Apple Financial Performance and 2015 Outlook

This post is divided into two sections: we start with a brief analytical look at Apple's historical financial data, followed by a narrative to describe the new products Apple will release in 2015. Companies cannot be analyzed solely by what's in a spreadsheet, which is why we will have to look at the big picture story of Apple too.

 Net Sales and Profit margin

Net Sales and Profit margin

  • Every December (Q1 for Apple), we see revenues spike considerably. These sales spikes are helped by the holidays (October, November, and December are holiday months), but perhaps their most strongest contributor is the release of the latest iPhone every September.
  • The iPhone 6 was the most popular iPhone yet. It finally appeased consumers who wanted larger screens, leading many Android users to switch to iOS. In December of last year, Apple had sales revenues of $57.5B. For this December’s numbers, I expect to see sales revenues increase to $67B (+17% from Q1 2014).
 R&D as a Percentage of Net Sales

R&D as a Percentage of Net Sales

  • There is a pretty clear trend with R&D spending. The lowest spending is in quarters ending in December, and the highest is for quarters ending in June. Given that Apple’s developer conference (WWDC) is in June, this makes a lot of sense. Apple is spending billions of dollars every year to announce its latest products in June so that developers can start getting ready to support the latest software and devices.
  • As a percentage of sales, R&D spending seems to be slowly increasing. It hit highs of over 4% of net sales, with an average of 3% over the last five or so years. Compared to Google and Microsoft, Apple spends very little on R&D. It’s hard to criticize Apple, however, since they keep releasing great products every year. Apple is not the type of company to release experimental technology to the public, which is likely the main reason for relatively its low R&D costs. For example, Google sells beta products like Google Glass and Android TV which are expensive to develop, and are unlikely to become profitable products in the near future. Apple, on the other hand, has a history of releasing products ready for the consumer market which go on to become highly profitable.
  • Profit margin, which is calculated as Net Income divided by Net Sales, is quite stable at 20%, bringing Apple roughly $20 in clean profits for every $100 they make. Behaving similar to net sales, profit margin usually peaks in Q1 (quarter ending December), since it is being aided by the excellent margins of the iPhone. I expect profit margin to increase in Q1 2015 since the iPhone 6 was offered in 16/64/128GB variants, opting many buyers to spend more for extra storage, resulting in even greater profits for Apple.

Going Forward

Revenues. Apple will post its highest revenues ever this quarter, but success hides problems. Most of the revenues Apple makes comes from the iPhone, distantly followed by iPad, Mac, iTunes/Software/Services (I/S/S), and finally, iPod. iTunes/Software/Services and iPod contribute only a sliver of those revenues, and I don’t expect either segments to grow rapidly (I/S/S is growing unlike the iPod, but it’s not a primary revenue driver for Apple). Next, we have the iPad. As I’ve written before, the iPad did not take over the world as many expected, and it is dwarfed by iPhone revenue and sales volume. This leaves us with the iPhone, which is increasingly Apple’s strongest revenue-driver. This means that the revenues of Apple are predicated upon one product. In the investing community, it is a well-established axiom that diversification is key in order to “diversify away the risk”. I don’t believe the Mac, the iPad and I/S/S are enough diversification, since their combined sales are still lower than those of the iPhone. As a percentage of revenues, the iPhone ranges from 50–57% (it changes quarterly), while the iPad+Mac+I/S/S ranges from 39–42%. What will happen when the market for iPhone becomes saturated? Of course it is possible that the iPhone will continue selling admirably for years to come, but more likely than not, another product will enter the market and take away from iPhone (or all smartphone) sales. Apple should aim to be the creator of that future product, or diversify away the risk of being disrupted through additional products and services.

New iPad and Mac? According to the credible supply chain leaks, we are likely to see an iPad Pro and a new Mac. I expect both of these products to be great, but it’s doubtful they will bring as much in as the iPhone does. The economics of the PC and tablet markets simply don’t allow for the immense subsidies that smartphones have. Moreover, smartphones are practically necessities all over the world. I challenge you to find a large portion of people who own a tablet but no smartphone. In short, these new products may boost revenues, but they won’t drive them. 

Apple Watch. I approach talking about the Apple Watch with caution. For a full analysis of it, read my piece from before. For this post, I will discuss only its effect on revenue. The reason for my caution is that nobody knows truly how large the market for smartwatches is or will be. Will people who wear watches now substitute them for the Apple Watch? What about people who don’t wear watches at all - will they buy one? Margins on the watch remain a mystery as well. We know that Apple will offer 3 tiers: Watch, Watch Sport, and Watch Edition. The cheapest model starts at $349, but the prices of the other two models is unknown, which says everything about my hesitance. From all accounts, the initial model of the Apple Watch will require an iPhone to connect to, further limiting its market. If you recall, however, the iPhone also needed a PC (Mac or Windows) to connect to, but it eventually became a standalone product. The Watch can plausibly take the same trajectory, and be the next revenue driver for Apple. 

Pessimistic Optimism. Apple is doomed is a cute aphorism to mean Apple isn’t growing as fast as before. While my thoughts from above may seem pessimistic, Apple is still a hugely successful company with great future potential. If I had to give this post as an elevator pitch, it would sound something like this: When you become as big as Apple, it’s hard to find markets that are large enough to make a a meaningful difference on revenues. That leaves Apple with two choices. Either find a large enough market, or diversify into a larger number of smaller markets. Which will it be?