Apple is close to an all-time high and I'm not selling a single share

July 24, 2014

Last night Apple published its financial results for Q3 fiscal 2014. iMore has already posted a very detailed set of notes from the quarterly conference call, so I'll just recap a few key numbers and then dive into what I think the quarter means to Apple longer term. As per usual, keep in mind I do own shares in the company and I have no plans to sell them anytime soon. My comments represent my thinking and you should not interpret any of this as investing advice.

Overall the quarter was very healthy. Apple generates the majority of its revenue from the iPhone, so the Mac line and even the iPad line are less meaningful right now. Apple's financial performance lives and breathes based on iPhone sales.

Revenue was $37.4 billion in Q3, with 52% of this coming from the iPhone, 16% from iPad and 15% from Mac. Another 12% of revenue came from iTunes, software and services. Interestingly, that iTunes category posted the fastest growth of all categories at 12% annual growth. When you consider that iTunes revenue mostly comes from iPhone users, it makes the case even more obvious as to how important the iPhone is to Apple right now.

Gross margin came in quite strong at 39.4%, beating guidance and analyst estimates. Apple talked about getting better cost reduction than anticipated, but I also think we have to consider that iPad sales were weaker than expected. iPads generate less profit margin than iPhones, so a mix shift towards iPhones will help margins.

Earnings per share was $1.28, slightly better than analyst expectations. But perhaps more important was the year over year earnings per share growth of almost 20%. For a company as big as Apple to post 20% earnings growth is darn impressive.

The gross margin strength and iPhone sales figures (35.2 million units) were the positive highlights of the quarter. iPad sales were the weak point, as Apple sold only 13.2 million tablets for the quarter. To put this in perspective, iPad sales haven't been that low for over two years. Specifically, in Q2 F2012 iPad sales were 11.8 million units, and never dipped below this quarter's result.

I'd like to see iPad sales get stronger, and I believe the IBM partnership should be a major opportunity to make that happen. On the call Tim Cook discussed the potential to push iOS and Mac device penetration deeper in enterprise channels. He mentioned that while Apple mobile devices reach the vast majority of the large global companies, the level of penetration is still quite low at about 20%. Think about how pervasive Wintel PCs are within the corporate world. If mobile computing is truly as important as many pundits think it is (and I'm one of them) then we have an opportunity to see Apple climb from 20% to something much higher. This will result in growth across the entire product line.

This, to me, is the biggest reason to keep holding onto Apple shares over the next few years. But in the short term I'm more interested in the coming iPhone 6 product refresh. It's incredible that Apple's iPhone sales are still so strong despite the form factor being too small for so many people these days. We're now accustomed to phones the size of a Samsung Galaxy 5 and it's all but a given that Apple will move to larger phones this year. That, along with whatever other surprises they have in store for us, should create some excitement heading into the fall.

But while it's fun to talk about near term excitement, I find that my investing profits come from making good long term choices. Apple's long term opportunity now centers around getting much deeper enterprise penetration as well as emerging market penetration. Then I think Apple will capitalize on the emerging "Internet of Things" by being one of only two major mobile operating systems that third party developers automatically have to work with if they are releasing mobile-compatible smart devices.

Apple's stock has recovered a lot in the last year. It may be on the verge of hitting a new all time high considering it's up almost 3% this morning (as I write this) and a new high happens the moment we get another similar rise in the stock. People often get scared off by stocks that are hitting new highs. But what other way can you possibly invest in huge winners? Stocks can't go up unless they hit new highs. It's about as obvious as saying you can't go swimming unless you get in the water.

Is Apple stock expensive today? Analysts expect the company to earn about $7 per share next year. That puts the price to earnings ratio (P/E) at 14. Consider that Apple also has about $133 billion in net cash (I'm subtracting debt from the reported cash position). That cash, while it would have to be repatriated and taxed if they wanted to distribute it to shareholders, works out to almost $22 per share.

The major risk in holding onto Apple seems to be the perpetual threat of commoditization of hardware. I acknowledge this is a risk. But I think Apple's track record for dealing with the threat is nearly perfect. They consistently add more features to their products at a faster pace than competitors while making reasonable price cuts over time.

Apple's financial performance continues to be very strong. If you believe in the incredible magnitude of change coming from the mobile computing generation then I think owning Apple is a no-brainer. And there's nothing wrong with owning the other clear leader, Google, too. I hold shares in both companies because I prefer the diversification in my portfolio.

How about you?