Are Investors Buying Apple Stock for the Right Reasons?

In the last decade, there have been few tech companies as important as Apple (NASDAQ: AAPL). Founder and former CEO Steve Jobs reinvented the digital experience by redefining the smartphone. Shares of the company have exploded nearly 1,000% since the first iPhone launch, propelling Apple closer to the first $1 trillion publicly traded company.

However, investors should look beyond iPhone sales as a reason to buy Apple stock. Instead, they should focus on the company’s services sales as the reason for owning the company.

Hands holding a phone displaying the Apple pay concept.

Image Source: Getty Images.

Growth: Powered by services, not iPhones

As far as iPhone sales go, Apple finds itself a victim of its past successes. After selling 231 million iPhones in fiscal 2015 on the back of a highly popular iPhone 6 and iPhone 6 Plus launch, the company sold fewer units in each of the following two years. Last year’s revenue attributable to the iPhone was 9% lower than 2015’s high-water mark. Below are the breakdowns for revenue by product, in millions, over the prior two years:

ProductFY 2017FY 2016Y/Y Growth ($)Y/Y Growth (%)% of Total Dollar Growth
iPhone141,319136,7004,6193.4%34%
iPad19,22220,628(1,406)(6.8%)(10%)
Mac25,85022,8313,01913.2%22%
Services29,98024,3485,63223.1%41%
Other products12,86311,1321,73115.5%13%
Total229,234215,63913,5956.3%100%

Non-percentage figures are in USD. Data from Apple’s 2017 fiscal-year annual report.

Apple was able to report total revenue growth of 6.3%, or $13.6 billion, over the prior year. Although the iPhone provides the bulk of total revenue, it did not provide the bulk of the year-on-year revenue growth; by growing 23% over the prior year, services provided 41% of the total dollar growth in revenue, more than the larger iPhone division that reported only 3.4% yearly growth.

iPhone sales are still important

iPhone sales are still critical to Apple’s success in two key ways. First is scale, as the segment will continue to be Apple’s largest for years to come. Even considering CEO Tim Cook’s audacious goal to double services revenue by 2020, the division would still amount to less than half of iPhone sales.

But Apple’s massive smartphone scale creates a huge installed base for its services segment, where the company can grab high-margin, long-tailed revenue over a consumer’s lifetime. 

In this case, growing the installed base, particularly from Android-switchers, and ensuring the installed base has the newest technology capabilities will lead to more rapid growth from Apple’s services division. Although Apple’s gross margin declined 60 basis points to 38.5% in fiscal year 2017, the company noted it was due to higher production costs and credits a “mix shift” to services as a reason it wasn’t lower.

iPhone as a platform device

Hammering home this point, the iPhone can be considered a platform device for its services division, connecting its user base to vendors and artists while taking a fee, or a toll, to do so. For example, Apple’s host of services include, among others:

  • Apple Pay: a transactional payment service that takes 0.15% of each purchase. Apple claims the number of active users has doubled, with Loup Ventures estimating nearly 130 million use the service.
  • Apple Music: a $9.99/month ($14.99 for families) streaming music service that provides unlimited streaming while passing along more than 70% to artists and rights holders and keeping the rest. The service has approximately 45 million global subscribers.
  • App Store: paid, free, and premium app downloads. According to data firm Sensor Tower, the App Store grossed $38.5 billion in 2017, with Apple taking between 15% to 30% of revenue.

While iPhone sales are often the first metric bandied about from quarterly earnings reports, investors should begin to pay more attention to Apple’s services division, which carries with it a longer tail for growth.

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Jamal Carnette, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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