Apple Inc. (AAPL): Why Investors Shouldn’t Be Alarmed

apple buzzJay Taylor:  Apple Inc. (NASDAQ:AAPL), the world’s largest company by market capitalization, reported earnings Tuesday that were full of bright spots. But it wasn’t the first time we’ve seen Apple disappoint investors despite its huge numbers.

The stock fell considerably in after-hours trading, tumbling more than 8% before paring losses to open Wednesday down roughly 6%.

Though the stock did recover and end Wednesday down only 4.3%, the effects of the stock’s sharp drop were felt across global markets – though, they too recovered most of their losses throughout the day.

Let’s take a close look at the Apple earnings report and what exactly the market saw that was so disappointing.

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The company reported a year-over-year revenue increase of 33%, from $37.4 billion in the third quarter of 2014 to $49.6 billion in the third quarter of 2015. Earnings per share grew by 45% from $1.28 per diluted share in the third quarter of 2014 to $1.85 per diluted share in the third quarter of 2015.

I have no doubt that Apple’s EPS metric was boosted by the elimination of millions of shares, thanks to Apple’s share buyback program.

Apple CFO Luca Maestri noted that the company returned $13 billion to shareholders through the company’s “capital return program,” a mix of dividends and stock buybacks. Considering that we can calculate the company’s dividend payments to have been around $3.1 billion, we know that the company spent just shy of $10 billion repurchasing its own stock, retiring nearly 70 million shares!

With fewer shares outstanding the company’s EPS will continue to look stronger and stronger.

Record iPhone Sales

The CFO also noted during the conference call that the average purchase price of the $90 billion worth of shares repurchased by the company is roughly $86 per share. This is well below the stock’s current price.

The company reported a record third quarter for iPhone sales, an increase of 35% over the previous year’s same quarter. CEO Tim Cook noted on the earnings conference call that this growth in iPhone sales was more than three times greater than the industry average. He also noted that while unit sales grew by 35%, iPhone revenue grew by 59%. This is a clear indication that the company sold a significant number of its premium-priced and newer models.

This information makes sense when you consider that Apple’s overall operating margin grew to 39.7% compared to 39.4% year-over-year.

Great Expectations

Huge increases in revenue, huge increases in EPS along with increasing margins. What’s not to like?

Indeed, it seems that Apple’s biggest problem is that investors have been happily surprised by Apple’s earnings reports so frequently that they expected more than Apple could deliver.

Apple’s cash pile grew to more than $200 billion during the quarter, an almost unfathomable quantity of liquid assets, especially when you compare it to those of other major companies. The Wall Street Journal image below does just that.

WSJ Apple Cash 7.23.15

 

 

Despite beating revenue expectations, including individual product expectations for the iPhone, Mac and even the beleaguered iPad, investors seem to have been looking for more. Perhaps they wanted to hear surprisingly good news about the recently released Apple Watch or Apple’s new Apple Music service.

Regarding those products, Apple didn’t provide concrete numbers. However we know that the Apple Watch falls under “other” revenue, that the company generated $1.74 billion in “other” revenue during the same quarter last year and only $2.6 billion in the quarter reported. Considering that analysts were hoping for $1.84 billion in Apple Watch revenue, these numbers suggest the Apple Watch fell well short of these expectations.

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