Apple’s New Era Has Begun

Apple
AAPL
 is probably the most misunderstood stock on this planet.

During one of history’s greatest recessions, Apple reported a second quarterly sales record—blowing nearly all Wall Street estimates. And yet the stock cratered 5% on the news.

You see, most investors got spooked because iPhone sales fell off the cliff. They think iPhone might be losing its crown. But they are dead wrong.

As I’ll show here, iPhone sales don’t tell a thing at this point. And as Apple enters a whole new era, this is not where investors should be looking.

The biggest misunderstanding about iPhone

For the past three years, iPhone sales have been marching lower. But last quarter, they cratered a frightening 21% compared to a year ago, as you can see: 

But here’s the thing. iPhone sales didn’t fall because people aren’t digging iPhones anymore. They fell because the cycle of phone upgrades has extended. In other words, people are keeping their iPhones for longer.

Take a peek at this chart. It shows how, over the years, people have been holding on to their phones longer and longer:

Now look at what portion of all iPhones worldwide were the latest models in 2019 vs 2017:

That is direct evidence that people are getting along with older phones just fine.

In 2017, the latest models made up 19% of all iPhones worldwide. In 2019, that share took a nosedive to 7.5%. Meanwhile, the most popular iPhone that year was the three year old iPhone 7.

Why? People don’t have much motive to upgrade. Phones get better, sure, but not so much that it’s worth splashing out hundreds, even thousands, of dollars for a marginally better device.

And remember, 5G is coming.  Surely lots of people have been holding out for Apple’s 5G phones—which came out right after the reported quarter ended.

The most important figure that drives Apple’s business

There’s probably no better proof that the iPhone is at the top of its game than this chart. It shows the ever-growing number of Apple’s active devices worldwide:

At the start of 2020, Apple had 1.5 billion active devices, most of which were iPhones. The company added a half billion devices during the last few years alone.

The growth of Apple’s devices didn’t lose steam last quarter either. In Apple’s latest earnings call, Apple’s CFO Luca Maestri said:

“Our sales results and the unmatched loyalty of our customers drove our active installed base of devices to an all-time high in all of our major product categories [including iPhones].”

In other words, there are more active iPhones out there than ever before. That should be a hell of a symphony to Apple investors’ ears. Because Apple earns way more from its old phones than it does selling new ones.

Apple’s services are a bigger moneymaker than iPhones

For starters, Apple sells one of the world’s steepest warranty and insurance services—AppleCare. In many cases, the yearly subscription comes to one-fourth of the phone’s price tag.

And how about that bill you paid with an iPhone? Apple earns money every time people use Apple Pay to shop online and at retail stores.

Then there’s an ever-growing suite of services that Apple conveniently puts in front of iPhone holders. Think Apple Music, Apple TV, iCloud, gaming service Apple Arcade, Apple News, and all that.

The most lucrative—and least visible—side of Apple’s services business is licensing and the App Store. Apple “taxes” companies by the billions to get their services or apps on Apple devices.

(For example, Google
GOOG
pays $12 billion a year to Apple to be the default search engine on iPhones.)

All these services add up to a humongous pile of money. Last quarter, Apple’s earnings from services hit an all-time high of $9.7 billion. That’s 21% up from just a year ago. And most important, that’s 23% more than from selling new iPhones.

Keep a close eye on these developments

If you’re following Apple stock, don’t get hung up on iPhone sales.

The most important figure driving Apple’s key moneymaker is its active devices. Because the more active devices there are, the more people are using Apple’s services.

That said, there are a few developments that could put a spoke in Apple’s wheel.

For one, Apple’s App Store is drawing scrutiny from antitrust lawmakers after a series of app makers (i.e. Epic, Spotify) sued Apple. They are accusing the tech giant of using its iPhone app supremacy to choke off competition.

If regulators take action, Apple earnings from the App Store could take a heavy blow.

Second, the US Department of Justice has recently sued Google for holding a tight-grip monopoly in search. The focal point of the lawsuit is Google’s exclusive search deal with Apple.

Chances are slim, but lawmakers may try to break up the Google-Apple love affair. With Google making up 15-20% of Apple’s services sales, tens of billions are at stake. So keep an eye out for news on that front.

Stay ahead with “big picture” market insights you won’t find elsewhere

Every week, I put out a story that explains what’s driving the markets. Subscribe here to get my analysis and stock picks in your inbox.

This is not investment advice.

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