Expectations Are Low Ahead of Apple, Inc.'s iPhone 7 Event

By Markets Fool.com

Piper Jaffray analyst Gene Munster brought up a good point in a note to investors on Monday after Apple (NASDAQ: AAPL)sent out invitations to its iPhone launch event next Wednesday: Expectations are low -- maybe too low.

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Apple CEO Tim Cook at an Apple event. Image source: Apple.

Low expectations

It doesn't take a Wall Street analyst to realize that expectations for Apple are low. Apple stock trades with a price-to-earnings ratio of just 12.5 -- wildly conservative for an established market leader with significant pricing power and a long history of earnings growth and customer loyalty. For comparison, the average P/E ratio of stocks in the S&P 500 is 25 -- about twice Apple's P/E ratio.

And given that iPhones accounted for 64% of Apple's trailing-12-month revenue, this low price-to-earnings ratio is obviously at least partially due to low expectations for the company's biggest product segment.

Of course, there's reason for investors to have low expectations for iPhone. Apple's iPhone revenue in its most recent quarters -- its second and third fiscal quarter of 2016 -- decreased 18% and 23%, year over year, respectively. Investors are worried that a year-over-year decline in iPhone revenue could mean iPhone sales have peaked.

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But if investors are wrong about peaking iPhone sales, Apple stock could prove to be a bargain at today's prices. And this seems to be what Munster is getting at with his note to investors. Munster (via AppleInsider) believes low expectations mean there is upside potential for the stock if the refreshed flagship iPhone attracts more customers than expected.

AppleInsider's Neil Hughes summarized Munster's sentiment: "Munster suggested that investor expectations for the so-called 'iPhone 7' are low. As a result, he believes any unexpected announcements or features unveiled next week --such as an improvement in battery life over the current iPhone 6s series -- could help propel shares of AAPL higher."

A huge opportunity

Not only may there be upside potential for Apple stock if iPhone 7 attracts more buyers than expected, but this potential upside could be substantial.

iPhone 6s. Images source: Apple.

Munster estimates that Apple's active installed base of iPhone users includes about 275 million who are still using an iPhone that's more than two years old, or pre-iPhone 6 phones with displays 4 inches or smaller. Given that Apple is currently selling slightly over 200 million iPhones a year, this base of customers makes for a large potential market for the rumored iPhone 7 if Apple can create a compelling value proposition for the device next week.

But the opportunity for Apple's iPhone business to return to growth and outperform expectations doesn't end with its iPhone launch next week. Apple will get, as Munster notes, "two shots on goal."

Its next opportunity? Next year's iPhone. If Apple can simply maintain current levels of iPhone sales but scores a big with its 10-year anniversary iPhone next year, which is expected to include a significant overhaul, Apple would essentially get another chance at making the stock's current valuation look borderline silly.

Low expectations may be suppressing Apple stock in the near term, but it may also be creating a near-term buying opportunity as investors fail to fully appreciate upside potential for the iPhone segment.

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Daniel Sparks owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.