Apple (AAPL) aims to continue its recent bullish momentum and is scheduled to report its fourth quarter results after the closing bell on Thursday, October 31st. This time, however, I’m more cautious. While I remain a long-term Apple bull, analysts have been raising their fourth-quarter estimates over the past three months, putting pressure on the company to meet these rising expectations. As a result, despite being optimistic for the long term, we’re not sure if now is the best time to buy.
This, coupled with overvalued stock valuations after recent gains, could add to the pressure for strong performance, leaving little room for error in guidance. The story surrounding the AI supercycle is still in its early stages, but it also adds a layer of short-term volatility.
I have a more cautious outlook on Apple stock ahead of its fourth quarter results, but last quarter was very strong, with the company beating expectations on both profit and revenue. Apple reported EPS of $1.40, beating the consensus estimate of $1.34, and revenue of $85.8 billion, beating expectations of $84.4 billion. This marks the sixth consecutive quarter in which the company has exceeded profit estimates, highlighting Apple’s consistent performance.
Two key takeaways from this quarter were Apple’s performance in China and its approach to capital expenditures (CapEx). First, despite a 6.5% year-over-year decline in sales in China, the result was better than expected, especially considering that the iPhone dropped out of the top five in terms of market share, falling to 14% from 16% a year ago. It became.
Second, while many Big Tech companies are significantly increasing their AI spending, Apple is taking a more conservative approach. The company’s capital expenditures are likely to remain in the range of $10 billion to $11 billion annually. In fact, capital spending is down 28% over the past 12 months compared to the same period a year ago, well below the $50-70 billion spent by some of our peers.
Apple’s conservative approach resonates with the market. Unlike its peers, Apple’s AI strategy focuses less on building data centers and more on improving existing products to more effectively monetize its vast user base. This prudent spending has resulted in strong cash flow, with operating cash flow of $29 billion in the June quarter, a record high. With $153 billion in cash and $101 billion in debt, Apple is well-positioned to reward shareholders, returning more than $32.7 billion last quarter through share buybacks and a $0.25 dividend.
The services sector also deserves special attention, as it has clearly been the company’s main growth driver over the past three months. The segment’s revenue was $24 billion, up 14% year over year. This growth is especially notable when considering profit margins. The gross margin for services was 74%, while the gross margin for products was 35.3%. As Apple’s hardware base expands, services revenue continues to hit new highs, driving overall profitability.
Despite strong momentum in AAPL stock, I remain neutral ahead of Apple’s October 31st earnings report. Part of my concern is with analysts’ optimism, with 21 of 26 companies raising their EPS estimates and 20 of 25 raising their earnings estimates in the past three months.
To beat expectations, Apple would need to post EPS of more than $1.59, 6% year-over-year growth, and revenue of more than 5% to $94.33 billion. However, analysts expect further growth in the next quarter, putting pressure on the company to deliver results.
Given the near-term stock price movement, the iPhone 16 and 16 Plus, both capable of running artificial intelligence (AI), should be the company’s next growth engine, but sales have been lackluster so far. Initial sales were 37 million units, 12.7% less than the iPhone 15. However, a recent report showed a more positive outlook, with iPhone sales in China increasing by 20% in the first three weeks.
But given that more AI features become available and the iPhone 16 may not reach its full potential until the AI-driven supercycle is delayed, it’s still time for a deeper analysis. I think it’s too early.
Beyond the iPhone, I think performance in the China region is very important. Apple’s sales in China have fallen 9.6% over the past nine months, reflecting its continued struggles in the region, where it is rapidly losing market share to local competitors. Although demand for the iPhone 16 is on the rise again, there won’t be any significant progress in the fourth quarter.
Perhaps the main reason for the market’s skepticism about Apple today is its valuation. This premium is supported by the company’s high-quality operations, but Apple continues to rely heavily on the iPhone, which accounted for more than 50% of its total sales last year. Meanwhile, the lucrative services division benefits from an installed base of 2.2 billion devices and currently accounts for nearly a third of Apple’s revenue (28% in the third quarter). This sector boasts high profit margins and is essential to maintaining valuation premiums.
That being said, analysts expect Apple’s fiscal 2024 EPS to grow only 9% year-over-year, with growth no more than 12% through fiscal 2026. As a result, Apple trades at a forward P/E ratio of 35 times, which is significantly higher than the expected stock price. The five-year average is approximately 24 times. Even adjusting for growth, which is expected to grow at a CAGR of 9.4% over the next three to five years, the resulting PEG ratio of 3.7x is nearly 50% above the historical average and nearly 3x that of Nvidia (NVDA) and this is multiplied many times over. It becomes increasingly difficult to justify.
Given Apple’s exceptional cash generation and strong return on capital, long-term investors may not need to worry too much, but the market may be biased toward short-term performance, especially in a rapidly evolving AI-driven environment. This valuation could contribute to short-term volatility as there is a lot of interest. .
On TipRanks, the Wall Street consensus for AAPL is a Moderate Buy with 23 Buys, 10 Holds, and 1 Sell. The average price target is $248.34, suggesting 8.16% upside potential.
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I have a “hold” rating on Apple ahead of its upcoming earnings, but this reflects a cautious outlook due to Wall Street’s high confidence that it will beat expectations during what is expected to be a slow quarter. It reflects. The impact of the AI supercycle will become more apparent in FY2025.
Additionally, keep an eye out for China’s better-than-expected numbers, which could be crucial for the region. That said, expanding valuations makes us even more cautious and leaves little room for retreat.
