Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How Apple Is Winning the Services Margin Game
Transcript
- Lucas: Apple just delivered one of its best weekly runs in years — up over 11 percent in five days. That is not a product-cycle pop. That is a repricing. Luna: Right, because it closed at $312.93 yesterday, and nothing fundamentally changed about iPhone shipments this week. Lucas: Exactly. The catalyst was a subtle shift in how analysts are modeling the services segment. Apple's services gross margin has quietly crept from the low 60s a few years ago to north of 72 percent in the most recent quarter. That is a SaaS-like margin profile on a $100 billion revenue stream. Luna: So the market is finally pricing Apple as a platform company rather than a hardware cyclical. Feels overdue, honestly. Lucas: Overdue but understandable. For years, services were seen as an iPhone accessory margin — nice to have, but dependent on device install base growth. What changed is the data. Even as iPhone unit sales have flattened, services revenue grew 14 percent year-over-year last quarter. The dollar per user keeps expanding. Luna: Let's put some numbers on that. Apple now has over 1.2 billion active devices in the installed base. If services annualized revenue per device is roughly $80 — that's a baseline. And the App Store, Apple Music, iCloud, Apple TV+ — they all have pricing power because the switching cost is high. Lucas: That switching cost is the moat. If you're in the Apple ecosystem, moving to Android means losing your iMessage threads, your photo library organization, your Apple Pay setup, your subscriptions. So Apple can gradually raise prices without losing users. That's exactly what they've done. Luna: And the margin expansion story isn't done. The App Store alone operates at an estimated 78 to 80 percent gross margin. iCloud is even higher. As those grow faster than hardware, the blended services margin should keep rising toward 75 percent over the next few years. Lucas: That is the math behind the repricing. At $312.93, Apple trades at roughly 31 times trailing earnings. That sounds expensive until you map the earnings trajectory. If services operating income grows from its current run rate of roughly $55 billion to $75 billion in three years, and hardware stabilizes, you're looking at a much lower multiple on future earnings. Luna: And free cash flow. Apple generated over $110 billion in free cash flow last fiscal year. A services-heavy mix means higher conversion of revenue to cash — less inventory, less capex tied to manufacturing. Lucas: That free cash flow yield is what attracted value-conscious growth investors. At current prices, the free cash flow yield is roughly 3.5 percent. That is not dirt cheap, but for a business with Apple's capital returns — $30 billion a year in buybacks — it is compelling. Luna: So does this shift change how you approach Apple in a concentrated portfolio? Because for a long time, the bear case was that Apple was just a mature hardware company trading at a growth multiple. Lucas: The bear case is weaker now. The hardware cyclicality hasn't disappeared — a bad iPhone cycle still hurts — but services now makes up 26 percent of total revenue and a much larger share of profit. That dampens the downside. For a concentrated portfolio, Apple becomes a core holding because it combines a defensible moat, recurring revenue growth, and capital return discipline. Luna: And compare that to other megacap tech. Meta trades at 26 times earnings but has regulatory overhang and a capital-intensive metaverse bet. Microsoft trades at 34 times but has a higher capex intensity due to AI infrastructure. Apple sits in the middle with a lower risk profile. Lucas: Exactly. The reason Apple surged this week while other megacaps were mixed — Microsoft up 4.4 percent, Meta up 5.3 percent, NVIDIA basically flat — is that Apple's story is the cleanest. You don't need to believe in a speculative AI boom to justify the valuation. You just need to believe that 1.2 billion people will keep paying for services that get slightly more expensive each year. Luna: Which they have done reliably for a decade. So the question for stock pickers is: is the repricing done? Or is there still room? Lucas: I think there is room, but not uniformly. If Apple executes on services margin and maintains free cash flow growth, the stock could re-rate to a 35 times multiple within two years. That implies a share price north of $400 in today's dollar terms. But the risk is regulatory — the EU's Digital Markets Act could pressure App Store margins in Europe, which is about 7 percent of services revenue. Luna: Worth watching. But the market seems to be saying that the services margin story is real enough to look through that risk. I'm curious how you'd position around it. Lucas: Let's shift to that positioning question. Because there is a broader lesson here for stock pickers: don't dismiss a company just because its core product seems mature. The margin expansion from recurring revenue streams can transform the entire earnings profile. Luna: That is exactly what we're seeing with Apple. And it's a reminder to look beyond P/E multiples at the composition of earnings. A company with growing high-margin services revenue is worth more than a company with the same earnings but flat hardware margins. Lucas: Right. And that is why we do these deep dives rather than just screen for cheap stocks. The qualitative understanding of where margin comes from — that is stock picking. Luna: Speaking of which, we should mention that these conversations are possible because we keep the show ad-free. We don't run sponsored segments or sell your attention. Lucas: That is a deliberate choice. The only reason we can do it is that some listeners support us directly. If you find value in these episodes, the link is buy me a coffee dot com slash fexingo. Luna: It's a small gesture that keeps us independent. No pressure, but it matters. Lucas: So back to Apple and the portfolio question. If you are building a concentrated portfolio today — say, ten to fifteen names — Apple makes sense as a core holding because it provides a ballast of predictable cash flows and a growth kicker from services. Luna: And you pair it with something more cyclical or smaller-cap for growth. But Apple is the anchor. Lucas: Exactly. The lesson from this week is that the market is finally giving Apple credit for a transformation that has been underway for years. Stock picking is about catching those re‑ratings before they happen. Luna: And now we have a clear framework to watch for the next one. Which company is next to undergo a margin transformation that the market hasn't priced yet? Lucas: That is the million‑dollar question. We will dig into that in a future episode.