Apple (NASDAQ:AAPL) stock has delivered lackluster returns lately. Shares of the iPhone maker are down over 20% from their highs of the past year because of slowing revenue growth. On the other hand, Apple looks undervalued in comparison with other big tech companies, such as Microsoft (NASDAQ:MSFT) and Cisco Systems (NASDAQ:CSCO), and the company could easily outperform expectations on the back of accelerating performance over the middle term.
Apple is priced for disappointing growth
The smartphone industry is maturing, and Apple makes nearly 68% of total sales from the iPhone business, so overall growth is slowing down. Apple reported $75.8 billion in revenue during the quarter ended in December, an uninspiring 2% annual increase. Sales in constant currency did much better, though. The year-over-year increase was a stronger 8%.
Management is expecting revenue during the March quarter to be between $50 billion and $53 billion. This would represent a considerable decline of 14% to 9% versus $58 billion in revenue during the quarter ended in March 2015. If sales numbers turn out to be in line with guidance, this will be the first time in more than a decade that Apple reports a substantial decline in sales, and this is a big reason for pessimism among investors.
The good news is that this is already incorporated into valuation to a good degree, and Apple stock is priced at attractively low levels when compared against other big and mature tech players such as Microsoft and Cisco.
Apple, Microsoft, and Cisco are different companies operating on their own industries and with their particular weaknesses and strengths, so comparisons aren't very straightforward. Nevertheless, when looking at ratios such as price to earnings, price to sales, and price to free cash flow, Apple is trading at a clear discount versus its peers. Not only that, but Wall Street analysts are also expecting Apple to outgrow both Microsoft and Cisco in the coming years, so this valuation discount doesn't make a lot of sense when incorporating growth expectations into the equation.
Apple has more room for growth
Bespoke Consumer Pulse recently published a survey among 2,000 U.S consumers, and the main takeaway is that Apple still has considerable room for expansion in the United States. According to these findings, 40% of smartphone owners have an iPhone, but 54% of respondents say they're buying an iPhone as their next smartphone, so Apple is positioned for market share gains in the future. In addition, retention rates among iPhone owners are amazingly high, in the neighborhood of 94%, according to the survey.
The slowdown in iPhone demand over the short term is probably related to transitory factors, at least to some degree. The iPhone 6 was a spectacular success for Apple in 2015. Many consumers were eagerly awaiting for a new iPhone with a larger screen size, so unit sales skyrocketed 28% during the fiscal year ended in September. This makes year-over-year comparisons particularly challenging for Apple over the coming quarters.
According to the company, nearly 60% of all iPhone users have not yet upgraded to the iPhone 6 or iPhone 6s. These customers are still using the versions with the smaller screen size, and these devices are becoming increasingly outdated as time goes by. It doesn't sound too unreasonable to expect improving sales growth as more consumers start upgrading their iPhones in the coming years.
In addition, CEO Tim Cook said in the latest earnings conference call that the rate of switchers from Android is at the highest level ever, and this supports the idea that Apple is gaining ground versus the competition in smartphones. According to shipment estimates from IDC, Apple still owns only 18.7% of the smartphone market on a global scale, so the company has considerable room for market-share expansion.
Emerging markets are going through considerable economic turmoil lately, but Apple still delivered impressive growth figures in some key countries. iPhone unit sales grew 18% in China, and overall constant currency sales in India grew 48%. Currency depreciations in many international markets are hurting performance when expressed in U.S. dollars, but the business remains fundamentally solid in these key geographies.
Apple stock is remarkably cheap because of slowing sales growth over the short term, but performance could easily improve because of factors such as product upgrades from current iPhone users, market share gains versus Android, and rapid growth in emerging markets. If this happens, then Apple stock could deliver substantial gains from current price levels.