Apple became the latest technology titan to get punished by investors after announcing positive quarterly earnings. On November 1, Apple announced Q4 quarterly results that exceeded analysts’ expectations for both revenue and earnings per share. And yet, the company’s stock value plunged in after-hours trading.
The drop in stock price followed a similar pattern seen with Alphabet and Amazon, each of which got thrashed despite beating analysts’ expectations with their earnings reports. Alphabet and Amazon were rocked because despite growing in profitability, they missed with their revenue growth. So what happened to Apple? Two things:
- Apple’s forecasted earnings for the holiday season that were weaker than analysts expected.
- Apple surprised analysts on an investor call by announcing that henceforth, Apple would not break out unit sales of iPhone, iPad and Mac. Instead, Apple would only report revenues, thus making it harder for investors to understand whether revenues are tied to unit sales or price increases.
It’s never a good idea to surprise investors, and Apple is paying a price for doing just that. In addition, Apple has been sucked into the technology backlash that has whipped the FAANG stocks in recent weeks. But over the long run, Apple’s decision to withhold product sales details is symbolic of Apple’s embrace of services. And that shift is good for Apple.
As I noted earlier this year, Apple’s burgeoning services business represents a remarkable growth story flying under the radar of many observers. Services encompass categories such as App Store, Apple Care, Apple Pay, iTunes, and cloud services. Services is where Apple has been steadily reinventing itself as a healthcare brand by providing wellness management tracking capabilities embedded in the Apple Watch. In addition, services is the home of Apple Music, which has challenged Spotify’s lead in just a few remarkable years.
On November 1, Apple reported that its services reached an all-time high of $10 billion for Q4. Services revenue grew from $7.9 billion in the fourth quarter of fiscal 2017 to $10 billion in the fourth quarter of fiscal 2018, an increase of 27 percent. To be sure, services represents a sliver of Apple’s revenues. But the company’s march toward services is inexorable and profitable, as is the case with Amazon. Here’s what Gene Munster, founder of Loup Ventures, has to say about this shift:
What investors are really going to focus on is how service margins are really going to progress. I think the grade that investors will give the Apple services segment will be predominantly driven off its profitability, which is, we think, should be a slowly rising trend.
A “slowly rising trend” is a trend in the right direction. But Apple faces challenges improving its services business. As noted by Neil George of Investor Place,
To get more services revenues, Apple needs a bigger universe of Apple users. And for the past ten years, Apple’s iOS operating system remains a very small piece of the mobile pie for handheld devices. Aside from a few blips, it has remained well below 20% of the market. Android is the market, and that’s where service revenues are operating. Alphabet and plenty of other companies are cashing in while Apple just sits there.
The key for Apple to expand its services: healthcare. As we’ve discussed on our blog, Apple is creating a healthcare services infrastructure that hinges on heavy use the Apple Watch for wellness care. As Tim Cook said on an Q4 investor call, Apple Watch is “One further example of the kind of contribution we can make in the health space, and we look forward to making more in the future.” He also said,
Apple has a huge opportunity in health. You can see from our past several years that we have an intense interest in the space and are adding products and non-monetized services so far to that. I don’t want to talk about the future, because I don’t want to give away what we are doing, but this is an area of major interest to us.
Interestingly, investors have never seemed to care that Apple has been vague about Apple Watch sales in the past. Based on investor sentiment, though, Apple may need to become more transparent about how it will grow healthcare services. In the meantime, healthcare businesses are collaborating with Apple to create better wellness services. In subsequent quarters, I expect we’ll be hearing more about Apple’s growth as a healthcare player.