Apple: Steady EPS Compounder, But The Past Will Not Repeat
Contributor since 2024 / 455 Followers
Summary:
- Apple fails to meet my Five Factor Model criteria, passing only one out of five factors, leading to a Sell rating.
- Despite steady Q3 results and financial stability, Apple’s sluggish revenue growth and high valuation are concerning.
- Potential growth from AI partnerships, enterprise market share, and new products could change my thesis, but the current outlook remains cautious.
- Conservative investors may appreciate Apple’s debt reduction, dividends, and share buybacks, but caution is warranted given current valuations.
Dimitri Otis
Some readers familiar with my articles may know that I invest based on my Five Factor Model, which screens companies for:
- Importance
- Insider Management
- Strong Revenue Growth
- High Gross Margins
- Acceptable Valuation
Passing all five factors is a strong sign of quality at a reasonable valuation. This situation is rare – very few companies pass all five metrics.
This brings me to Apple (NASDAQ:AAPL), a company with a fantastic track record, strong branding and an incredible market presence. I will review Apple through my proprietary Five Factor Model, including the related update. I’ll discuss the recent quarterly results, risks and come to a conclusion on Apple that I have reached for my own portfolio.
Apple Through the Five Factors
Keep in mind that a company doesn’t need to pass the five factors to be a reasonable investment, nor does it become a great investment passing all five factors. These factors are a starting point for investors’ early consideration for a stock, after which their own risk tolerances, personal comfort holding the stock, and personal opinions on the company in question should be developed and weighed. That said, for my own investing, a company passing few or none of the five factors would not make sense to own.
- The Company is Important – There should be no doubt that Apple is important. The company is the premier luxury smartphone, tablet and laptop producer, all coherently branded. It commands an impressive market share in these categories of technology, with iPhone users hooked on its storage offerings and app developers hooked on iPhone users.
- The Company is Founder-run, or the Founders are on the Board – Apple’s original management is no longer running the company and no longer on the Board of Directors. With just 0.06% insider holdings, the original founders are no longer significant shareholders. On the positive side, CEO Tim Cook’s roughly $770M in shares represents 35% of his net worth. This represents some alignment between management and shareholders, yet it is not the 95-99% net worth concentration in the company one would expect of a founder, and further, Tim Cook is himself not a founder. As such, I have to give Apple a light fail on being founder-led or managed, without significant insider holdings. For reference, a good example of founder-led management would be Amazon (AMZN), which I detailed here, or Meta Platforms (META), detailed here.
- Gross Margins are Over 60% – At 46%, Apple does not pass my requirement for high gross margins, nor does it come close for any of the past ten years. Recall that high gross margins allow for flexibility in cost reductions during a downturn, while allowing for higher bottom line growth during upturns. For more details on why I selected 60% gross margins as a requirement, read the explainer.
- Reasonable Expectation of 15% Revenue Growth Over the Next 3 Years, with Similar Historic Growth – Apple’s paltry revenue growth expectations in the 6-8% are a positive for investors who have suffered through three years of roughly 2% annual revenue growth, but both figures demonstrate the company is far outside the acceptable growth metric in the Five Factor Model. Other mega cap companies like Microsoft (MSFT) and Meta Platforms are currently growing revenues at 16% and 19% respectively, with similar forward growth prospects, demonstrating the 15% three-year revenue growth target is certainly achievable, yet not by Apple. I give Apple a fail here.
- Valuation – 4% Owner’s Yield: (Fwd R&D+EBIT)/EV – Owner’s Yield means if Apple cut all R&D, and paid out its R&D budget and EBIT as a massive dividend at a 100% payout ratio, Apple’s forward yield would be 4.8%. In my update on Owner’s Yield, I explained it should somewhat correspond with revenue growth (4% is a blanket rate for all companies in general which pass all five factors). Based on several companies I’ve looked at, an Owner’s yield of 10-13% is available for investors from companies with 10-12% revenue growth, some of which do pass or come significantly close to passing the Five Factor Model. The further down the growth table, the higher the Owner’s Yield “should” be to compensate the shareholder. Apple’s 4.8% Owner’s Yield makes the company roughly as expensive as Nvidia (NVDA), recently covered here – without the 40% revenue growth that I, and some other analysts, expect over the next three years. In fact, across the Magnificent 7 stocks that I have covered, Apple is notably the most expensive with the least growth expected.
