As the market undergoes sustained selling pressure, dragging down quality stocks, Apple (AAPL) is still a go-to stock.
Last week, Apple reported stellar second-quarter earnings, dampened by cautious guidance related to production-related challenges. The 8.5% reported revenue growth would sharply decelerate in the third quarter, perhaps leading to a decline in earnings per share year of year. Market weakness and shorter-term headwinds, however, create a buying opportunity for Apple shares.
To some effect, every negative current market and economic concern potentially hurts Apple -- higher interest rates compressing growth tech multiples, supply chain challenges, chip shortages, a Fed-induced recession, slowing consumer spending, and China lockdowns. On the other hand, relief on any of these fronts will benefit Apple. The recent Q2 earnings, however, demonstrate the company's ability to weather many of the prevailing challenges.
Apple guided to a $4 billion to $8 billion supply chain effect that will limit revenues. Notably, demand remains intact. Due to the uncertain extent of the disruptions, in recent years Apple's guidance has been overly conservative, leading to large estimate beats. So, investors will be keen to reward Apple shares upon any supply chain relief, especially related to China's Covid lockdowns.
Apple's stock multiple has compressed from a high of 30 down to the 25s. While not cheap, the investment case is still intact. The company continues to invest heavily in research and development (over 6% of revenue), continues to expand into new industries such as auto, health, augmented reality and virtual reality, and to pursue additional service offerings. Steady buybacks keep reducing shares outstanding, averaging about 2 million shares per day. The 5G cycle, with wireless telecom competitors promoting iPhone upgrade deals, is still the driver of strong sales.
The fundamental tailwinds were on full display in Q2. Apple's successful development of its own chips has rejuvenated PC sales, with Mac's increased performance, speed, and battery efficiency. Replacing Intel's (INTC) chips has continued to bolster margins, demonstrating that the successful chip development program will bring lasting effects on profitability as additional Mac lines get swapped. Indeed, Q2 had the second-highest reported gross margins of 43.7% in the past 10 years.
A regulatory crackdown on various big tech practices is always a risk for segments of Apple's business. Consumer weakness and dollar strength could also weaken Apple's performance. In an interview on Monday, Bank of America's (BAC) CEO was optimistic on the quality of consumer credit and domestic consumer spending, which accounts for 40% of Apple's sales. Overall, Apple's products are in high demand and still growing in popularity worldwide.
Morgan Stanley (MS) on Tuesday noted that based on the latest disclosures from Sensor Tower, April App Store net revenue growth accelerated to 8% year-over-year, as strength in China offset weaker trends in the U.S. The growth reflects a two-point increase from the March quarter growth of 6% year-over-year, evidence of continued momentum.
At Berkshire Hathaway's annual meeting this past weekend, we learned Warren Buffett added more than 3 million shares in Q1 to their massive 5.4% stake in Apple, buying on weakness in the $150s, with the stock down around 15% from the highs.
Apple's CEO, Tim Cook, emphasized the strength of the demand for the company's products and services, although third-quarter sales will be limited because of supply constraints. Some bearish pundits believe the lack of Q3 growth portends a far lower multiple to earnings. But, as long as demand stays solid, any stock market overreaction to short-term supply constraints and the lockdown in China offers an excellent entry to buy shares of this juggernaut. New products and services will provide growth in years to come, and the earnings growth trajectory of high single digits, helped by buybacks and strong margins, will continue.