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Is Apple a Buy or a Sell Right Now?

January 10, 2019

Apple (AAPL), to its credit, is as much of a cult for its customers as it is for its shareholders. And that’s a plus for the company. Its customers have been very sticky, meaning that they continue to buy and own their iPhones, remaining inside Apple World and paying for all of the content and apps that run through iTunes.

These same customers fawn over the annual product presentations and even line up at stores around the globe to buy the latest new (or not-so-new) devices.

Shareholders have had much of the same relationship with the company. They have bought and held the stock even with its paltry dividend, willing to pay nearly 7 times its underlying book value even though a large share of that value is just in cash and its equivalents. However, that has been paying off for investors: The last five years have seen the shares rise by just shy of 100%—more than double the gains of the S&P 500 Index.

But the stock has really not done that much better than the S&P 500 Information Technology Index, as Apple beat the tech index by only 6% for the trailing five years. Now, as the shares have dropped from October 3 to date by 34.11%, is Apple’s stock a buy or a sell right now?

Sell It?

Apple’s business model is really showing its flaws right now. Unlike the more successful technology companies that have or are moving away from unit sales to recurring income, Apple is still locked into trying to move more iPhones. For the most recent reported quarter, sales of individual iPhone handsets amounted to 59.12% of its overall revenues. And as we’ve been learning, iPhone unit sales are not expanding, and for some of the newer models they are actually slipping.

Remember, Apple doesn’t really engineer much of its iPhones and other devices, as that is outsourced to other technology companies. And it doesn’t assemble its products—that is outsourced again. And both the component makers and the assemblers have been reporting big drop-offs in orders, with some announcing production line shutdowns on order by Apple.

Apple, in turn, has moved to raise unit prices to keep revenue topped up. It has also announced that it won’t tell shareholders how many units its sells anymore. That can be figured out, of course—but the end of transparency is still a problem.

Apple is trying to focus the attention on recurring income through its service offerings. This includes sales of apps and content through iTunes. But the problem is, if the number of units sold declines, then the universe of customers for services will decline—not a good recipe for building more recurring revenue.

And it is beginning to get worse. Already, the company is facing class-action suits over its monopoly over app sales in its iTunes. Since the company has a lock on its platform (which customers are obligated to use), Apple can and does charge more for app purchases and downloads without competition. This is unlike Android devices from Alphabet’s Google (GOOGL), which, while it has its own Google Play, allows other platforms for apps.

And now, two major companies are cutting out Apple from its apps—Netflix (NFLX), which will force customers to pay separately, and Epic Games, which is pulling its products including the popular video game Fortnite from iTunes. If others join in, it could be a rout, threatening services revenues for Apple.

And since Apple’s iOS operating system is a small fraction of the global universe for mobile, which is dominated by Android, having fewer users and fewer vendors would be a potential death knell for the company—much like what happened to the likes of Palm and Nokia and even the old version of Blackberry (BB).

Buy It?

But is Apple really done? Or is it about to transform the company and its mission to genuinely be a recurring revenue giant?

One of the biggest ways to get on its way would be to license its iOS systems for other companies, so it could offer access to Apple services on non-Apple devices, much like Google does with Android. And while that might sound far-fetched, a deal just announced with Samsung Electronics (SSNLF) to offer Apple TV on Samsung’s own televisions is a big first step that could be game-changing.

Then there’s what some are calling “Apple Prime” after the Amazon (AMZN) subscription services moniker. Apple would offer a subscription service with monthly or annual charges, for which its customers would get the latest iPhones as well as all or some of the content from iTunes. This could be tiered depending on the products and services.

This, again, could be a game-changer for the company. And one bit of evidence was the tease-out of a suggestion that the company is thinking of making a simpler trade-in service for iPhones in its retail stores.

Right now, the company has quite a bit of capability for funding change. It has plenty of cash, and its credit is excellent, with debt to assets sitting at only 31.30%. Its trailing operating margins are fat, resulting in excellent appearing returns on shareholder’s equity and the company’s capital—though that’s all hindsight, and without changes to keep those numbers solid, they could change for the worse soon.

And while the shares are expensive on a price to book basis, as noted above, they are more reasonable on a price to trailing sales, at only 2.9 times.

But before you buy it or continue holding it, you need to ask yourself whether you expect big changes with proof along the way. If not, then it’s time to sell, take the capital gains, pay the taxes and redeploy the cash to a company that’s focused on advancing and not just relying on the past.