| Company | Revenue Growth | Owner’s Yield |
| NVIDIA CORPORATION (XNAS:NVDA) |
40% |
4.9% |
| APPLE INC. (XNAS:AAPL) | 8% | 4.8% |
| MICROSOFT CORPORATION (XNAS:MSFT) | 16% | 5.7% |
| ALPHABET INC. (XNAS:GOOGL) | 14% | 10.7% |
| AMAZON.COM, INC. (XNAS:AMZN) | 12% | 9.9% |
| Meta Platforms, Inc. (XNAS:META) | 15% | 9.5% |
| TESLA, INC. (XNAS:TSLA) | 17% | 1.5% |
| MASTERCARD INCORPORATED. (XNYS:MA) | 12% | 3.9% |
| ASML Holding NV (XNAS:ASML) | 16% | 7.5% |
| ADVANCED MICRO DEVICES, INC. (XNAS:AMD) | 20% | 4.3% |
| ADOBE INC. (XNAS:ADBE) | 12% | 6.0% |
Passing only one of the five factors in my Five Factor Model, this is the point where as an investor I would look elsewhere. As such I’m giving Apple a Sell rating as the company’s prospects don’t meet my goals. However, I’d like to discuss Apple’s Q3 results, it’s financial stability, and some risks to not assigning Apple a stronger rating.
Apple Q3 Results: Steady As She Goes
Despite the aforementioned sluggish revenue growth, Apple had another steady quarter of increased operating income (EBIT), to $29.6B for the quarter over last year’s quarterly EBIT of $27.0B. The company paid a very unusual $14.9B in taxes in the quarter compared to normal quarterly sums in the $4-6B range, assumed to be strategic pull-forward of tax liabilities given the potential increase in corporate taxes that Warren Buffett has warned about as a solution to the U.S. debt problem.
On the balance sheet, Apple increased cash holdings marginally while decreasing debt, a trend initiated in 2021. Share buybacks have slowed considerably since the heydays of the 2015-2021 period, but continue nonetheless.
Notably, there appeared to be no large “apple refresh cycle” for which some analysts had hoped. However, investors can continue to take heart in the reliability of cost reduction, debt reduction, share buybacks and dividend payments as levers to steadily increase EPS and total return over time.
Risks and Opportunities
Apple is a company with few existential risks, though growth and valuation remain a concern. There are risks to my thesis, which I’ll outline below. One could view some of these risks to my Sell thesis as opportunities for Apple.
- Apple is able to generate significant new revenues from its AI partnership with Open AI. If this were to happen Apple could be worth more than its current share price and the valuation would be more justified than I feel it currently is. If Apple CEO Tim Cook explains what this growth runway looks like in detail, and proves the runway via increasing AI-based revenues, my thesis could change.
- Apple finds a way to grab further enterprise desktop market share, driving iCloud growth. Despite Mac computers being beautiful, simple and very user friendly, such an advance in market share has not occurred, though there is potential if Apple can integrate AI well into its desktop computers and laptops the way Microsoft is doing with Co-Pilot.
- Apple finds a way to monetize new products or services, such as its metaverse headset Apple Vision Pro, which was generally received poorly. Alternatively, a successful foray into smart glasses announced for 2027 could provide upside to Apple, though it sets Apple far behind Meta Platform’s Ray-Ban smart glasses which (if competing headsets are any indication) could be both cheaper and better than Apple’s smart glasses.
- As a side note risk to Apple, Apple could lose up to a third of its revenue that comes from Google’s payments to keep Google Search the default browser on Apple’s browser, Safari, a result of the anti-trust case against Google’s parent, Alphabet. Jeffries analysts consider this to take 3-8 years to play out, with a risk of $19/share to Apple’s share price.
Conclusion
Apple fails to meet most of my criteria of the ideal investment, characterized by my Five Factor Model. The company’s valuation especially is somewhat detached from fundamental realities.
There are opportunities that will hopefully transpire, in the form of AR glasses, Services growth, desktop market share growth, and AI that could change my thesis on Apple.
For conservative investors who enjoy compounding qualities such as debt reduction, dividends, share buybacks and large cash reserves, Apple is a sensible company, although caution is warranted given current valuations.
I rate Apple a Sell as the company does not offer asymmetric upside compared to mega cap peers Amazon, Microsoft, Meta Platforms, Google (GOOGL) and Nvidia.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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