Heading into Apple's (NASDAQ:AAPL) second-quarter earnings on Wednesday, it's helpful to have a useful framework on how to think of the stock. Shareholders and prospective Apple investors alike may be asking similar questions as the latest earnings report approaches:
- Is there potential upside to the stock at today's prices?
- Can Apple continue to grow its business?
- Is the downside limited?
Answering questions like these can help investors figure out if they want to take any action before or after earnings, depending on what happens to the stock.
In an attempt to bring color to these questions, let's look at Apple's valuation and analyze current catalysts driving the underlying business.
It's no secret that there is very little growth priced into Apple stock. In fact, trading at just 13 times earnings, it could be argued that Apple's underlying business is priced to simply maintain its current levels of profits over the long haul. Even the broader S&P 500 trades at a considerable premium to Apple at 18 times earnings.
But is maintaining its bottom line really that easy? After all, Apple's 2013 net income of $37 billion was down from $41.7 billion in 2012. Is this the beginning of the decline of Apple's fundamentals?
Probably not. Without even considering potential catalysts for the company's business, three underlying financial trends point to slow growth going forward.
First, Apple's top line is still growing. The tech giant's 2013 revenue of $170.9 billion, for instance, exceeded the company's 2012 revenue by more than $10 billion. Second, Apple's narrowing gross profit margins seem to have stabilized at about 38%. Finally, Apple's pricing power appears to remain intact, with only nominal declines in the average selling price of the iPhone.
And looking out into the future, two macro trends look like they will serve as growth opportunities for Apple.
First, the smartphone and tablet markets are still growing robustly. In the U.S., for instance, the base of smartphone users grew 24% in 2013, according to ComScore. Tablet users grew by 57%.
"The rapid evolution in mobile usage will only expand," said ComScore marketing insights analyst Adam Lella (via Mobile Marketer).
Second, Apple is just getting revved up in China with the world's largest carrier, China Mobile. With Apple only beginning to sell iPhones through the carrier in January, and the carrier's 4G network barely started, China Mobile's 776 million subscribers will likely serve as a market for steady meaningful growth over the next several years.
And if anyone doubts the iPhone's potential in China, they only need to glance at statistics from app analytics firm Umeng, which show that Apple has 80% market share of the 27% of smartphones in China priced at $500 or more.
Apple and Q2 earnings
A conservative valuation combined with meaningful catalysts for continued business growth make Apple stock look enticing. Even more, the risk profile looks so favorable that the stock could even be a buy before earnings.
Sure, neither of these reasons for buying Apple stock is new. In fact, both are somewhat boring. But no matter how uninteresting these reasons for buying Apple stock may be, both are difficult to refute.