Apple Stock's iPhone 7 Sell-Off -- a Buying Opportunity?

By Markets Fool.com

Since Apple's (NASDAQ: AAPL) iPhone 7 unveiling on Wednesday morning, the stock has pulled back about 5%. While it's not a significant sell-off, it's worth noting since the stock was already trading conservatively. Is this a buying opportunity, or is a lower share price justified?

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iPhone 7. Image source: Apple.

Why iPhone 7 may worry investors

It's true that the iPhone 7 may not represent a significant step change compared with its predecessor. Sure, it's water resistant, comes in new colors, has a faster processor, and sports a better camera. But with the same overall form factor as both the iPhone 6s and the two-year-old iPhone 6, the iPhone 7's launch departs from the Apple's typical pattern of overhauling the phone's exterior every two years.

By keeping the same form factor, some investors might feel Apple is missing out on potential incremental iPhone sales; after all, the significant form factor change to the iPhone 6 compared with the iPhone 5s before it sparked a monster boost in iPhone sales.

Data for chart retrieved from Apple SEC filings for quarters shown. Chart source: author.

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For the quarters iPhone 6 was Apple's flagship phone, total smartphone unit sales during this period increased an impressive 37% compared with the prior year's sales.

On the other hand, iPhone sales during the iPhone 6s's first three quarters of flagship sales have largely been a disappointment. Q1, Q2, and Q3 iPhone unit sales were down 0.4%, 16.3%, and 15% year over year, respectively. And the revenue comparisons for the segment during these periods were even worse, with year-over-year declines of 0.9%, 18.4%, and 23.3%.

Since iPhone 6 sported a new form factor and iPhone 6s didn't, the respective performance of Apple's iPhone segment during these two phones' flagship years provides context for why investors may be be concerned about iPhone 7's prospects.

While it was clear going into Apple's event that the iPhone 7 probably wouldn't include any major changes to its outer design, some investors may have been hoping for a more significant feature to set it apart, akin to Siri for the iPhone 4s. For example, investors may have been hoping Apple would deliver a bigger improvement is battery life. With some competing smartphones already outperforming iPhone on this front, a significant jump in battery life could have been a key selling point. But the iPhone 7's and 7 Plus' two- and one-hour increases in battery life compared with the iPhone 6s and 6s Plus, respectively, weren't enough to get excited about.

Looking beyond the iPhone 7

So should investors be worried about iPhone or not? I don't think so.

Sure, the iPhone 7 doesn't possess the characteristics needed to guarantee iPhone sales will return to growth during the next four quarters. But there are two things Apple shareholders should keep in mind to fully capture the stock's potential.

Image source: The Motley Fool.

First, Apple investors should realize that Apple's iPhone segment shouldn't be judged solely by the performance of each year's flagship phone. Instead, the segment should be viewed at a 10,000-foot level, taking into consideration Apple's customer loyalty, pricing power, history of blockbuster product hits, and an inevitable return to a more significantly redesigned iPhone every now and then (even if it may take more than two years sometimes).

When investors zoom out and look at Apple's iPhone business with a more holistic approach, Apple's iPhone business looks healthy. Indeed, the best explanation for lower upgrade rates for the iPhone 6s compared with the iPhone 6 is simply that customers are holding onto their iPhones longer -- an unsurprising side effect of Apple's relentless efforts to create products with the best user experience. Apple reiterated in its most recent earnings call its installed base of active iOS devices is growing and the rate of people switching from other smartphone brands to the iPhone is at the highest rate it has ever recorded.

As it turns out, Apple's planned new iPhone for next year is rumored to include a major overhaul to its form factor (surprise!). So while the Street worries about the possibility of another year of declining iPhone sales, Apple may be preparing for its best iPhone upgrade option ever.

Second, Apple stock's valuation simply doesn't price in growth anyway. With a price-to-earnings ratio of just 12, Apple's revenue could never grow from current levels and investors could still earn a good return on their investment from today's stock price of $103. Apple can increase the intrinsic value of its shares over the years by simultaneously repurchasing shares and paying out dividends -- just as it has been doing since 2012.

It's difficult to predict how iPhone 7 sales will fare. And it's even more difficult to predict where Apple stock will go as the Street contemplates the implications of quarter-to-quarter iPhone sales. But this iPhone 7 sell-off definitely looks like a good opportunity for buy-and-hold investors to pick up shares.

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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.