The following commentary was originally sent to Action Alerts PLUS subscribers on May 16, 2016, at 11:44 a.m. ET.
There are no two ways around it: Apple's (AAPL) descent over the past month has been a tough, frustrating and at times confounding pill to swallow. One moment, the company is the stock market's darling, impervious and impenetrable. The next, it is its biggest blemish, dismissed as broken beyond repair. We think the truth lies somewhere in between, with valid short-term supply-chain concerns (driven by weak global smartphone demand, a bottoming iPhone 6 cycle and supply-chain hiccups) outweighed by the combination of myriad tangible catalysts in the medium term and the presence of powerful, sustainable growth drivers over the long term. (Apple is part of TheStreet's Action Alerts PLUS portfolio.)
In our view, while the market's overtly pessimistic outlook and insular focus on minute-to-minute iPhone sales trends raises the likelihood of continued near-term volatility, the same negativity has created a compelling value opportunity for investors willing to exercise interim patience and employ the long view in what has increasingly emerged as an attractive risk-reward setup.
We fully expect weak results to spill into Apple's next quarterly results (fiscal third quarter, ending in June) and would not be surprised to see another wave of analyst downgrades and/or estimate reductions in the meantime. Anyone invested in the stock for hope of outperformance between now and its late-July earnings release should only do so with full understanding of the risk and downside potential. For those investors in it for the long haul, we expect shares to pick up traction in the back half of the year as investor focus shifts past the bottoming iPhone 6 cycle and toward the expected September release of the iPhone 7.
From a higher level, we believe growth will be driven by 1) opportunities in emerging markets such as India (zero LTE penetration thus far, a digitalization movement and a growing middle class amid a population of 1.3 billion) and China and 2) the high-growth, high-margin Services business, which is now the company's second-largest revenue contributor. Apple's Services revenue is based on the 1 billion-plus installed devices and should continue to accelerate as more users add devices and as these users adopt more features per device (apps, Apple Pay, Apple Music, etc.). As we've said, Apple isn't simply a hardware company; it is an ecosystem that engenders long-term loyalty and constantly innovates on behalf of its customers.
Although none of this is new -- clearly we have long touted Apple as a stock to own and not to trade; click here, here and here to read some of our recent analysis -- there are some interesting developments over the last few days that we think could help improve sentiment in the short term while also providing benefits for the long term.
First off, Apple announced on Friday that it had made a $1 billion investment in China's Uber-like ride sharing service Didi Chuxing. While Didi is typically referred to as Uber's China rival, the company actually likely has a sizable lead ahead of its Silicon Valley counterpart in the world's most populous country. Concrete data on these ride-sharing companies (especially in China) is obviously very difficult to obtain, but Didi reported last year that it fulfilled 1 billion rides and holds 87% of China's private ride-hailing market. Respected analysts in the industry generally agree that Didi's leadership over Uber in China is wide and deep.
From Apple's perspective, the investment in Didi is certainly an efficient way to gain a long-term return on its capital (especially considering the investment is funded by the enormous cash balance Apple holds abroad, something it is unlikely to repatriate). From a purely financial perspective, Didi not only has a long and open growth runway but could be monetized should the company go public in the future (Reuters has indicated that Didi has plans for an IPO in 2018, but these claims have been denied by the company, at least for now).
The real value-generating benefits from the relationship with Didi, however, will extend way beyond simple capital returns. Apple will be given access to Didi's consumer data, affording the smartphone maker a chance to acquire a deep and detailed knowledge of the ins and outs of the Chinese consumer, economy and regulatory structure. The partnership will also allow Apple to explore new avenues to promote its other products and services (e.g., Apple and Didi could easily partner to install Apple's CarPlay into Didi drivers' cars, effectively spreading Apple's services offerings and encouraging consumers to purchase Apple products).
Secondly, aside from the investment in Didi, we also would note that Warren Buffett's Berkshire Hathaway reported a major stake in Apple today as part of its quarterly filing. While one fund's investment -- Berkshire or otherwise -- should never be used as the sole reason to own a particular stock, Berkshire is the consummate value investor, investing in high-quality companies it believes to be trading at a discount to its intrinsic value.
Bottom line: Although the path to value creation will inevitably take time, we continue to view Apple as a stock that should be owned, not traded.