Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How Apple Is Becoming a Cash Machine Beyond iPhones
Transcript
- Lucas: Apple is up 6.3 percent in the past five days. The Nasdaq as a whole is down 1.1 percent. And I think the market is finally waking up to something that's been quietly true for about four years now: Apple isn't really a hardware company anymore. Luna: You mean the services narrative? I've heard that pitch before, but the stock has always traded more on iPhone units. Lucas: That's the old playbook. Let me give you the numbers that changed my mind. Last quarter, services revenue was about 26 percent of total revenue—roughly $26 billion. But services gross margin is above 70 percent. Hardware margins are around 36 percent. So services contributed somewhere around 40 percent of gross profit. Luna: That's a massive shift. So the earnings quality is getting much better. Lucas: Exactly. And it's a big reason why Apple can now trade at roughly 30 times earnings, where five years ago it was lucky to get 18 times. The market is slowly repricing the stock for a high-margin, recurring-revenue model. Luna: You know, this is exactly the kind of shift we try to highlight on this show—understanding what a company actually earns, not just what it sells. And I think it's worth saying: we do all this research and we keep the podcast ad-free because we want you to hear the unfiltered analysis, not a pitch. If you find value in that, supporting the show is easy—buy me a coffee dot com slash fexingo. Every bit keeps us independent. Lucas: Absolutely. And listener support lets us spend the time to dig into these margin trends rather than chasing headlines. So back to Apple: the services business is now about $100 billion in annual run-rate revenue. That's up from about $50 billion five years ago. Luna: What's driving that? Is it just the App Store, or is there more? Lucas: It's a portfolio. The App Store is the biggest piece, but Apple Music, iCloud, AppleCare, advertising—they all feed into it. And the beauty is that incremental services revenue has very high marginal margins. Once you have 1.8 billion active devices in the field, adding a new subscriber costs almost nothing. Luna: Right, so the installed base becomes a moat. That's why investors are willing to pay a premium. Lucas: Exactly. And it's similar to what Microsoft did with Azure a decade ago—the stock multiple expanded as the mix shifted from Windows licenses to cloud subscriptions. Apple is in the middle of that same transition. But there's a risk. Luna: Regulation? Lucas: That's the big one. The App Store faces antitrust pressure in Europe and the US. If regulators force Apple to open up sideloading or cut its commission, that 70 percent margin on services could compress. Even a 10 percentage point drop in services margins would knock about 4 percent off total gross profit. Luna: So the bull case depends on the regulatory outcome. What's the counterargument? Lucas: The counterargument is that Apple's ecosystem lock-in is stronger than any regulator can easily break. Users don't leave because the apps they rely on only work well on iOS. And Apple has already started diversifying—advertising revenue is growing fast, and it's not subject to the same commission structure. Luna: Let's talk about the advertising piece. I've seen estimates that Apple's ad business could hit $30 billion by 2028. That's a significant new leg. Lucas: It is. And it's high margin, because it leverages the same infrastructure as iCloud and the App Store. The key question for a stock picker is: can Apple sustain this services growth without a new hardware catalyst? Historically, services growth accelerates after big hardware cycles—like the iPhone 12 super-cycle in 2021. We haven't had one of those recently. Luna: So the market is basically betting on organic services growth without a hardware tailwind. That's a different kind of bet than buying Apple five years ago. Lucas: Exactly. And it's a bet that's paying off so far. If you look at free cash flow, Apple generated about $100 billion in free cash flow last fiscal year. That's more than any other company in the world. And they're returning most of it via buybacks and dividends. Luna: But at 30 times earnings, you're paying for that cash flow to grow. If services growth slows, the multiple could contract. Lucas: That's the risk. The bull case assumes services revenue grows at 15 percent compound annual growth rate for the next five years. That's a high bar. But if they hit it, the stock could still deliver double-digit annual returns even from here. Luna: So for someone building a concentrated portfolio, does Apple still belong? Or is it fully priced? Lucas: I think it belongs, but you have to size it based on your conviction in the services story. If you believe the installed base is a durable moat and regulation is manageable, then Apple offers a rare combination of growth and capital return. If you think regulators will gut the App Store margin, then it's a value trap at 30 times. Luna: That's the kind of binary outcome that makes it a high-conviction pick—or a risky one. Lucas: Exactly. And that's why we do this show—to think through those trade-offs. So to sum up: Apple's earnings quality is dramatically better than it was five years ago. The market is repricing for that. The risk is regulatory, not competitive. And the opportunity is a transition from hardware to a high-margin services model that could still have years of runway.