Apple became the first US-listed company to cross the $2 trillion market cap threshold on August 19. The number is staggering and is even more astounding when it is compared with Apple reaching $1 trillion on market cap about 24 months prior. Most times when assessing technology companies like Apple, growth is the name of the game. Growth in revenues and growth in earnings drives higher valuations as investors clamor to get a piece of the company’s future cash flows.
Apple’s case is a bit different this time around. Obviously a well-known hardware-maker producing some of the world’s most popular products including the iPhone, iWatch, and Air Pods, Apple has ventured in to becoming a services business that generates recurring revenue through monthly subscriptions. As Apple has continued to shift its business model, it is clear that investors are valuing the stock more similarly to a software company, which has caused the run up in the stock price while earnings have remained relatively flat. The following chart shows Apple’s net income for 2018, 2019 and the trailing twelve months ending June 30, 2020.
We see that earnings are relatively flat in the mid to high $50 billion range, with the trailing twelve month income coming in at $58.424 billion. We contrast that with Apple’s market cap over that time in the chart below.
It is clear that investors are pricing Apple’s equity with a larger multiple as its market cap has doubled, while earnings have not moved significantly.
Valuation methodology guides us in the direction of applying larger multiples to a company’s earnings when there is less risk. Investors appear to view Apple differently, now that it has grown its services business. Investors are more confident in the future earnings of the business with recurring revenue and earnings related to Apple Music, Apple TV, and Apple News.
Although explosive growth in top and bottom line often drive valuations, there can be other factors that can allow significant increases in equity valuation of a large company like Apple, or a small privately-held business. The composition of the revenue matters and investors will pay more for a business that generates cash flow on a recurring basis.
Will the services business drive Apple to add another trillion dollars in market cap as fast as it added its most recent trillion? Or is it possible to add $1 trillion in market cap in less than 2 years? It seems like anything is possible for the Apple machine.