At first glance, Apple's (AAPL +2.65%) third quarter report looked stellar. Revenue soared 33% annually to $49.6 billion and net income surged 39% to $10.7 billion. Both figures topped consensus estimates for $49 billion in revenue and $10.3 billion in profit. Apple's operating cash flow rose 46% annually to $15 billion, and it finished the quarter with over $200 billion in cash.
Source: Pixabay.
But sales of the iPhone, which rose 35% annually to 47.5 million units, fell short of the 49 million units that analysts were expecting. Apple's fourth quarter revenue guidance between $49 billion to $51 billion also barely missed the average estimate of $51.1 billion, due to the strong U.S. dollar. Investors looking for reasons to dump Apple were spooked, and the stock slipped 7% in pre-market trading on July 22 before closing down 4% for the day.
But as a longtime Apple investor, I believe that it's premature to sell this stock. Let's discuss three reasons that investors should buy, not sell, Apple stock after its earnings report.
1. Check the fundamentals
First and foremost, Apple is still a cheap stock. It currently trades at 14 times trailing earnings, versus the S&P 500's P/E of 21. That's also considerably lower than its P/E of 18.5 last November, which represented a 12-month high for the stock.
That's also lower than the average P/E of 19 for the electronic equipment industry, which includes industry peers like BlackBerry and Hewlett-Packard. Apple also trades at 14 times analysts' earnings estimates for fiscal 2015, versus the S&P 500's forward P/E 18.
Therefore, Apple's stock price might be near a historic high, but that doesn't mean the stock is trading at a premium to the market.
2. Don't overlook the iPhone's strengths
Meanwhile, Apple's 35% unit growth in iPhones is far more robust than unit growth in the third quarters of previous years. In the third quarters of 2013 and 2014, iPhone unit sales respectively climbed 20% and 13% annually.
The average selling price of the iPhone also rose $100 from the prior year quarter to $662.42 thanks to the larger form factor iPhone 6 and 6 Plus. That's more than double the global average selling price of $297 for all smartphones worldwide in 2014, according to IDC. Apple can keep charging higher prices because it brands its devices as "luxury" products -- something that rivals like Samsung can't easily do.
The iPhone 6. Source: Apple.
Thanks to that brand appeal, Apple can sell mid-range hardware at top-tier prices. That's how it claimed 92% of the world's smartphone profits during the first quarter of 2015, according to Canaccord Genuity analyst Mike Walkley, while only controlling 18% of the overall market. That appeal also helped Apple's revenue in Greater China more than double to $13.2 billion, although the region's smartphone market recently contracted.
3. Look beyond the iPhone
Many investors only check iPhone numbers when judging Apple, since 63% of its revenue came from smartphone sales last quarter. However, Apple's opportunities for diversification and growth shouldn't be overlooked.
First, Apple is expanding its digital ecosystem with Apple Music, Apple Pay, CarPlay, HealthKit, HomeKit, streaming TV, and other services. These platforms can help Apple leverage its strength in hardware to defend against Google, which has crept into iOS with apps like Google Now, Drive, Chrome, and Maps. If Apple can expand its walled garden to those other areas, its services revenue -- which generated 10% of its sales last quarter -- could rise.
Apple Music. Source: Apple.
Second, Apple's brand strength gives it the momentum to enter other markets. There are currently rumors about Apple developing an electric car, augmented reality glasses, a gaming console, an action camera, and other products. If Apple revolutionizes any of these markets in the way it did with smartphones or tablets, it could eventually diversify its top line away from iPhones, iPads, and Macs.
The bottom line
If Apple starts trading at a premium to the market, iPhone sales slow down significantly, and average selling prices decline, I would probably sell my shares. However, Apple's iPhone-fueled sales momentum hasn't slowed down yet, which gives CEO Tim Cook more time to shape the company's future. For now, it seems smarter to buy, not sell, when Apple stock dips.
