a wild card
Of course, investors can't escape the fact that iPhone still dominates Apple's business. In fiscal 2019, $142 billion of the company's $260 billion in total revenue came from iPhone.
Overall, Apple's iPhone business looks healthy. But there's no reason to get excited about it either. In fiscal 2019, iPhone revenue fell 14% year over year. However, this was up against a tough comparison in fiscal 2018, when iPhone revenue jumped 18% year over year. More recently, the iPhone 11 and iPhone 11 Pro lineup seem to be resonating with consumers. In the company's first quarter of fiscal 2020, iPhone revenue actually rose 8% year over year. Of course, iPhone revenue fell 7% year over year in fiscal Q2, but this was due to headwinds related to COVID-19.
Barring any temporary setbacks from COVID-19's impact on Apple's business, the company's iPhone segment looks well-positioned for flat to moderate growth in the coming years. But it also wouldn't be surprising to see the important segment surprise to either upside or downside.
Buy, sell, or hold?
Assuming Apple's iPhone business can remain competitive, Apple stock still looks compelling at $350 given its impressive momentum in services and wearables.
But there's very little margin of safety built into the stock's premium price tag today. Shares trade at about 28 times earnings. Investors who are interested in buying shares, therefore, may want to keep any purchases today small as a percentage of their total portfolio. If for any reason the stock takes a five to 10 percent haircut, however, that would likely represent a great buying opportunity for investors willing to hold the stock for the long haul.