Why You Should Hold on to Apple Shares – Barron’s | Tech Industry

In other words, Apple (ticker: AAPL) is on its way to trading at a premium price, which it hasn’t done in nearly six years.

That might make this look like a wise time for shareholders to take profits. But they should hang on for more upside, for two reasons. First, investors are finally beginning to give the iPhone maker credit for more than its handset volumes, including its swelling trade in services and accessories. At the same time, the setup for handsets going into the fall is promising. Second, Apple compares well with the broad market on measures of risk, financial strength, and growth potential, which means it arguably deserves a premium valuation. It wouldn’t take much of one to send shares 20% higher over the next year.

When Barron’s warmed to Apple shares four years ago, the appeal was simple—big screens. Samsung Electronics (005930.Korea) and others had them. Customers wanted them. Apple was poised to offer them, meeting pent-up demand for upgrades among its loyal user base. The stock price, a split-adjusted $76, was agreeable, at a 21% discount to the market, relative to earnings, and Apple held cash and investments equal to a third of its market value. When the big screens arrived, demand was fierce, setting off what Wall Street has come to call an iPhone supercycle. Unit sales jumped 37% during the fiscal year ended in September 2015.

Last fall, there was chatter about the 10th anniversary phone setting off a sorta-supercycle. At the time, sales for the year through this September were expected to reach 243 million handsets, meaning 12% growth—stellar, considering how saturated the smartphone market has become. But the latest consensus estimate is 219 million handsets, for just 0.9% growth. Consumers, it turns out, weren’t ravenous for phones they can unlock with their faces, or for the ability to drop augmented-reality dinosaurs into their backyards.

But there’s more to Apple than iPhone unit growth. It is moving beyond big peaks and troughs for handset sales and toward steadier growth, as we wrote in a cover story late last year, where we predicted the company would win the race to 13 digits. Revenue from services, including the app store, music streaming, movie rentals, AppleCare repair plans, and online storage, is growing quickly. Gadgets beyond iPhones, iPads, and Mac computers are selling well, too—like AirPods, which are wireless earbuds, and the Apple Watch 3, which brings stand-alone phone service.

Apple shares have risen to $207 from $175 since that article. They got a boost from the corporate tax cut, which included a sweetener for companies with overseas cash to bring home, prompting Apple to more than double its spending on stock buybacks compared with last year, to $53.6 billion during the nine months through June 30.

Apple’s latest earnings release, dated July 31, called out record services revenue, which rose 31%, year over year, to $9.5 billion during the third fiscal quarter. The company’s “other products” sector, which includes accessories, watches, Apple TV, and more, brought in $3.7 billion, up 37%. For the iPhone, unit sales grew just 1%, but revenue jumped 20%, to $29.9 billion, as buyers snapped up pricier models. Overall revenue rose 17%, to $53.3 billion, and profits, 32%, to $11.5 billion. Earnings per share soared 40%, to $2.34, easily topping estimates. Apple shares gained 6% the day after the report.

Analysts gushed about services, which are believed to carry gross margins above 60%, compared with a companywide 38%. But let’s not overstate the case; with 56% of revenue coming from iPhones last quarter, Apple is still a handset company. According to Canaccord Genuity analyst Michael Walkley, Apple appears to be taking market share from Samsung, its primary competitor in high-end phones. “We believe our [calendar 2019] estimates could prove conservative, as new iPhones could drive a stronger replacement cycle than the initial iPhone X,” wrote Walkley on Wednesday, referring to the 10th anniversary phone at the top of the lineup.

This fall, Apple is widely expected to introduce a phone with a 5.8-inch OLED screen, like the X, as well as a pricier 6.5-inch version and a cheaper model with a 6.1-inch LCD screen. That could lure holdouts who were put off by higher prices to upgrade, while testing the limits of what big spenders will pay.

There are the usual rumored upgrades, like a jazzier camera, and some new rumors, like something called dual-Sim functionality, which would allow users to switch carriers when traveling, and could prove popular in China. But the best reason to expect a good year for upgrades might be the simplest: Those millions of projected upgrades that didn’t happen in recent quarters represent more iPhone users with old phones who will be eyeing the next launch.

In addition, Apple still has cash and investments equal to nearly a quarter of its market value. With a rising portion of profits coming from subscriptions, its earnings trajectory in recent years has had a statistical smoothness befitting a consumer-staples company, but with much faster growth.

Next fiscal year, Wall Street predicts, earnings per share will rise 15%, and the one after that, 12%. All of that makes a 5%-to-10% premium valuation for Apple look plenty reasonable, and its shares worth holding for longer.

Write to Jack Hough at jack.hough@barrons.com