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Wall Street Sees Apple Doing Two Very Important Things Right

Photo: Brendon Thorne/Bloomberg/Getty Images

If it is possible for Apple, arguably the world’s most successful company, to be in a rut, it was in one a year ago. Last January, the company sent a letter to shareholders saying it was cutting revenue forecasts, due to worse-than-expected consumer demand in China and weaker-than-expected iPhone sales globally, as customers waited longer than anticipated to upgrade their phones. After the letter, the company reported four consecutive quarters of declining revenue.

Yet, through 2019 the company’s stock soared, steadily rising to double from a low it set on December 31, 2018. And on Tuesday, the company issued a blockbuster earnings report: Earnings in the last calendar quarter of 2019 were 11 percent higher than a year earlier, breaking the streak of declining earnings and beating Wall Street expectations by over 9 percent. The report bears out the optimism that investors showed throughout last year, and it reflects two key positive stories that have given investors reason to believe Apple’s future remains insanely bright and profitable.

The first positive story is a return to form: iPhone sales are growing again. To a large extent, the iPhone business is the Apple business, with iPhone sales accounting for over 60 percent of the company’s total sales in the fourth quarter. But iPhone sales had slumped in recent quarters, in part because of weak Chinese consumer spending and in part because customers were waiting for the iPhone 11 to launch, which it did on September 20, just before the start of the fourth calendar quarter (which is Apple’s first fiscal quarter).

With the iPhone 11 now available, iPhone sales have rebounded, with even stronger growth than analysts had expected, rising 8 percent in the last quarter from the quarter a year earlier. Sales growth has even been strong in mainland China — though the Wuhan coronavirus outbreak gives reason to wonder if that trend will continue, and CEO Tim Cook said on the company’s earnings call that coronavirus-related uncertainty is a reason the company is giving a wide range of possible revenue estimates for the current quarter. But overall, they are giving investors guidance that they should expect strong performance to continue.

As an owner of an iPhone 11, I am unsurprised that the product has sold very well. The battery life and camera are markedly improved over past models. The phone takes great pictures even in the dark. And I no longer even really think about my battery. Previously, my main battery problem was draining it on active days away from my desk, like at a theme park or ski resort. But on a recent ski trip, I found I would start the day with a full battery and finish over six hours later with 70 percent battery life remaining — despite using the phone enough on chairlifts that I got windburn on the back of my right hand.

But a problem with being a product company, even if your products are excellent, is that you need your customers to keep replacing their products. Currently, the iPhone 11’s new features are driving customers, including me, to upgrade, but how much battery life does a phone really need? I’m not sure the promise of a theoretical iPhone 12, which could allow me to end a ski day with 85 percent battery life, would compel me to pay for another upgrade. The possibility of a quality plateau, where product improvements from generation-to-generation aren’t compelling enough to spur product replacements, is a medium-term risk to Apple’s product sales growth.

That gets to the other bright spot in Apple’s earnings report: services revenue. “Services” means the suite of nonphysical paid products offered by Apple: AppleCare product servicing, iCloud storage, Apple Music, Apple TV+, and sales and subscriptions through the App Store. Apple also earns revenue from payments through Apple Wallet and the Apple Card, which are free to you as a consumer, but not to the retailers you are paying. These businesses constitute small piece of Apple’s overall revenues but are still enormous — the company reported $12.7 billion in revenue from sales of services in the last quarter. Most important, service revenue is growing faster than product revenue and is central to the company’s growth strategy going forward.

A great thing about services is you can sell them to people who own your products, even if they aren’t buying new products. (To an extent, this logic about services also extends to ancillary products, like AirPods, which have been another area of strong sales growth; customers might replace their earphones even if they aren’t replacing their smartphones.) Focusing on services allows Cook to brag about Apple’s “installed base” of 1.5 billion actively used devices. That’s 1.5 billion products that can be used to sell services, even if they’re not getting replaced with new products.

An expansion of the services business also allows the company to extract more value from its brand halo: If customers already inclined to think positively of Apple believe its services will be of higher quality, or better optimized to work with the Apple products they already own, then Apple won’t have to compete so aggressively on price. A margin advantage also makes Apple less reliant than other technology companies on revenue from advertising and sales of data, which further enhances the brand halo by allowing the company to be almost smug about customer privacy.

The strong performance of the iPhone today and the positive outlook for revenues from services in the future — which could allow the company to improve its revenue per customer over time even if the iPhone product cycle slows — are reasons that Wall Street has found room for even more enthusiasm about Apple than it’s already showed, clearing a high bar.

Wall Street Sees Apple Doing Two Very Important Things Right