What's Happening to Apples Product Cycles?

By Markets Fool.com

Apple(NASDAQ: AAPL) recently unveiled their iPhone 7 and 7 Plus, and despite some dismay around the headphone-less design, the company's stock has popped a whopping 10% on the news of record-breaking pre-order numbers.

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In this segment fromIndustry Focus: Tech, Motley Fool analystsDylan Lewis and Evan Niu discuss what Apple's growth trajectory might look like for the next few years (given the comps they're up against), how and why the company might have to change its design cycle timeline in the not-too-distant future, where the Watch 2 fits into all of this, and why Apple is going to eventually have to come up with a new naming scheme for the iPhone line.

A full transcript follows the video.

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This podcast was recorded on Sept. 16, 2016.

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Dylan Lewis: This recent rise that we talked about actually pushes Apple above a 13 P/E on a trailing basis for the first time in a year.

Evan Niu:Ooh, so expensive! (laughs)

Lewis:Yeah, right? It'skind of insane. But looking athow all of this fits intowhere the business is going,last quarter, the company guided forrevenue between $45.5 billion and $47.5 billion. Andeven if they dramatically beat that guidance, which, they'vetypically been in the high end of their guidancerange or slightly above it,they will likely fall short of previous years' number for thethird straight quarter. I believe lastyear ago quarter,the fourth fiscal quarter, they were around $51 billion, justto give you an idea of how different the guidance is there. It's tough to keep seeing this. Theproduct is really successful. Customer satisfactionwas really great. They just keepgoing up against these really tough comps. Eventually that's going to change, but don't expect thattrajectory to be any different for the next couple quarters. I think that's one of the key thingsinvestors need to keep in mind here. You're going to probably seeyear-over-year declinesfor this quarter, next quarter, possibly eventhree quarters out.

Niu:I think there's a chance the iPhone 7could, generally speaking regardless of the time... thetiming for the year-over-year comps isalways tricky, because it's always really dependent onwhen they launched the phone. In this case, they're launching the phonewith two or three weeks left to the quarter. Last year, I think they hadjust a couple days.So, the launch timing really has a big impact on how much of that launch getscaptured in which quarter. But,in general, I think there's a chance that the 7 could push the cycle up.

The sense is,iPhone unit sales have picked because they've been flat-ish,roughly, over the past year,year-over-year or whatever. But if you look, every two years,they basically pushed higher because of the cycle, this two-year design cycle of 5, 5S, 6, 6S, etc. So,the performance ofthe sales, at least for the past twomajor product cycles,they tend to go in tandem. Because if most people upgrade their phonesevery two years, and all the people who upgraded for the 6 areprobably all going to upgrade for the 7, they had this pattern of going in pairs. Who knows if thatactually plays out again this year,because thesales are so high that is hard to really grow. ButI think there's a possibility,particularly with all the kinds of indications that we're seeing. ButI wouldn't bet on it. I'm just saying,it's like a curveball, it's possible.

Lewis:We'vetalked in the past about the idea of two-year comps being a bit more relevant for Apple,because of the update cycle that they're on. I think, as you talked about before, their refreshes on the product become moreincremental and less major step changes, thenI start to look at them moreon a year-over-year basis. To your point about releases,another important thing to remember here is,all the numbers that Apple will be reporting for fiscal Q4,calendar Q3, only two weeks of that period will have the iPhone 7 available. It will be a part of those numbers,but it will not be a major contributor. You're going to really want to look at fiscal Q1, calendar Q4, forwhat it's going to be doing for the financial statements. I'm sure we're going to get some commentaryin the company call come fiscal Q4. But that's something to keep in mind.

Niu:Andit's weird, because this is the first time they've ever pushed a three-yeardesign cycle. It'll be really interesting to see how that changes theperformance. They've never done a three-yeardesign cycle before. And it's also a testament to smartphones getting more mature. It'skind of like laptops. They redesign laptops every four to five years, but they would redesign their phones every two years. So now you're seeing, they feel comfortable that they can push that limit on the design side. But then,the real question is, what happens next year? Because everyone is expecting a new design next year, maybe another display, maybeno home button, maybe curb display, whatever. Then,it just throws everything out of whack,the fact that they're changing the timing of these cycles. It'sgoing to be cool to see what happensgoing forward. And plus,what are they going to call it? They can't call it the 7S if they change the design altogether.

Lewis:Eventually they're going to have to ditch that naming convention,one way or another.

Niu:I've been saying they should ditch that thing for years. This is the iPhone 7. It's the 10th iPhone. And what, next year it'll be the iPhone 8, the 11th iPhone? It justmakes no sense.

Lewis:Yeah. I think, to bring itback around, and what to watch for here, if the productincremental upgrades that we talked about,some of their performance changes are visible enough to people that maybe currently hold an iPhone 6, or the offers from these wireless carriers look compelling enough,I think you could seesome really great numbers for fiscal Q1, which will be calendar Q4. But you won't get a report on that for quite a bit. Be wary of that, and know that any really bigenthusiasm is going to come through more onthe company's call than in the numbers that the company reports next quarter.

Anything else on this? That'skind of investing take away. Obviously,everything that they delivered here was what we'd been expecting from pre-launch leaks and rumors.

Niu:Yeah. Everythingpretty much came in right on target withexpectations, as far as the product specs and things like that. I think the Watch 2 looks OK,it's kind of the same thing, Watch 2looks like what they should have done with the first one. I don't thinkmany people are going to upgrade from the Watch 1 to the Watch 2.It just doesn't seem very compelling. Butmaybe they get more first-time adopters that were on the fence about Watch 1 and didn't do it, but now Watch 2 is more compelling, a stronger product, so maybe the people that wereon the fence will jump in and go ahead and be a first-time buyer for the smartwatch. And, of course, once they do that, they're on this upgrade track, and they're going to eventually upgrade, however long, who knows.

Lewis:Yeah,you have the chance towin over those people who don't want to own a first-generation device with the Watch, basically.

Niu:Right. I think the Watch 2 does lookcompelling in that sense. Of course,there's no detailed results to compare to, because Apple won't give them to us. But just generally, I think,products just get better over time. Next month, they'resupposed to have these new Macbook Pros, whichmight reinvigorate the Mac lineup. That lineup has been there for four years. So,coming out with a new thing there could really juice the Mac performance for the next few years.

Dylan Lewis owns shares of Apple. Evan Niu, CFA 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.