Photo: Sita Magnuson. Source: Morguefile
Companies have life cycles. They get started, expand, mature, and get old. Different life stages have different needs. Start-ups need to prove that their business model works; growing firms have to find the right people and markets for their products; mature companies maximize their profitability and may use excess cash to make targeted acquisitions; and older companies have to either re-invent themselves or prepare for a shrinking annuity business.
The question for investors is where a company sits in this cycle. It’s not necessarily an issue of size. Bigger companies can still be in start-up mode, proving the viability of a new product; smaller firms may be in the mature phase, looking to try something new or exit a declining product line. The most telling factor may be sales growth, whether it’s accelerating, stable, or declining.
Source: CoVergence Group
The market values stocks based on where they sit here. Google and Facebook are considered growth companies, with price-earnings ratios in the 30s. IBM is struggling with the transition phase, with a PE in the low teens. It’s unclear whether they will be able to reinvent themselves a fourth time: from mainframes to PCs to services to AI. Time will tell.
Where is Apple in this rubric? The company is 40 years old, but in fact it was re-born in the late ‘90s when Steve Jobs came back and negotiated financing with Apple’s old nemesis, Microsoft. He eliminated extraneous products and re-focused the company around a radically simplified product line. Then he introduced the iMac, iPod, iTunes, and less than 10 years later, the iPhone. iPhone sales now dominate Apple, and it’s easy to see why. Over 77% of Americans own a smart phone, and the devices are continually adding functions and features.
But iPhone unit sales have stagnated. After seeing a big increase when they went to the larger models – something Jobs had resisted – sales have leveled off. Revenues are growing modestly, but that’s only because prices have gone up. There’s a segment of Apples user base tha lives for their newest product.
This is why Apple’s stock seems so cheap, valued at 13 times 2018 earnings. Over 60% of their revenues come from iPhone sales, and lately, those revenues have been flat. The natural next step for them would be to use their ubiquitous platform to expand into services: Apple Pay, Apple Music, Cloud storage, and so on. Services are just a small sliver of the company, however. And Apple’s software hasn’t necessarily distinguished itself. Their devices are cool. But the cool kids don’t listen to Apple Music or send photos via iMessage.
Software is different than hardware. Software needs to be transparent and platform-indifferent, giving you what you want when you want it wherever you want it. Hardware, by contrast, is meant to be seen and exclusive. I love my iPhone, but I use the Apple apps on my phone only because they’re already there. They’re not the first place I go to play music or read books or write my blog.
Apple is a mature company with a growing market. It’s just not growing explosively, because the high-end smart phone market isn’t growing explosively. It’s well-managed with a sound strategic vision and healthy profit margins. But I don’t expect another revolution in Cupertino anytime soon.
Douglas R. Tengdin, CFA