One of the key drivers behind Apple (AAPL +0.11%) stock's recent ascent to a new all-time high is undoubtedly the tech giant's improving gross profit margin. In 2013, when Apple stock fell sharply from a post-split $100 to levels around $60, the Street saw the company's narrowing gross profit margin as a sign of increased competition and possibly the beginning of weakening pricing power. By looking at the trend of Apple's gross profit margin in the last few years in relation to the company's stock price, it even appears that the company's profit margin may be one of the biggest drivers for the stock.
This historical trend of gross profit margin as a driver for Apple stock is one of the reasons Barclays analyst Ben Reitzes (via AppleInsider) is raising his 12-month price target for the stock to $140 from $120. The stock closed on Dec. 3 at $115.93. Over the past year it has ranged from $70.51 to $119.75, according to S&P Capital IQ data.
Not only is Apple's gross profit margin already on the rise, but Reitzes sees a hot-selling iPhone 6 line, a "high-margin" Apple Watch, Apple Pay, and other "soon to be announced" digital services as catalysts for further margin expansion.
Apple's improving gross profit margin
One of the main catalysts behind Apple stock's rebound in 2013 was likely a trend of a narrowing gap in year-over-year gross profit margin comparisons in the second half of the year.
Data from SEC filings; author's chart.
The trend of improving comparisons has continued and comparisons have even turned positive, remaining positive for the last three quarters. Apple's midpoint for its gross profit margin guidance in the first fiscal quarter of 2015 is also higher than its gross profit margin in the year-ago quarter, suggesting Apple expects this trend to continue.
Given that Apple management has said that its iPhone is its most profitable product, and considering that Apple looks poised to post record-shattering iPhone sales in Q1 on the strength of strong iPhone 6 demand, positive gross profit margin comps are probably already in the bag for the immediate quarter.
Will Apple's gross profit margins be higher than expected?
There is a strong possibility that Apple could post a higher-than-expected gross profit margin in Q1. While the iPhone 6 almost certainly costs the tech giant more to manufacturer than previous iPhones further along the cost curve, Apple is introducing other measures to boost the profitability for its iPhone.
First, Apple has flexed its pricing power by introducing a $100 higher pricing tier with the iPhone 6 Plus.
Further, Apple has structured the storage offerings for its iPhone lineup in a way that makes upgrading to a higher storage level beyond the entry-level version. While the rest of the industry is beginning to offer 32GB of storage for their entry-level smartphones on flagship lines, Apple is keeping its entry-level iPhone at 16GB of storage and boosting the storage for the $100 more expensive iPhone to 64GB. Even more, Apple has introduced a 128GB smartphone to both the iPhone 6 and iPhone 6 Plus lineup, creating yet another, more expensive tier that didn't exist before.
One version of the Apple Watch Edition: 18-karat rose gold. Image source: Apple
Going out beyond Apple's first quarter, predictions about Apple's gross profit margin are more speculative in nature. Still, Reitzes has a solid point: There is potential upside to Apple's gross profit margin if the rollout of these new products and services plays out optimistically.
Consider the Apple Watch, for instance. While pricing begins at $349, the high-end gold versions of the watch could cost several thousand dollars. The Apple Watch could, therefore, be one of the company's most profitable products. But the key question remains: How many Apple Watches can the company sell?
It makes sense that an expanding gross profit margin could serve as a catalyst for Apple stock. Given Apple's fairly conservative valuation of 18 times earnings, meaningful margin expansion could make Apple stock look considerably cheaper at these levels as earnings get a boost from a higher level of profitability.
