Apple (NAS: AAPL) is set to release its fiscal third-quarter earnings report on Aug. 1. Here’s Morningstar’s take on what to look for in Apple’s earnings and the outlook for its stock.

Key Morningstar Metrics for Apple

  • Fair Value Estimate: $170.00
  • Morningstar Rating: 2 stars
  • Morningstar Economic Moat Rating: Wide
  • Morningstar Uncertainty Rating: Medium

Earnings Release Date

  • Thursday, Aug. 1, after the close of trading in the US

What to Watch for in Apple’s Fiscal Q3 Earnings

  • We continue to see iPhone revenue as the bellwether for Apple’s business, making up a majority of total revenue. iPhone sales have had headwinds from slowing global refresh cycles and greater competition in China. We will see whether those headwinds remain or dissipate.
  • We will also look keenly at Apple’s gross margin, which has been on a steady upward trajectory over the past few years as the firm has brought more of its supply chain in-house and grown its services business.
  • Finally, we will look for continued strong (double-digit) growth in services, now Apple’s second-largest business at about a quarter of total revenues.

Fair Value estimate for Apple

With its 2-star rating, we believe Apple’s stock is overvalued compared with our long-term fair value estimate of $170 per share. Our valuation implies a fiscal 2024 adjusted price/earnings multiple of 26 times, a fiscal 2024 enterprise value/sales multiple of 7 times, and a fiscal 2024 free cash flow yield of 5%.

We project 6% compound annual revenue growth for Apple through fiscal 2028. The iPhone will be the greatest contributor to revenue over our forecast, and we project 3% growth for iPhone revenue over the next five years. We expect this to be driven primarily by unit sales growth, with modest pricing increases. We think pricing increases will be driven primarily by higher features and a mix shift toward the more premium Pro models.

Apple

Economic Moat

We assign Apple a wide moat, stemming from customer switching costs, intangible assets, and a network effect.

In our view, Apple’s iOS ecosystem extends far-reaching, sticky tendrils into customer wallets, entrenching them with software capabilities and integration across disparate devices like the iPhone, Mac, iPad, Apple Watch, and more. We also see immense design prowess at Apple, most impressively from its deep integration of hardware, software, and semiconductors to create best-of-breed products. Finally, we see a virtuous cycle between Apple’s affluent customer base and its vast ecosystem of developer partners. We believe Apple can leverage these qualities into continued economic profits over the next 20 years.

Financial strength

We expect Apple to focus on using its immense cash flow to return capital to shareholders while increasing its net leverage over the medium term. The firm has a terrific balance sheet, with a net cash position of $51 billion as of September 2023. Management has set a goal to eventually become cash-neutral, though there is no set timetable. We don’t anticipate the company to hit this target in the next five years, but it should progress toward it. Since announcing the goal in 2018, Apple has reduced its net cash position by more than half, from over $100 billion.

Apple supplements its strong balance sheet with impressive cash flow. Over the last five years, the firm has averaged more than $85 billion in free cash flow generation annually, and we forecast more than $100 billion annually over the next five years. Since 2019, this cash flow has generated an average free cash flow margin of more than 25% and converted more than 100% of net income into free cash flow. We anticipate the firm will hit these figures over our five-year forecast as well.

Risk and uncertainty

We assign Apple a Medium Uncertainty Rating. We believe the firm’s greatest risk is its reliance on consumer spending, which sees great competition and cyclicality. Apple is at constant risk of disruption, just as the iPhone disrupted BlackBerry in the budding smartphone market. The iPhone could be unseated by a new device or “super app.” Still, we view the firm as defending against this risk by introducing new form factors (like a watch and an augmented reality headset) and selling an ecosystem of software and services on top of hardware.

We also see geopolitical risk arising from Apple’s supply chain. It heavily depends on Foxconn for assembly and Taiwan Semiconductor Manufacturing TSM for chip production. If there were a souring of relations between the United States and China, or if China threatened Taiwan, Apple could see a severe hit to its supply. Additionally, the Chinese government has recommended that government officials not conduct business on iPhones, which presents a current and potential future risk to Apple’s sales in China.

AAPL bulls say

  • Apple offers an expansive ecosystem of tightly integrated hardware, software, and services, which locks in customers and generates strong profitability.
  • We like Apple’s move to in-house chip development, which has accelerated its product development and increased its differentiation.
  • Apple has a stellar balance sheet and sends a great deal of cash flow back to shareholders.

AAPL bears say

  • Apple is prone to consumer spending and preferences, which creates cyclicality and opens it to disruption.
  • Apple’s supply chain is highly concentrated in China and Taiwan, making it vulnerable to geopolitical risk. Attempts to diversify into other regions may pressure profitability or efficiency.
  • Regulators have a keen eye on Apple, and recent regulations have chipped away at parts of its sticky ecosystem.

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

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