Shares of Apple (NASDAQ: AAPL) are up nearly 12,000% since the launch of the very first iPod in 2001. With that wildly successful product, Apple began its transformation from a niche computer company to a mobile device powerhouse. The iPhone came along in 2007, and the rest is history.
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Apple is now valued at roughly $800 billion, making it the most valuable publicly traded company by a wide margin. Profits remain out of this world -- the company produced $45 billion of net income last year. Could Apple stock keep moving higher? The company's vastly powerful brand is one reason to believe the run isn't over. But as annual smartphone upgrades become increasingly incremental, all the customer loyalty in the world won't matter if Apple can't convince its users to shell out for a new iPhone.
A brand like none other
When billionaire value investor Warren Buffett first invested in Apple last year, it came as quite a surprise. Apple is a tech company, after all, and Buffett generally avoids the tech sector. But it was the brand and the customer loyalty that convinced Buffett that Apple was different.
In an interview with CNBC earlier this year, Buffett laid out his simple argument for buying the stock: "Apple strikes me as having quite a sticky product and enormously useful product that people would use." He continued, "I mean, if they bring in an iPhone, they buy a new iPhone. I mean, they're ... it just has that quality. It gets built into their lives."
Buffett views Apple as more of a consumer products company, with a brand that keeps customers coming back, rather than a technology company that must continually innovate to stay one step ahead of the competition.
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That brand is the most valuable in the world, worth $184 billion according to Interbrand's most recent annual rankings. It's the brand that prevents many iPhone users from even considering an alternative, instead simply taking the path of least resistance and upgrading to Apple's latest device. Apple's ability to sell $700+ smartphones despite plenty of nearly as-good alternatives available at far lower prices demonstrates the power of Apple's brand.
Buffett believes this brand is durable, and that customers will keep coming back for new iPhones and other Apple devices again and again. If he's right, Apple stock could have more room to run.
Trouble with the upgrade cycle
It wasn't too long ago that each year brought a new array of smartphones that came with dramatic improvements over their predecessors. Convincing consumers to upgrade after two years, or even one year, wasn't challenging when their current phone looked like a relic compared to the newest gadget.
That era, I think, is over. Annual improvements no longer impress. Sure, new phones come with faster processors, more memory, and nicer screens. But the relative improvements are becoming less meaningful each year. There are some reports suggesting that Apple's new iPhone 8 isn't selling all that well, at least compared to the past few iPhone generations. If true, I'm not surprised.
The average smartphone user doesn't care about specs. They care about how the phone looks, feels, and performs. The iPhone 8 is fast, but so is the iPhone 7. So is the iPhone 6s. So is the iPhone 6. Some iPhone users may be waiting for the $999 iPhone X, which will be available later this year. That could explain some of the reported softness in iPhone 8 sales, but I doubt it explains all of it.
Apple may be able to offset any decline in iPhone sales with other products and services. The services segment produced $7.3 billion of revenue during the latest quarter, growing by 22% year over year. And the "other products" segment, which includes the Apple Watch, grew by 23% to $2.7 billion. Whether the immense profits generated by iPhone sales can be replaced is another question entirely.
There's no doubt that Apple's brand is powerful, and that the iPhone is an incredibly sticky product. Buffett sees that powerful brand as the source of Apple's economic moat. But the benefit of loyal customers diminishes as annual upgrades become less compelling. Customer loyalty doesn't automatically lead to growing profits, in other words. Weak iPhone 8 sales could be a canary in a coal mine, an indication that the iPhone upgrade cycle is lengthening. That's one reason to take a pass on the smartphone king.
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