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Betting on Apple’s Future: Can Its Services Sustain It?

After iPhone sales failed to meet anticipated sales projections in 2018’s fourth quarter, Apple(NASDAQ: APPL) stated that it would no longer report its performance in unit sales. Instead, it will announce only revenue, sales growth, and guidance. Although Apple’s stock performance under Tim Cook has been celebrated over the past few years, market observers are concerned. Some suspect that the company’s slowing revenue and earnings growth, and this different approach in reporting its overall performance, may signal a change in the company’s trajectory.

The iPhone starts losing signal

At the close of 2018, Apple captured the lion’s share of smartphone profits worldwide, but it still suffered major setbacks in that market.  It registered lower-than-expected demand for the new iPhones on their release dates. Subsequent low sales in China and other markets caused Apple and its suppliers to cut their anticipated sales targets and profit expectations. Moreover, iPhone sales did not increase year over year for the first time since its release.

Apple has performed well with its other products (e.g., Apple Watch, AirPods)and services (e.g., Apple Pay, App Store, and iTunes). Revenue from services increased by 17%, and other products’ revenue rose by 31%. Apple’s overall performance in 2018 was so great that it increased its market cap, had record high stock valuations, and issued generous dividends to its shareholders. So, does the decline in iPhone sales mean anything to investors?

… Yes, but also no

The global economy in 2018 was sluggish, and Apple faced increased competition in the mobile phone market. Still, it seems that Apple’s current market success is based on hardware launched under Steve Jobs, and a corporate and product reputation formed, marketed, promoted and ultimately made successful by Jobs, the company’s late, iconic co-founder and CEO.

There is little doubt that Jobs’s successor Tim Cook streamlined Apple’s supply chain, put new Apple products on the market, was key to the growth of the services section of the company, and significantly increased profit margins.

Still, some of the company’s growth has come from increasing its prices, spurring consumers to replace their older iPhones by shortening those iPhones’ battery life, and obliging customers to buy new attachments for its redesigned hardware.

More notably, Apple has grown revenue by increasing its subscribers for ApplePay and iTunes, and sales of the Apple Watch, the best-selling watch in the world. Yet the rest of the company’s hardware, for which Apple is still known, and which made its products “must own,” has not made major ripples in years.

Apple’s Next Challenge

Apple seems to be pushing its services and other products instead of its trademark market-driving,profit-delivering iPhone.The services division of Apple accounted for 16% of the fourth-quarter earnings in 2018. Based on earnings, it is worth more than the individual Mac, iPad, and Apple Watch product lines. The services division has grown revenue by double digits since 2017.

Can Apple’s services keep its legion of followers bound to its integrated and closed hardware, software, and services system? If it can, then the stagnating iPhone sales are not a concern. Once consumers become smitten with Apple’s services, they are more likely to purchase Apple’s iPad, Mac, TV, and Watch.

But while Apple has been successful in its services area, the iPhone is still the top-selling product and profit driver at Apple. It creates bottom-line profits that drive Apple’s growth and deliver dividends to shareholders. If iPhone sales decline, Apple’s suppliers and iPhone-related divisions will feel the pain, but so might the company and its shareholders.

Current Outlook

Apple is no longer the most valuable company in the USA. Its position was usurped by Microsoft in the third quarter of 2018. While it captured the bulk of smartphone profits in 2018, as in previous years, the question of whether the iPhone has peaked hangs in the air. Furthermore, Apple faces more competition now than it did under Jobs. The growth in sales of its services and other products is outstanding, but Apple’s services are tied to its hardware.

Some investors now wonder whether the desire and demand for Apple’s services and other products can keep its legion of customers and fans invested in its exclusive, closed technology, and drive sales of its hardware in the future.

For current investors, it is best to stay put and watch how Tim Cook steers Apple through these uncharted waters. For new investors, carefully consider if the stock’s valuation is likely to increase to an extent sufficient to justify shares’ current price. Apple is performing well now, but do you want to hold onto its stock for the next 10 years?

Apple’s past performance may not be indicative of its future performance. But then, that was true when Steve Jobs took over the company in 1996 – and when Tim Cook took over in 2011.

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Disclosure: Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance. Alisa Hopkins doesn't own any shares of the companies mentioned.