In a rare move, analysts at Jefferies downgraded one of the largest companies in the world, Apple (AAPL -0.59%), to underperform. Wall Street analysts are known for being bullish, so underperform and sell ratings tend to make up only a small percentage of overall analyst ratings.

For its part, Jefferies sees weak iPhone shipments in the fourth quarter, with Apple's artificial intelligence (AI) features not resonating with consumers. It cited a survey that most U.S. consumers do not find AI features very useful. As such, it thinks this is an indication that there will not be an AI power upgrade cycle for the iPhone.

Jefferies expects Apple to miss current analyst revenue estimates, calling for 5% growth when it reports its Q4 results at the end of January. It also thinks there is a good possibility Apple's Q1 guidance could disappoint as well. Its price target for the stock is $200.75.

Given the rare underperform rating, many investors may be wondering if it's time to sell the stock.

A strong business model

Despite the downgrade related to iPhone sales projections, one thing has not changed: Apple has a strong business model. The company's revenue growth was pretty lackluster throughout its fiscal 2024 ended in September. It only grew its revenue 2% on the year and 6% for its fiscal Q4. Revenue growth for its devices, meanwhile, has been even worse. Product revenue actually fell by 1% for its fiscal year, while rising by 4% last fiscal quarter.

Where Apple has seen stronger growth is in its high-margin services revenue. This includes revenue from its App Store, search-sharing revenue, Apple TV, Apple Pay, and other subscriptions and services. Last fiscal year, its services revenue climbed 13% and was up 12% in Q4.

Its services gross margin is close to 74%, while its product gross margin is about 37%. With the services margin nearly double, revenue coming from services more easily drops to bottom-line profits. As such, the company was able to grow its adjusted earnings per share by 11% last year to $6.75, despite only a 2% increase in revenue.

Image source: Getty Images.

Right now, it appears that the big iPhone upgrade cycle related to Apple Intelligence is not materializing. The company has had some issues with its offering, such as its AI producing inaccurate news alerts. Meanwhile, both iPhone and Android smartphone users in surveys have indicated that that AI features are adding little to no value. Then there is the whole question of whether users will eventually pay for AI subscription services. Right now for Apple, AI seems to be more of a cost without any offsetting revenue benefit.

The company also hasn't been able to include Apple Intelligence with its smartphones in China. It had already been struggling in the country against local competitors, and according to Counterpoint Research, iPhone sales plunged in China by 18% in Q4. Sales of smartphones from rival Huawei, meanwhile, climbed 15.5% in the quarter.

Apple initially saw strong iPhone sales in China after it debuted its latest version. However, its AI is not approved in China and it must find a local AI partner to incorporate its technology to run Apple Intelligence in China. Apple mostly competes in the premium smartphone market in China, so the lack of the latest AI technology has left it behind competitors.

Outside of smartphone sales, Apple also faces another big risk related the Alphabet antitrust case. Alphabet has been paying Apple an estimated $20 billion a year as part of its revenue-sharing model for Google to be the default search engine for its browser Safari. This revenue is also virtually pure margin, dropping right to operating income. With Alphabet losing its antitrust case and this agreement in jeopardy, the impact it eventually could have on this revenue stream is still very much in the air as the case could lead to some pretty big changes. However, any impact is likely years away as the ruling gets appealed and both companies have reason to try to protect what is currently in place.

Expanding valuation

Apple stock has seen a lot of multiple expansion in the past several years. Its trailing price-to-earnings (P/E) ratio has essentially tripled from 12 times to 36 times, while its forward P/E based on current fiscal year estimates is around 30 times.

AAPL PE Ratio (Forward) data by YCharts

Some of this multiple expansion can be attributed to the shift toward high-margin services revenue, as these businesses tend to carry higher multiples than hardware businesses. Apple has also proven to be a steady business that tends to have a somewhat predictable, albeit lengthening, replacement cycle.

That said, with the hope of an iPhone upgrade cycle diminishing and the stock seeing a lot of multiple expansion in the past six years, I think it would be smart to take some profits on the stock.