iCan't Afford This

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by Peter Jones, CFA
Vice President of Research

Week in Review

Stocks and bonds moved in opposite directions as the S&P 500 finished positive on the week despite falling about 1.5 percent between Thursday and Friday. Bonds, on the other hand, declined due to higher interest rates. The 10-year U.S. Treasury rose to 2.96 percent, representing the highest reading since 2014. Earnings season kicked off in earnest this week, shifting investor focus away from political drama and back to the fundamentals. After a strong start, corporate earnings, aided in part by tax cuts, are expected to grow an impressive 19.2 percent in the first quarter, the highest growth rate since early 2011. 

iCan’t Afford This

The world’s largest company, Apple, and its suppliers suffered significant losses this week amid fears that iPhone shipments are about to fall short of investor expectations. The global uptake in iPhone purchases over the last decade has been astonishing. However, with the introduction of formidable international and domestic competitors entering an increasingly concentrated market, Apple has had to shift its strategy from increased penetration to increased pricing. There is no better example than the iPhone X model released last fall, which costs over $1,000. There is no doubt that the phone features breakthrough technology such as facial recognition but with a price point approximately $400 higher than Google’s Pixel, for example, consumers are showing elastic demand. Elasticity of demand is a measure of a consumer’s sensitivity to changes in price. High elasticity means that consumers will either forego a purchase or find a substitute at a lower price. Inelastic demand refers to goods that producers can increase price without materially damaging sales volumes. A classic example of an inelastic good is cigarettes (or your Netflix subscription) — smokers tend to accept higher prices year after year. With respect to Apple, as can be seen from the chart below titled, "iPhone Units Sold," the price elasticity of iPhones indicates that Apple’s strategy of price over volume may have reached its limit.  


Given Apple’s monumental size, any decline in unit deliveries reverberates throughout the global technology hardware and semiconductor equipment industry groups. For example, Cirrus Logic, who generates around 80 percent of its revenue from Apple, has declined 30 percent this year. As fears of lower shipments ramped up this week, the Dow Jones U.S. Semiconductor Index declined nearly 7 percent, wiping out more than $70 billion of market value.

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While Apple may face flattening revenue from the iPhone which is still over 60 percent of their revenues, their business services offering is growing rapidly, nearly doubling sales from approximately $18 billion in 2014 to an expected $35 billion this year. Additionally, Apple’s war chest of $285 billion in cash should allow the company to return substantial amounts to shareholders in the form of dividends and share repurchases, while making investments into adjacent products and technology that will allow them to continue growing both revenue and profits. Apple’s increasingly diversified revenue stream can insulate the company from flattening iPhone sales, but the outlook might be far more onerous for its suppliers that are completely dependent on smartphone sales in order to grow.

Takeaways for the Week:

  • First quarter earnings are expected to grow at the fastest rate since early 2011
  • A saturated smartphone market could stymie the growth of Apple’s suppliers more than Apple