This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Apple (NASDAQ: AAPL) has been a great stock to own since late September 2019. During that five-year stretch, its shares produced a 328% total return. This gain absolutely trounces the broader S&P 500 Index (SP: .INX).
The momentum has continued this year, as Apple is up 18% (as of Sept. 27). But investors care about what the future holds. Where will this consumer discretionary stock be in five years?
Apple's underlying business
Apple's business model has shifted in the past several years. To be more specific, services have become a bigger contributor to financial success. Offerings like iCloud, Pay, TV+, and the App Store, among others, are a growth engine, posting 14% sales growth in the latest fiscal quarter (Q3 2024, ended June 29).
Even better, services boast a stellar gross margin of 74%. And they provide a recurring and predictable revenue stream for Apple, which is exactly what shareholders want.
However, this remains a hardware company at its core. Sales of physical products represented 72% of overall revenue in Q3. These hardware devices are still key to Apple's success. The iPhone in particular accounted for 46% of Apple's sales last quarter.
Although services are becoming more important, I think five years from now, products, especially the iPhone, will still be the main aspect of the company's financial performance. Consequently, the business will most likely look very similar to how it does today.
But artificial intelligence (AI) is set to feature more prominently. Apple just released its 16th lineup of iPhones. And these newer devices will be compatible with Apple Intelligence, the company's new AI-powered software that can help users summarize text, boost their writing skills, and edit photos. The hope is that AI can spur greater demand for new iPhone sales, but this hasn't been the case so far.
Not the best setup for investors
Apple might have been a wildly successful investment in the past five years. But I don't believe this will be true over the next five.
The reason I think this way partly has to do with the valuation. If you want to buy Apple shares, you'll pay a price-to-earnings (P/E) ratio of 34.7. On the one hand, it's easy to argue that such a dominant business deserves a high multiple. After all, Apple possesses one of the world's strongest brands, is incredibly profitable, and is even a top holding for Warren Buffett-led Berkshire Hathaway.
However, that P/E ratio is 22% higher than the stock's trailing five-year average. Expectations have outgrown the underlying fundamentals. Paying a premium valuation would make sense only if investors believed that Apple was going to register outsize growth in the years ahead. It's hard to be optimistic in this regard, though.
Compared to five or 10 years ago, Apple is now a very mature enterprise. There are more than 2.2 billion active devices scattered across the globe. While this figure inches higher each quarter, there are simply fewer opportunities to get these products into more hands, especially the iPhone. Revenue is slated to increase at just a 5.8% yearly rate between fiscal 2023 and 2026.
And even though the iPhone is arguably the single most successful product of all time, newer updates aren't as revolutionary as they once were. This doesn't incentivize consumers to switch to the newest model, which can pressure revenue growth. When it comes to AI, the jury is still out on whether or not people even want or need these new features. It could all prove to be hype.
There's a very good chance that the stock could underperform the broader S&P 500 over the next five years. And that's why I don't own shares.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
