The Surprising Reason Why Apple's Slowing Growth Isn't as Bad as It Seems

Apple (NASDAQ: AAPL) stock popped 6% on Friday despite the company reporting sluggish growth and weak guidance. The positive response could be due to Apple underperforming the S&P 500 and tech sector by a considerable amount over the last year and the stock looking like a decent value relative to other opportunities.

But another contributing factor for investor optimism could be that Apple's growth just isn't as bad as it seems. Here's why the investment thesis is still strong and why the tech stock is worth buying now.

A person wearing sunglasses looks surprised and happy while looking at a smartphone.

Image source: Getty Images.

Weak results

Apple's fiscal second quarter of 2024, ended March 30, included record services revenue and record earnings per share (EPS). But net income is down, and sales are declining throughout Asia.

The multiyear period of sluggish growth would normally be cause for alarm. But Apple is undergoing a prolonged downturn in its upgrade cycle and hasn't had a meaningful boost in iPhone demand since 2021. Investors were hoping that would change in 2024, but so far, that hasn't been the case.

Apple's Q2 guidance came in low, and analyst consensus estimates for fiscal 2024 earnings are just $6.53 per share -- which is just 6.4% higher than fiscal 2023. Fiscal 2025 projections are a little better, coming in at $7.13, which would be 9.2% growth over the consensus fiscal 2024 figure. But still, the days of double-digit earnings growth seem unattainable, at least in the short term.

Potential growth on the horizon

There's no denying that Apple is lacking growth in its products segment. But the services segment continues to be a juggernaut, notching a 74.6% gross margin in the quarter compared to 36.6% for products. That helped the company's overall gross margin come in at 46.6%.

Apple isn't just sitting back and doing nothing about this lull in its growth. During its recentearnings call management said it has spent more than $100 billion on research and development (R&D) over the last five years and that it is excited about the potential of generative artificial intelligence (AI). It stands to reason that much of this investment still hasn't translated to meaningful bottom-line results.

We'll learn more about what Apple has in store next month during its annual Worldwide Developers Conference and in September during its yearly new iPhone unveil. But for now, there's reason to be optimistic that Apple has some growth potential that hasn't been fully realized, such as iPhones with artificial intelligence (AI)-enabled chips.

Apple's backup generator

In the meantime, Apple can rely on buybacks to spur growth. The company announced a 4% increase in its dividend and that the board of directors authorized an additional repurchase of up to $110 billion in stock. For context, Apple spent $81.8 billion on buybacks and $15 billion on dividends over the last 12 months.

Buybacks historically made up the bulk of Apple's capital return program and have been a major reason why earnings can continue to grow even with lower net income. Despite having a $2.81 trillion market cap, Apple can meaningfully reduce its outstanding share count with buybacks -- which is hard for a company of its size. Even if Apple bought back $110 billion in stock in a single year, that would still reduce the share count by less than 4%. It doesn't seem like much, but over time, it can work wonders.

AAPL Net Income (TTM) Chart

AAPL Net Income (TTM) data by YCharts

As the chart shows, Apple reduced its share count by more than a third over the last 10 years. That reduction helped the company grow EPS at a far faster rate than net income.

Even at its current low pace of growth, Apple is still a cash cow that can grow earnings with buybacks. Apple's stock repurchases are like a backup generator that can fuel growth when the main power source (iPhone and product revenue) isn't performing to expectations. It's not a sustainable system, but then again, it's highly unlikely that Apple will remain in a downturn forever.

That being said, investors should keep a close eye on Apple's innovation, or lack thereof. The company can spend all the money it wants on R&D. Eventually, those dollars have to translate to a return on invested capital, or else the money would be better spent on acquisitions or even more buybacks. Buybacks are a reason for the market to stay patient with Apple. But the longer the lull continues, the less patience Wall Street will likely give Apple -- which could pressure the stock.

A balanced buy for patient investors

Despite a lack of growth, a 28.5 price-to-earnings ratio is a reasonable price to pay for Apple stock. The company is simply too good a brand and has too many resources at its disposal to stay in this glut over the long term.

Given its reasonable valuation, buying Apple now is a bet that the company will return to modest growth -- not even strong growth. If Apple does come out with a successful new product or the next upgrade cycle is better than expected, the company could become much more valuable. Given the low risk and potential reward, Apple is a good buy now.

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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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