The curious case of Apple

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Good morning. Brian Niccol started at Starbucks yesterday. Since I wrote about his hiring, the market has supported Niccol’s huge run up in Starbucks stock. We’re still skeptical that any CEO can be worth a $20 billion jump in valuation, but we’ve been wrong before. Send us your thoughts: [email protected] and [email protected].

Apple

Nvidia’s stunning run aside, the best-performing Big Tech stock since the pandemic hit is — surprisingly, at least to me — Apple. Stocks also did very well in the last leg of the equity rally that began in April as concerns about resurgent inflation began to fade and rate cuts emerged:

Apple beats Google, Microsoft and Meta as AI rally heats up; got a big boost from the announcement of its partnership with OpenAI in June. And it widened its lead as Nvidia hit a plateau and declined.

Unhedged noted two years ago that Apple is rallying with technology but not getting into tech fixes. So this phenomenon is not new. But it only got more remarkable, because in those two years, Apple’s growth, already the slowest of Big Tech companies, got slower:

The pattern, though interrupted by a burst of pandemic demand, is clear: growth is slowing, with each new product cycle providing less of a boost. How much of this is due to the law of large numbers and how much to a slowed rate of innovation is open to debate. But it’s a fact, and even sales analysts can’t imagine a future where revenue grows by double digits.

Apple’s plan to reignite growth involves more artificial intelligence, as yesterday’s iPhone 16 event highlighted. I have no idea if this will work, but it does nothing to solve the fundamental puzzle: Why does Apple consistently outperform its peers through market cycles while growing more slowly than them? Clearly, this has to do with the stickiness of Apple’s revenue, which is increasingly derived from services. But as the stock’s price-to-earnings ratio nears its highest level since 2021 and reaches parity with Microsoft, one begins to wonder how much longer this can last:

Earnings Estimates

Here is an interesting graph:

These are analysts’ one-year estimates for S&P 500 profit margins. They’re nearing all-time highs. There has been a lot of concern about a cooling labor market and the possibility of a recession. Well, Wall Street analysts expect the good times to continue.

Is this realistic? The estimates are really high! By this time next year, the consensus is that profit margins in the S&P 500 will be close to 13.6%, a full percentage point higher than today and close to post-pandemic peaks in 2022. Estimates are and higher in other databases — S&P Capital IQ expected net margins of 13.8% for 2025 and 14.4% for 2026.

These estimates come from sales analysts, who could be accused of professional optimism. But so far they’ve been reasonably accurate. Here are S&P’s actual profit margins compared to year-ago estimates:

Analysts, unsurprisingly, aren’t great at nailing the big inflections. They were very slow before Covid-19 and didn’t expect companies to get margin growth in 2021. But it’s not a bad effort overall.

Rob remembers writing about how margins were unsustainably high a decade ago (Aiden was too busy studying for the PSAT at the time to care about margins). Time has proven his worries wrong, in part because high-margin tech companies are now a bigger part of the index.

That said, analysts expect profit margins to return to levels seen in early 2021, when consumers were stuck at home spending excess savings online and big companies had huge pricing power due to supply chain turmoil . This seems a bit dizzying to us. As I’ve written before, some companies are already seeing their pricing power erode as American consumers become more demanding. And the AI ​​cost revolution, as wonderful as it is, won’t arrive next year. Add high expectations to your list of market risks.

(Reiter)

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