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Why Apple, Inc. Stock Fell -- And Why You Shouldn't Sell

By Daniel Sparks - Apr 27, 2016 at 8:35PM

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Why the Street sold off Apple stock on Wednesday is clear, but the reason to continue holding the stock, even amid the market's knee-jerk reaction, is just as well defined.

Apple (AAPL 4.08%) stock was hit hard on Wednesday following the company's second fiscal quarter earnings release. Shares wrapped up the trading day down 6%, with the stock trading below $98. Here's why the Street was selling off Apple stock on Wednesday, and why the market may be overreacting.

Investors wonder: Can Apple continue to grow?
The most likely reason for bearish sentiment toward Apple stock on Wednesday is its worse-than-expected revenue decline -- both for the current quarter and the implied decline factored into guidance for Q3.

Apple reported second-quarter revenue of $50.57 billion. This was below analysts estimates for revenue of $52 billion, and at the low end of the tech giant's guidance for the quarter of revenue in the range of $50 billion to $53 billion. Making matters worse, the company guided for third-quarter revenue of $41 to $43 billion -- a range well below analysts' consensus estimate for $47.3 billion in revenue for the quarter.

The reported revenue for the quarter that just ended, and the company's guidance for the current quarter's revenue, both imply a significant year-over-year decline. For Q2, Apple's revenue was down 13% compared to the year ago quarter; and the midpoint of the company's Q3 revenue guidance implies an even worse 15% year-over-year decline.

The overarching concern is that Apple will struggle to grow its sales beyond current levels. iPhone sales, which largely drive the company's total revenue, are particularly a concern. With iPhone accounting for 65% of the company's total revenue, Q2's 16% year-over-year decline in iPhone unit sales may have some investors wondering if Apple's blockbuster iPhone 6 cycle was the important device's peak in terms of annual sales. If iPhone sales plateau or -- even worse -- continue to decline, Apple may struggle to grow its business.

iPhone. Image source: Apple.

But it's not just iPhone that may be raising concerns about the company's growth prospects from here. Apple's iPad and Mac segments also saw declining unit shipments on a year-over-year basis in the company's second quarter. iPad and Mac unit sales were down 19% and 12% compared to the year-ago quarter, respectively. Together, these two segments account for 19% of Apple's total revenue.

Reasons not to worry
Despite the company's obvious near-term growth challenges, the market's sell-off of Apple stock on Wednesday isn't necessarily justified. Here are three reasons why the market may be overreacting.

1. Apple's 2015 iPhone 6 cycle was extraordinary. Taking advantage of pent-up demand for iPhones with larger displays, the iPhone 6 launch was a wild success. Its success, however, makes iPhone sales comparisons in 2016 difficult.

For perspective, if you compare Apple's Q2 iPhone sales to iPhone sales in the same quarter two years ago, iPhone sales are up 17%. The company's iPhone segment, therefore, is still performing exceptionally well -- just not as well as it was last year.

Apple Watch. Image source: Apple.

2. Apple's "services" and "other products" segments look promising. The tech giant's services and other products segments, which together account for 16% of the company's total revenue, were up 20% and 30%, respectively. While these segments' year-over-year growth rates are bound to see volatility on a quarter-to-quarter basis, they're likely to continue to grow over the long haul, driven by the company's loyal installed base and Apple Watch (Apple Watch revenue falls under Apple's other products segment).

3. Growth isn't priced into the stock. Apple trades at just over 10 times earnings. This conservative valuation essentially prices in zero growth. In other words, Apple could live up to this valuation by maintaining current levels of profitability and continuing to repurchase shares with its hefty free cash flow.

When it comes down to it, the reasons the Street sold off Apple stock on Wednesday are clear, but the reasons to continue holding the stock, even amid the market's knee-jerk reaction, are just as well-defined.

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