It might be worrying to see that Apple's (AAPL 0.06%) revenue has declined on a year-over-year basis in each of the last three quarters. But shareholders don't seem concerned. The stock has climbed 38% so far in 2023, a better return than the Nasdaq Composite.
Zooming out, Apple's rise is even more impressive. This has benefited Warren Buffett's Berkshire Hathaway tremendously, as the conglomerate's portfolio is heavily concentrated in the tech giant. But is now a good time for investors to buy shares in the iPhone maker?
There are strong arguments to consider before making a decision. Let's take a look at them.
The best business ever?
The iPhone might be the single-most successful product ever invented. More than 16 years after the first model was launched, Apple is still releasing updates to the smartphone. And consumers have shown a propensity to pay steep prices for these upgrades, even though the new features might be limited.
Apple has a stranglehold on the global smartphone market. While it has just a 21% share of unit volume, due to its premium status, the iPhone accounts for a whopping 82% of operating profits in the industry. And it's still the key driver for Apple's business, representing 49% of overall revenue in the most recent fiscal quarter (third quarter of 2023, ended July 1).
Besides the iPhone, Apple has launched other popular hardware products like the iPod, MacBook, iPad, AirPods, and Watch. All of these benefit from strong demand, bolstered by Apple's incredible brand presence. On their own, the products aren't that impressive, to be clear.
What makes Apple arguably the best business ever is how it combines this incredible hardware with its own internally developed software and services. The ecosystem is Apple's secret to success. It drives customer loyalty and stickiness. And in recent years, services like Music, Pay, and TV+ are driving greater usage. In Q3, services represented 26% of revenue but 41% of company gross profit.
A top-notch product and services portfolio has resulted in massive financial success. Apple's operating margin has averaged a stellar 27% in the past five years. And this company generates so much free cash flow that management has to figure out what to do with it. To its credit, Apple has repurchased a lot of its stock, which boosts earnings per share. And it pays a dividend, further adding to shareholder returns.
Not a good setup for investors
Finding a wonderful business that possesses all of the positive characteristics that Apple does is only part of the challenge. Investors then need to be critical about the valuation that they are willing to pay for such a great company. Even the best businesses can be terrible investments if the price is too high. I don't think Apple is any different.
After soaring 216% in the past five years, the stock currently trades at a price-to-earnings (P/E) ratio of about 30. In my opinion, this isn't cheap by any means. It's 50% more expensive than Apple's trailing 10-year average P/E multiple. And the current valuation is astronomically higher than the P/E ratio that Buffett paid in early 2016 when he first bought the stock.
But isn't it worth paying up for one of the best businesses in the world? If you're willing to pay such a high P/E, you need to question where the market-beating returns will come from. Quite frankly, it takes a lot to move the needle financially for a company that has the scale that Apple does. And unless a game-changing product is introduced that can drive higher growth, I just don't see huge gains coming from Apple in the years ahead.
The current valuation provides no margin of safety, so it might be best for investors to pass on the stock right now.
