Technology

Why I Wouldn’t Touch Apple’s Stock With a 10 Foot Pole

Many investors believe Apple (AAPL -1.64%) is one of the best companies in the world, and I’m not here to argue against that proposition. Its brand loyalty and widespread use throughout the U.S. make it one of the top consumer goods companies (if not the top).

However, its stock is an entirely different story. While many stocks have seen their valuations come down, Apple’s has stayed elevated. Additionally, economic headwinds are popping up that could spell disaster for Apple. While this is a contrary view, I think this case should be made, as Apple stock could cause a significant move in the markets.

Consider that Apple makes up about 7% of the S&P 500. So a 15% drop in Apple’s stock would cause a 1% decline in the index, and market worries over such a drop could cause even more selling. Let’s dive into the bear case for Apple stock and see if there is trouble on its horizon.

Apple hasn’t been doing well recently

Apple is primarily a consumer-facing business. So as the consumer weakens, so will Apple. With inflation raging, consumers can no longer splurge on the newest iPhone or accessories, because they have to focus on essentials like housing, food, and energy. This has taken a toll on Apple’s revenue growth.

Year-Over-Year Revenue Growth
Q3 FY 2022 Q2 FY 2022 Q1 FY2022
1.8% 8.6% 11.2%

Source: Apple. Q3 ending June 25, Q2 ending March 26, Q1 ending December 25, 2021.

If Apple follows this trend, then it’s possible the company may report negative revenue growth when it reports Q4 results on October 27. However, the average analyst believes Apple will report 6.3% growth.

I think this is misguided as Apple recently informed suppliers that it was cutting back on its iPhone 14 production by 6 million units. This reduction brings Apple’s iPhone production to similar levels as 2021, which would likely keep revenue in the no-growth region.

Apple is also selling fewer units than its competitors. In Q4 2021, Apple led the way among smartphone companies, shipping a world-leading 23% of smartphone units. However, in this year’s Q2 (ended June 30), Apple only shipped about 16% of smartphone units, dropping to second place. While this could be a side effect of consumers waiting for the newest iPhone to release (the iPhone 14 was launched in late Q3), it could also indicate that consumers don’t have the cash to fork over for an expensive piece of hardware.

In reality, the demand situation will likely worsen for Apple before it gets better. But what does this mean for the stock?

An expensive stock is about to get cheaper

Throughout 2022, nearly every tech-related stock saw its valuation decline — except Apple. In fact, it’s even outperforming the S&P 500 this year. And up until news broke about Apple cutting iPhone production, it maintained a premium valuation of 25 times earnings. Now Apple’s valuation has slightly dropped to just under 23 times earnings.

Still, that’s a high price for a business whose revenue is beginning to flatline. Another item to watch is Apple’s margins, which have begun to shrink.

Margin Q3 2022 Q3 2021
Gross Margin 43.3% 43.3%
Operating Margin 27.8% 29.6%
Profit Margin 23.4% 26.7%

Source: Apple.

With margins compressing and revenue staying constant, Apple’s price-to-earnings (P/E) ratio will increase due to a decrease in the denominator. As a result, the stock price should fall so that Apple maintains a reasonable valuation level.

Is this the end of the world for Apple? Absolutely not. However, I think Apple’s stock could have a rough couple of months (or even years) until its valuation matches its business performance. Still, selling Apple’s stock isn’t a good idea, as its brand dominance should continue to shine when consumers regain their spending power. However, there are far better investment opportunities available in the market right now, and investors should be focused on them instead of Apple.

Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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