The market has been upbeat about demand for Apple's (AAPL +0.37%) iPhone 13 and growing services business. The stock briefly hit $3 trillion in market value recently, which is more than 10% of the U.S. economy. Apple has soundly beaten the market averages, with the shares rising 360% over the last three years.
Most of the gain is a result of an expansion in the multiple investors are willing to pay for Apple's earnings per share (EPS), or the price-to-earnings ratio, rather than growth in the business itself.
Image source: Getty Images.
The growth of services, which carries less business risk than sales of hardware, explains why investors are paying a higher P/E for Apple. But there are other aspects of the business that show why Apple is worth an impressive $3 trillion and could perhaps grow to be worth more.
Investors pay up for consistency
The market has a history of placing a high value on consistent growth. For a brief example, let's compare Costco Wholesale and Kroger. Costco trades at a 43 P/E based on next year's earnings estimates, while Kroger sells for 13.5. Both companies sell everyday essentials in high volume, but the main difference in these two businesses is that Costco has a history of delivering consistent growth in EPS, while Kroger does not.
COST PE Ratio (Forward) data by YCharts.
Apple does not sell everyday essentials. While virtually everyone needs a phone or computer these days, not everyone chooses to pay a higher price to own an Apple device. Still, the tech titan has delivered very consistent EPS growth. Here's how Apple's performance compares to top software provider Adobe, which sells at a much higher P/E than Apple.
AAPL EPS Diluted (TTM) data by YCharts.
Apple's services reached a record $68 billion in revenue during fiscal 2021. That is three times higher than six years ago. Apple credited record results across a number of services: iCloud, Apple Music, Apple TV+, advertising, Apple Care, Apple Pay, and a quarterly record for App Store sales.
Apple's large installed base of devices was 1.65 billion at the start of calendar 2021, but management noted that it hit another record high during the September-ending quarter. This large and growing base of devices is clearly leading to consistent sales of services that generate a high gross margin of 70% compared to Apple's companywide gross margin of 42%.
But it's not just the growth of high-margin services that deserves attention. Specifically, investors should pay attention to the explosion in subscriptions across Apple Music, Fitness+, and Apple TV+, which should justify a higher valuation for the stock.
Apple deserves to trade like Netflix
Investors are already valuing Apple stock similar to one of the most popular subscription services: Netflix. The top streamer has a recurring monthly revenue stream coming from 213 million paying members. The stock currently trades for a P/E of 49 and 8.6 times trailing-12-month revenue. That's only slightly higher than Apple's price-to-sales multiple of 7.9.
AAPL PS Ratio data by YCharts.
It's easy to see why. Apple has 745 million paid subscriptions across its services. That's five times the level of subscriptions it had five years ago. Wedbush analyst Dan Ives believes Apple's services business is currently worth $1.5 trillion alone, or half of the company's current market value.
If this business already makes up half of Apple's value when services accounts for just 19% of total revenue, it's clear that services will gradually become the primary value creator for the iPhone maker, which supports the case for buying Apple stock at these highs.
Management made the case for this scenario on the last earnings call. CFO Luca Maestri pointed to the growing installed base of devices and the double-digit growth in customers paying on the platform as indicators of the sustainability of services revenue.
The case can be made that Apple is fairly valued at $3 trillion. Of course, the stock price could fall during a market correction, but if Apple fell back toward $2 trillion, it would be a no-brainer buy based on how much the company could be worth in another 10 years.
