When Apple's (AAPL 0.12%) market capitalization crossed $1 trillion for the first time in 2018, few investors likely imagined the company adding another trillion dollars of value to its name over the next two years. But it happened.
The stock's huge run (up 133% over the past 12 months) has brought a lot of new attention from individual investors to the already-popular tech stock. Many investors are likely wondering whether there's still sharp upside ahead for the company, particularly ahead of its 4-for-1 stock split later this month.
So is Apple stock a buy, hold, or sell today?
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Momentum where it counts
On the surface, Apple's 5.7% trailing-12-month year-over-year revenue growth isn't impressive. But this misses the underlying story that has shareholders so excited.
Perhaps the main pillar in a bull case for Apple stock today should be its fast-growing services business. The lucrative segment is growing as a percentage of revenue and looks poised to grow at double-growth rates for years to come. This is key since the segment boasts a much higher gross profit margin than Apple's product sales and is a more dependable revenue stream, given its recurring nature. The segment's revenue is generated from third-party app sales and subscriptions; Apple services like Apple Pay, AppleCare, and iCloud; advertising in the App Store; and other largely recurring streams. And these growing revenue sources are making Apple less dependent on successful new product launches.
To illustrate why investors are willing to pay a higher premium for Apple's earnings as its services segment becomes a larger portion of its overall business, take a look at the segment's impressive performance in the tech company's most recent quarter.
- Services revenue is growing rapidly: Total services revenue increased 15% year over year in fiscal Q3. During the same period, product revenue increased 10%.
- The segment has an impressive gross margin: Fiscal Q3 services gross margin was 67%, compared with products' gross margin of 30%.
- The segment is becoming increasingly important to Apple's business: Services accounted for 39% of the quarter's total gross profit, up from 36% in the year-ago period.
With the segment growing as a percentage of total revenue, and given its much higher gross profit margin compared with the rest of Apple's business, it can help drive substantial earnings growth for the tech company in the years ahead.
What about valuation?
While Apple's momentum in services is promising, here is where the stock's value proposition today begins to break down: The valuation is becoming difficult to justify.
Apple now has a price-to-earnings ratio of 37. To justify such a high price-to-earnings multiple, the company would likely need to grow its earnings per share at rates of around 13% to 15% annually over the next five years, with growth only decelerating moderately after that. Yet even analysts are modeling for annual average compound earnings-per-share growth of about 12.5% over the next five years.
While the growth prospects for Apple are strong, especially with the help of a rapidly growing wearables business and an expanding services segment, the stock is arguably a better hold at this level than a buy.
Of course, it's also worth emphasizing that selling the stock today could be a mistake. While there's always a chance the stock could fall in the near future (especially after such a huge run-up), it does not seem grossly overvalued to the point that shareholders will see poor returns over the long haul.
