With a market cap of $2.26 trillion, Apple (AAPL -0.35%) is the most valuable company in the world. Its dominance in the tech world has made it one of the best growth stocks, with its shares rising 227% in the last five years despite a sell-off in 2022, which has pulled its stock down 22% year to date.
There are numerous green flags for the iPhone manufacturer, with its walled garden of products capable of pulling consumers further into its ecosystem with just one purchase. However, its services business, including subscription-based platforms such as Apple Music, TV+, Fitness+, Arcade, News+, and iCloud, is especially promising for its long-term growth.
Meanwhile, Apple's reliance on China for its iPhone production could present more short-term headwinds. Here's why.
Green flag: Growing services business
Apple's services business has quickly become its second-biggest segment, earning 19.8% of the company's revenue in its fiscal 2022 (which ended in September). Throughout the year, services revenue increased 14% year over year to $78.1 billion.
The most attractive aspect of Apple's services business is its considerable profit margins. In fiscal 2022, the company's gross profit margin for its services stood at 71.7%, while the same metric for its products came in at 36.3%. Gross margins in services have also grown over the last three years, with the segment reporting 69.7% in 2021 and 66% in 2020.
In its products business, Apple accrues an operating expense for each device made, from the materials and labor involved. However, with services, the company can pay once for a piece of content and sell it millions of times over to consumers worldwide. And adding a monthly subscription for consumers to access that content benefits margins further.
In October, Apple introduced price hikes across all of its services, with Apple TV+ specifically rising 40% from $4.99 to $6.99 per month. With 2023 just around the corner, services revenue is likely to increase over the next year as Apple products continue to grow in popularity and consumers are attracted to all of the offerings associated with them.
Red flag: Production strains for its cash cow
In Apple's fiscal 2022, its iPhone segment earned $205.5 billion, making up 52% of its total revenue. As a result, when news broke at the end of October that an outbreak of COVID-19 cases in China had prompted the government to introduce strict lockdowns, Apple's stock began to slide as investors grew concerned over potential issues with iPhone production. From Oct. 28 to Nov. 9, the company's shares dipped 13.4%.
On Oct. 31, Reuters reported that Foxconn -- also known as Hon Hai Technology Group (HNHPF 2.17%), which manufactures about 70% of all iPhones -- could see a 30% decline in iPhone production amid the lockdowns. While lockdown measures in China allow factories like Foxconn to remain active, workers must live at the plants to continue working, understandably leading to pushback from employees.
Foxconn said it coordinated backup production with other plants to reduce the impact. However, that has done little to quell investor concern about Apple's overreliance on China to produce its biggest earner.
Apple has recently made moves to relocate portions of its iPhone production to India; JPMorgan Chase estimates the tech giant will move about 5% of iPhone 14 manufacturing to the country by the end of 2022, and 25% of all of its products by 2025.
China's zero-COVID policy seems to have been the last straw for Apple as it begins to improve its supply chain. However, shifting countries won't come quickly. Wedbush analyst Daniel Ives estimates it will take until 2025 or 2026 for Apple to relocate 50% of its iPhone production to India or Vietnam, if it takes an aggressive approach.
Apple may suffer temporary headwinds from a troubling supply chain; however, its stock remains a buy for the long term. The company ended Sept. 30 with $111.4 billion in free cash flow, proving it has the means to invest heavily in altering its production strategy. Given that it's the home of a quickly growing services business and some of the world's most in-demand products, I wouldn't bet against Apple's long-term prospects.
