The curious case of Apple

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Good morning. Brian Niccol started yesterday at Starbucks. Since we wrote about his hiring, the market has sustained Starbucks shares’ huge Niccol bump. We are still sceptical that any CEO can be worth a $20bn leap in valuation, but we’ve been wrong before. Send us your thoughts: robert.armstrong@ft.com and aiden.reiter@ft.com.

Apple

Setting aside Nvidia’s mind-bending run, the Big Tech stock that has performed the best since the pandemic hit is — surprisingly, at least to me — Apple. The stock has also done very well in the latest leg of the equity rally, which began in April, as worries about resurgent inflation began to fade and rate cuts came into view:

Apple outperformed Google, Microsoft and Meta while the AI rally was hot; it got a big boost from the announcement of its partnership with OpenAI back in June. And it has increased its lead while Nvidia has plateaued and fallen.

Unhedged noted two years ago that Apple rallies with tech but doesn’t fall in tech corrections. So this phenomenon is not new. But it has only become more remarkable, because over those two years, Apple’s growth, already the slowest of the Big Tech companies, has only gotten slower:

The pattern, while 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 down to the law of large numbers and how much to a slowing rate of innovation is open for debate. But it’s a fact, and not even sellside analysts can imagine a future in which revenue grows in the double digits. 

Apple’s plan to reignite growth involves more AI, as yesterday’s iPhone 16 event emphasised. I have no idea whether this will work, but it does little to solve the fundamental puzzle: why does Apple consistently outperform its peers through market cycles while growing more slowly than they do? Clearly this has something to do with the stickiness of Apple’s revenues, which are increasingly derived from services. But as the stock’s price/earnings ratio approaches its 2021 high and touches par with Microsoft, one starts to wonder how long this can go on:

Earnings estimates

Here’s an interesting graph:

That is analysts’ one-year forward estimates for S&P 500 profit margins. It’s approaching an all-time high. There has been a lot of fretting over the cooling job market and the possibility of recession. Well, Wall Street analysts expect the good times to keep rolling.

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

These estimates come from sellside analysts, who might be accused of professional optimism. But to date they have been reasonably accurate. Here are actual S&P profit margins compared with estimates from a year before:

The analysts, unsurprisingly, are not great at nailing the big inflections. They were very off before Covid-19, and they did not expect companies to get a margin boost in 2021. But not a bad effort overall.

Rob remembers writing about how margins were unsustainably high a decade ago (Aiden was too busy studying for the PSATs at the time to care about margins). Time proved 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 the levels of early 2021, when consumers were stuck at home spending excess savings online and big companies had tremendous pricing power because of supply chain snarls. This seems a bit giddy to us. As we have written before, some companies are already seeing their pricing power erode as US consumers become choosier. And the AI cost revolution, wonderful as it may be, is not going to arrive next year. Add high expectations to your list of market risks.

(Reiter)

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