It's hard to overstate how great of an investment Apple (AAPL +1.08%) has been. The stock's 52% trailing-three-year return crushes the 18% gain of the Nasdaq Composite. And if we zoom out even further, the tech giant's shares have climbed at an even more impressive clip.
But while looking at past data can show us previous winners, investors care about what the future holds. With our eyes set on the next three years, what are the prospects for this FAANG stock?
Services leading the way
The iPhone needs no introduction. Apple's flagship product represented nearly half of companywide sales in the most recent quarter (the Q3 2023, ended July 1). With the recent launch of the latest upgrade cycle, these smartphones could be an even more important contributor when Apple reports its fourth-quarter financials on Nov. 2.
Other hardware products, like the iPad, MacBook, AirPods, and Watch, are incredibly popular among consumers. And they exemplify the strong brand presence that the company has. In recent years, though, it's the services segment that is rapidly ascending, now accounting for a quarter of Apple's revenue. Notable offerings in this division include iCloud, Pay, Music, and TV+.
I see two major benefits for Apple from its budding services. The fact that this group carries a gross margin of more than 70% means that as it continues on its path of becoming a bigger revenue contributor for Apple, the company's overall profitability should get a boost.
And from a strictly qualitative perspective, this drives stickiness from consumers to not want to leave the ecosystem. Customer loyalty is what every business strives for. Apple has cracked that code. Looking ahead, it's clear that services will be even more critical to the company's financial success.
NASDAQ: AAPL
Key Data Points
Continued operating leverage
In the last three years, Apple's revenue increased at a compound annual rate of 11.1%. That's an impressive rate for such a massive corporation. What's encouraging, however, is that its net income expanded at an even faster clip, an annualized pace of 20.9% during that same time.
This is what's called operating leverage. Apple has proven that it can spread out its fixed costs for things like research and development and SG&A (selling, general, and administrative) functions over rising sales. And this has led to an expanding bottom line. The operating margin went from 21.9% in Q3 2020 to 28.1% in the most recent quarter.
And as I alluded to above, as services grow quicker than products, profitability is set to keep rising. Plus, Apple's pricing power helps. Investors worried that inflationary pressures will continue for an extended period of time are somewhat protected by the company's premium status in the marketplace. That's because consumers have shown the propensity to pay up for what Apple sells.
Keep expectations in check
With the potential for services to become a bigger part of the overall business, coupled with the continuation of faster-rising profits, Apple's fundamentals are almost certainly going to be heading in the right direction over the next three years.
This doesn't mean the stock will automatically end up being a winning investment. The final variable to consider is the valuation. As of this writing, shares are trading hands at a price-to-earnings ratio of 30. On a historical basis, that's way on the expensive side of the equation.
For a company that's mature in its lifecycle, I think the valuation is steep. Expectations are likely pricing in double-digit revenue growth for Apple going forward, which could be a bit of a stretch.
Unless there's another breakthrough product that gets introduced, which is impossible to predict, there's a very real possibility that this stock will disappoint investors looking out over the next three years.
