The tech giant is in the midst of diversifying its revenue base.
With a market cap of $2.6 trillion, Apple (AAPL -1.22%) is the world’s second-most-valuable company. It has gotten to this point by selling some of the most popular consumer electronics products in the world. This success has resulted in huge gains for shareholders over the years.
To be clear, this is still an enterprise built on hardware sales. In the latest fiscal quarter (Q1 2024 ended Dec. 30, 2023), devices generated $96 billion in revenue, accounting for 81% of the total.
But Apple produced $23 billion in sales from something else entirely during the three-month period. Is this budding segment enough of a reason to consider buying this top Warren Buffett stock?
Creating Apple’s ecosystem
Buffett once argued that if you offered someone $10,000 on the condition that they could never use an iPhone again for the rest of their life, they’d likely decline that deal. This not only points to the popularity of the world’s most successful smartphone, but it also demonstrates the power of Apple’s ecosystem.
That ecosystem not only consists of different hardware devices, but of various services as well. Apple’s offerings — including the App Store, News, Music, Pay, Fitness+, TV+, iCloud, and advertising — raked in $23 billion in sales last quarter. This segment reported 11% revenue growth in Q1, a much faster pace than the company’s products division. Even better, services boast a stellar gross margin of 73%.
As more revenue is derived from services, Apple’s margin should trend higher over time. From a competitive standpoint, these services are what differentiate Apple in the industry. They result in loyal and sticky customers who don’t want to leave the ecosystem. And they provide the business with a more predictable and recurring revenue stream.
Still relying on hardware sales
Apple currently has more than 2.2 billion active devices across the world. That figure continues marching higher with each quarter. The company is getting more of its products into the hands of more consumers, which is obviously a positive trend.
It’s not a surprise that as Apple expands its installed base of devices, its service revenue will also get a boost. On the other hand, if this installed base started to shrink for whatever reason, services would take a hit. This points to the fact that Apple depends on the ongoing success of its products to keep growing the services division.
That wouldn’t be a problem if the hardware segment was registering strong growth. But it hasn’t been. In fiscal 2023, Apple’s overall sales declined 2.8%, with products posting a 6% drop. The iPhone remains the company’s key revenue contributor. But it has entered a mature stage of its life cycle, with people less inclined to keep upgrading to the latest version.
The bulls argue that with Apple expected to release greater artificial intelligence (AI) functionality, consumers will rush to upgrade to the newest iPhone model, while at the same time buying other products like the MacBook and iPad. This could reinvigorate the company’s sales.
Analysts aren’t that confident. They estimate revenue will rise at a compound annual rate of 4.5% between fiscal 2023 and fiscal 2026, which is much slower projected growth than in the past.
As of this writing, Apple shares have fallen 12% so far this year, and they trade 14% below their all-time high. But don’t rush to buy this Buffett stock just yet. It still sells at a steep valuation. Its current price-to-earnings ratio is 26.4, well above the trailing-10-year average.
Despite Apple’s expanding services division, I think investors should pass on the stock.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.
