Unpacking Apple's Valuation: Why Its Stock Rose 9 Times While iPhone Sales Remained Flat for a Decade

Although Apple expects iPhone sales in 2024 to match those of 2015, the company's stock valuation has increased ninefold during this time, mainly due to the considerable growth and profitability of its services division.  This segment, which includes offerings like iCloud storage, subscriptions, paid apps, in-app ads, and payments for web search integration, has seen a revenue increase by five times since 2015. This far surpasses the device revenue growth of under 40% during the same period.  It is worth mentioning that these services have gross margins that are substantially higher than those derived from hardware sales, with the former estimated by Bank of America to exceed 70% and the latter averaging 30-40%. As a result, these services have a greater effect on Apple's net profits. Bank of America analyst Wamsi Mohan attributes the investor premium on Apple stock to this distinct, high-growth, and highly profitable services business.

However, the post-pandemic surge in services growth has recently plateaued, and two significant challenges now threaten to diminish key components of this revenue stream. A crucial pillar of Apple's services revenue is derived from App Store transaction fees, which accounted for nearly one-third of total services revenue in the fiscal year ending September, according to Bank of America. App developers have raised concerns regarding these fees, leading to regulatory complaints and legal action. A California court has ruled that Apple must permit developers to process iPhone service transactions via their own websites, stipulating that Apple would not be entitled to collect fees in such instances. While Bank of America estimates a worst-case scenario loss of approximately 10% of Apple's net profits if all major developers move all transactions off the App Store, this outcome is deemed highly improbable, and Apple is currently appealing the ruling in the U.S. Similarly, the European Union's Digital Markets Act mandates comparable changes, compelling Apple to allow developers to circumvent fees, leading some experts to anticipate potential global ripple effects. An Apple spokesperson has indicated the company's disagreement with both the California court's decision and the European Commission's ruling, arguing that these compelled alterations are detrimental to user experience and exceed legal mandates.

Another highly lucrative component of Apple's services revenue is the substantial payment from Google for its status as the default search engine on the Safari browser. This payment constituted approximately 6% of Apple's total revenue in the twelve months ending March, yet it contributed a disproportionate 19% of Apple's operating profit due to minimal associated costs. Following the U.S. Justice Department's antitrust victory against Alphabet, Google's parent company, the agency has petitioned the court to invalidate the contract between Google and Apple, a matter currently under judicial review. Apple's services chief, Eddy Cue, has expressed significant concern regarding the potential termination of this contract. Furthermore, advertising, particularly in-app advertising within the App Store, remains a substantial contributor to the services segment. While other services, including iCloud storage subscriptions, Apple Music, and Apple TV, continue to bolster the segment's profitability, analysts anticipate that Apple will face challenges in fully offsetting potential revenue losses from the App Store fees and the Google search engine agreement.