Why Apple is tech stock that will win race to $1 trillion market cap

Current market cap: $935 billion (as of market close on June 1, 2018)

Why it will get to $1 trillion first: The market has for years asked one thing of Apple: Show you are more than iPhone Inc. Now it’s happening.

The key to recent stock upgrades, like one from Morgan Stanley, whose $214 price target projects Apple will cross $1 trillion in the next year, is Apple’s services business, which grew 23 last fiscal year and 31 percent in the second quarter of fiscal 2018, ending in March. Morgan Stanley’s Katy Huberty thinks services will reach 27 percent of Apple sales by 2022, up from 15 percent now, and contribute 40 percent of gross profit.

The key stat: Only about a quarter of Apple’s device owners are paying users of Apple services like Pay, Music or iCloud, Goldman Sachs analyst Rod Hall said. On top of that, the wearables business (including Apple’s Watch and Beats headphones) is now the size of a Fortune 300 company, with $9 billion in sales in the last 12 months.

Diversification matters for two reasons. First, more profit almost always helps stocks rise. But investors also put higher multiples on services companies than on hardware companies, and Apple has long been a cheap stock with a low price-to-earnings multiple by technology-industry standards. The bull argument is based on the idea that investors will pay more for each dollar of Apple profits as more of those come from services, argued CFRA analyst Angelo Zino.

“At this point it starts and ends with the services business,” Zino said. “As long as the iPhone business can even be maintained at current levels, the free cash flow it generates can be invested in other businesses.”

Valuation: The valuation needed to push Apple over $1 trillion isn’t very daunting. Shares are trading at 16 times this year’s expected $11.43 in per-share earnings. But not everyone is sold on the transition: Nearly half of the 29 analysts rating Apple shares recommend that clients “hold” or “sell” Apple, rather than buy more.

Why it might not happen. The risk to Apple hitting $1 trillion is something that, in theory, is actually good for the stock: the $100 billion expansion of its stock buyback plan, announced in April. Driven by the new tax law’s treatment of offshore earnings, the bill lets Apple buy its shares with retained earnings, wherever they are earned for accounting purposes, rather than borrow money to expand U.S. buybacks. Each remaining share will theoretically be worth more, if earnings stay constant, but with fewer of them, and less cash on its balance sheet, Apple may not get to $1 trillion as quickly.

“It depends on how quickly they do the buyback,” Zino said. “At the end of the day, though, we don’t think the buyback will keep them from getting to $1 trillion.”

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