Apple Hits One Trillion

 In Market and Investment Insights

Research analyst Jon Bathgate comments on the $1 trillion market capitalization milestone reached last week by Apple.

Key Takeaways

  • Fueling much of Apple’s rise to a market capitalization of $1 trillion was the disruptive nature of its flagship iPhone smartphone.
  • As evidenced by the iPhone, the pace of disruption has never been faster, and leading tech companies must continue to innovate to maintain their market positions.
  • A new wave of disruption is coming from the cloud, artificial intelligence and the Internet of Things and investors are likely to reward the companies that most effectively harness these technologies.

Last week, the market capitalization of computer and smartphone maker Apple crested $1 trillion, a new milestone for corporate valuation. The company’s current market cap accounts for roughly 4% of the total value of the S&P 500® Index. When adding in the next four most highly valued companies – fellow tech titans Amazon, Alphabet, Microsoft and Facebook – the combined market cap of this select group represents 16% of the index.

What’s in a – Very Large – Number?

Any management team able to deliver such an achievement merits congratulations. Yet the symbolic 13-digit valuation also presents an opportunity to look at how Apple got here, what the future may hold and how the pace of innovation that fueled Apple’s ascent could eventually come back to haunt it.

Apple could be considered the ultimate disruptor. We vaguely remember landlines, Internet cafes, portable compact disc players and having to print directions to find one’s vacation rental. Sometimes lost is the fact that all the ways in which smartphones have revolutionized our lives have occurred in just over a decade. This demonstrates that the pace of change has never been more rapid. Just as important, technological achievements are no longer confined to the tech sector but instead permeate across all industries as companies seek methods to drive efficiencies and meet customer needs.

We see this every day in the rollout of the Internet of Things (IoT), the transition from servers to the cloud and the improving problem-solving capabilities of artificial intelligence (AI). These themes are the new disruptors, reshaping how we shop, view media and operate our cars.

The Pace of Disruption Meets the Innovator’s Dilemma

Apple has played a major role in influencing how we interact with technology. But what’s next? The company’s hardware of iPhones, Macintosh computers and iPads accounts for a massive 75% of its total revenue. Revenue from services is growing at a 28% annual clip, accounting for an increasing portion of the product mix. But margins on this business line may not be sufficient to offset the compression experienced within the company’s high-profile hardware, namely Macs and iPads. Implicit in the concept of innovation is the ability to generate high margins as competitors scramble to play catch up. Apple’s current search to identify the next source of lucrative growth is indicative of what other highly successful companies have had to grapple with.

Apple is facing a classic example of Clayton Christensen’s “Innovator’s Dilemma.” While the company defined the current generation of smartphones, a new wave of disruption and innovation is coming from cloud, AI, IoT and augmented reality. Investors are closely following these trends. The market typically rewards innovation, whether from established players or scrappy upstarts. To maintain their positions, the likes of Apple may need to seriously consider increasing research and development spending and/or be more acquisitive to drive innovation. They must also be willing to disrupt their own cash cows, in the case of Apple: iPhones. Paying dividends and engaging in large-scale stock repurchases may feel good in the short term, but investors with a longer-term horizon will likely expect a greater commitment on the part of management to innovate.

Risk-averse decision making, designed to protect the core business, has been the downfall of many companies as they became vulnerable to disruption from new platforms and technology paradigm shifts. History is dotted with examples of heretofore-innovative firms getting out-innovated. IBM’s mainframes dominated computing until the advent of the personal computer. Kodak was a large-cap company whose flagship product is irrelevant today. Malls across the country are seeing tenants disappear as customers prefer the convenience of online shopping.

Looking Forward – or Reminiscing

Stock markets tend to be forward looking, thus Apple’s year-to-date stock gain of roughly 23% signals that many investors see a favorable future for the company. And indeed, recent earnings were fueled by higher prices commanded by iPhones. But Apple has also rewarded shareholders by repurchasing $173 billion worth of stock since 2012, reducing its outstanding shares by 27% in the process.

All innovative companies must strive to keep their edge. It is possible. Subscription-based cloud services have been a lifeline for some legacy software companies. Media producers are scrambling to develop or acquire (often digital) platforms to deliver content globally. Soon we may get our kale delivered by drone. Investors must recognize that resounding success in one business line or timeframe is not necessarily a harbinger for future triumphs.

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