Apple (NASDAQ:AAPL) seems to be a stock which, in spite of a premium valuation, exhibits characteristics of a defensive stock. This isn't that surprising, considering the company's consistent profits and generous shareholder returns of dividends and share repurchases. Further, the company's business model is steadily shifting towards a greater emphasis on service revenues, which have higher profit margins and are more recurring in nature than product revenues. These factors help explain how the stock has held up so strongly even while the rest of the tech sector cannot find a bottom. Is this a good reason to buy the stock?
AAPL Stock Price
I last covered AAPL in February when I stated that it was an incredible time to sell and reallocate toward more beaten down tech names. Since then, AAPL has matched the return of the S&P 500, declining just under 10%.
During that same time period, high-growth tech stocks across the board have continued to struggle, many declining even more than 30%. The struggling stock prices have often been mostly attributable to multiple compression, which may make AAPL's outperformance even more surprising considering that it trades at a premium valuation itself.
What's going on here? I'll explain the reasons for AAPL's defensive characteristics in this report.
AAPL Stock Key Metrics
AAPL's latest quarter showed resilience in spite of supply chain issues. That is one important characteristic of the company: it generates consistent revenues and net income.
AAPL saw total revenues grow by 8.6%, powered by 17.2% growth in services. Gross margin improved from 52.4% to 55%, largely due to both an increasing services revenue base as well as expanding gross margins in its services revenues.
Operating income grew a bit faster at 9.1% as the company realized some operating leverage, though net income grew slower at only 5.9% because the income tax rate increased from 15.7% to 16.9%. Earnings per share however grew by 8.6% due to aggressive share repurchases.
In total, the company returned just under $27 billion to shareholders through $3.6 billion in dividends and $22.9 billion in share repurchases.
The company ended the quarter with $193 billion in cash and marketable securities versus $120 billion in debt, for a net cash position of $73 billion. On the conference call, management reiterated its intentions to reach a leverage-neutral position.
AAPL authorized another $90 billion for share repurchases - based on trends of the last few years, I expect 2022 to see that program used up in its entirety.
The company also raised its dividend by 5% to $0.23 a share.
Is Apple A Defensive Stock?
That was a lot to unpack, let me highlight the key points with regards to how they impact the stock's defensive characteristics. In the current market, investors are rewarding AAPL for both the consistency as well as the existence of positive net income. Investors are also favoring the mature capital allocation strategy of paying out dividends and buying back shares. The company's willing use of leverage is another positive as that would help increase shareholder returns. Valuation isn't under the company's control, but it appears to be doing everything it could besides that.
Wall Street analysts have in general supported the company's strategy, with an average rating of 4.37 out of 5, a "buy".
That sentiment is especially surprising considering that the average price target of $190 per share represents only 20% potential upside.
It is clear that AAPL, despite being a richly priced tech company, is being valued more like a consumer staples stock on a growth-adjusted basis.
Is Apple A Good Stock To Invest In Long-Term?
AAPL is trading at just under 27x forward earnings, which looks like an aggressive multiple considering that consensus estimates call for single digit growth over the next decade:
As just stated, that kind of multiple makes AAPL look more like a McCormick (MKC) or Hormel (HRL) as these stocks tend to trade around 30x earnings with modest growth. Assuming a 4% earnings yield, around 8% annual growth, and stable multiples, investors may expect around 12% annual returns for the stock. If the stock can continue to show the same defensive characteristics that it has shown in recent years, then that kind of return profile may appear attractive for those looking for a lower risk name with market-beating potential.
Is AAPL Stock A Buy, Sell, or Hold?
My personal view is unfortunately less bullish. While AAPL has generated stellar returns with defensive characteristics in the past, there is no guarantee of that continuing in the future. I note that AAPL curiously spends far lower on R&D than mega-cap peers. For reference, AAPL spent $21.9 billion or 14.3% of gross profits on R&D in 2021, versus $26 billion or 28.9% at Alphabet (GOOGL) and $24.7 billion or 25.9% at Meta Platforms (FB). I frequently see AAPL investors touting the potential for upside surprise from innovation, but that optimism looks misplaced when compared against the likes of GOOGL and FB. When combined with the fact that the company continues to aggressively repurchase stock even at these premium valuations, one would be better off making the argument that this is a company more focused on generating present-day profits than maximizing growth over the long term. The stock could nonetheless still beat the market, even as growth is expected to slow gradually over the next decade. It wouldn't be unheard of for the stock to sustain a premium multiple even as growth slows to the low single-digits - as referenced above, many consumer staple stocks trade at those kinds of valuations. Yet at the same time, my view is that it is more likely for the stock to experience some multiple compression as growth slows - especially considering that its product revenues are still rather cyclical in nature. Perhaps if the company can show greater exposure to services revenues then it would be more insulated from that kind of risk, but services gross profits still make up only 31% of gross profits (as of 2021). By the time services gross profits make up a large enough percentage of the overall business, services growth would have likely already slowed down as well. Based on consensus estimates, the stock trades at 13x 2031 earnings. I could see the stock trading at 15x earnings by then - that would represent a 2.5x price to earnings growth ratio ('PEG ratio') which would still be quite rich. That would place return potential from capital appreciation at only 15.4% in total or 1.44% annualized over the next 10 years. Throw in the 0.58% dividend yield and investors might get 2% annualized returns. Sure, some may argue that 15x 2031 earnings is too pessimistic, but with a 6% projected growth rate by then, many could also argue that it is even too optimistic. Clearly, forward returns are highly reliant on the stock sustaining an elevated PEG ratio - this is the kind of investment strategy that feels inherently unsustainable. Luckily, it isn't so hard to avoid buying AAPL here because there are so many more compelling alternatives available. While one could find deep value amongst high-growth tech, even established names like FB and GOOGL are both trading at far lower multiples in spite of stronger forward growth rates. I rate AAPL a hold because of both the high potential of poor forward returns as well as the better alternatives available in tech today.
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