Last week the stock market took a big bite out of the Big Apple.
No, not New York … the maker of the world’s most popular smartphone.
On Thursday Apple Inc. (Nasdaq: AAPL) released its fiscal fourth-quarter results: earnings per share (EPS) of $2.91 on revenue of $62.9 billion.
That’s up 41% and 20%, respectively, from a year ago. That beat the consensus forecast, which was EPS of $2.78 on revenue of $61.46 billion.
But as has been the case throughout this earnings season, markets seem more interested in where companies are going than where they’ve been.
That’s why Apple stock fell by almost 6.5% in overnight trading after the earnings call.
As the old saying goes, to those to whom much has been given, much is expected.
In Apple’s case, the era of high expectations may be ending. Yours should, too.
Apple: Money for Nothing
Apple is the world’s most profitable company. It can thank its flagship product, the iPhone, for that.
Curiously, however, the iPhone only holds significant per unit market shares in three countries: the United States, the United Kingdom and Japan. Even there, its share is less than 50%.
Everywhere else, the iPhone enjoys a much lower share of national markets — between 12% and 25%. Globally, iPhone sales represent less than 20% of the smartphone market.
How can a company with such a relatively small market share reap most of that market’s profits?
The answer: Apple has pricing power.
When a person buys an iPhone, they’re buying more than a smartphone. They’re buying an Apple product. And they’re willing to pay a lot more for that … even if its performance is about the same as its competitors.
The additional money Apple can charge for its products is a measure of its pricing power. It reflects the value of the Apple brand rather than the functionality of its products.
Apple is the world’s most valuable brand. Forbes estimates the value of that brand at $182.8 billion. It also reckons that about 60% of Apple’s revenues result from the pricing power that brand gives it.
Building brand value takes work, so this extra revenue isn’t exactly money for nothing.
But it’s pretty close.
Apple is Running out of Steam
Building and exploiting brand value, as opposed to building better products, is central to the business models of modern technology companies.
Companies like Google, Facebook, Microsoft and Amazon all derive a significant portion of their revenues from the fact that customers want to buy products with their name on it.
But unlike its fellow tech companies, whose brand values enjoyed double-digit increases in the last year, Apple’s grew by only 8%.
That’s bad news for Apple. It’s the world’s most profitable company only because it can charge higher prices for its products than comparable items made by other companies.
As Apple’s relative brand premium declines, so does its pricing power. Eventually, that must hit its bottom line.
Perhaps it already has.
After Apple stock tanked in overnight trading last Thursday, analysts uniformly blamed the company’s guidance for 2019 fiscal first-quarter revenue.
It said it expected to earn between $89 billion to $93 billion during the all-important holiday season. Analysts had projected $93.02 billion.
Apple also came up short in unit sales. It sold 46.9 million iPhones in the final fiscal quarter of 2018. That was the same as a year ago, and less than analysts had expected.
By contrast, the average sales price per iPhone user was $793, versus the $729 expected by analysts. That’s a big jump.
Also last week, Apple introduced new versions of its MacBook Air, Mac mini and iPad Pro products. All are priced significantly above their predecessors … even though they don’t do much more than the older versions.
The implication is straightforward. Apple’s unit sales are beginning to stall, and its profits increasingly rely on the fact that users are willing to pay more for its products.
But Apple’s pricing power is diminishing rapidly relative to its competitors.
Eventually, its profits must fall as well.
Shooting the Messenger Won’t Help
Apple clearly knows it has a problem.
That’s why the company says it will no longer disclose unit sales of its products, as it has for more than a decade.
The market took this as a clear sign that Apple expects those sales to decline. Profits can only continue to increase if consumers are willing to pay ever-higher prices for Apple products.
But this problem is much bigger than Apple.
As I’ve said repeatedly over the years, an economy where so much “wealth creation” depends on pricing power, like Apple’s, is inherently unstable. Stock valuations rooted in brand values can fall just as fast and far as they rose.
And because all the returns to brand valuation go to owners of capital, not workers, a pricing power-based economy is a major cause of soaring inequality. We are living with the fruits of that right now.
That’s why I recommend you keep a close eye on Apple. It’s the canary in the coal mine we’re all in.
Kind regards,
Ted Bauman
Editor, The Bauman Letter