Chit Chat Stocks - Apple (AAPL) | Not So Deep Dive

Episode Date: January 25, 2022

Apple may very well have the most recognizable brand in the world. The company recently reached a 3 trillion dollar market cap. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of Apple. Enjoy the show! This episode is sponsored by Commonstock, a social network for smart money investors. Check-out the platform here: https://commonstock.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Contact us: [e-mail] Timestamps Company Background | (3:09) Industry | (9:04) Management & Ownership | (11:21) Valuation | (14:59) Earnings | (17:15) Balance Sheet | (20:31) Our Analysis | (23:55) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chitchat Money, the show where we go over an individual security in 30 to 45 minutes. Well,

usually lasts about 45 minutes. And I think this one will probably go along too, because it's a very complicated company. And it's Ian's choice, maybe something people haven't heard of before it's called apple apple computer i think yeah can you remind us what they do yeah how'd you how'd you find this company huh yeah well i will say for full disclosure this is my um largest thing currently so um i don't want to be pumping the stock and i know that our podcast will probably have a big effect on the stock price the next five days but um you know just just for full disclosure out there right right three trillion dollar market cap that can be easily swayed by uh by some tweets and some downloaded audio. But yeah, we're going to talk about Apple.

This should be a fun one. We haven't talked about it in a long time. And they got a lot of things brewing and a lot of rumors out there of what they're going to be doing after the iPhone and stuff like that. So I don't think it's going to be... Hopefully, we can get into the actual details. A lot of people kind of know the overview of the business. We'll kind of hopefully get to actually how everything works, their profitability, all that good stuff. And I'll let Ryan introduce the company. But first, let's talk about our sponsor for the not-so-deep-dive episode, CommonStock. Today's episode to you is brought to you by CommonStock, a social network for smart money investors. It allows you to put in real-time trades on

their platform and show your portfolios, do write-ups associated with your trades, all that good stuff. And the best part, anyone can sign up for CommonStock account. It is free. There are no subscriptions and there are no paywalls. CommonStock isn't a brokerage itself, but it built custom APIs to let investors link their Robinhood, TDA Ameritrade account, Coinbase, E-Trade, and others to show that they have skin in the game. So basically the best part about it is you can connect your portfolios to it. They can see your allocation. For example, if Ian was on there, people would see that he had his largest position was Apple.

So if he did a write-up on Apple, people would know that he actually owned it, wasn't trying to do anything. He actually knows the company quite well. And you can learn from other investors on there too. So it's a fantastic place to go, learn about investing, see people's write-ups. um i don't know what else is that is that everything we got yeah we've we've talked to the uh management or the founders over there and it's a very good group uh and i got a feeling they're going to roll out more stuff uh as as it goes along so that's right they're still very

early so hopefully they'll grow and get better each and every year all right ryan do you want to hit what apple does i think everyone knows this but maybe give into the details of what is important to their business yeah i'm going to try to but yeah i i would provide no value by describing what Apple does. So I'm just going to go through each reporting segment and kind of how much of the top line they make up. And so Apple breaks up its revenue into five reporting segments and I'm going to go through them in order of size. So the first one is the iPhone, and this makes up 52% of their revenue. This is obviously their line of smartphones and maybe the single greatest product ever made. In September, the company released their line of iPhone 13. So this

includes iPhone 13, iPhone 13 mini, iPhone 13 pro and iPhone 13 pro max. Um, I don't know the technical, uh, differences, but I'm sure there are some, and then each of these runs on the Apple iOS operating system. And I believe there's basically a new iteration that comes out every year. Am I getting that right? Yep. Is it, I don't know if it's designed to be annually, but there's been 13 lines of them. So, um, yeah, that's kind of the main revenue driver. Everyone kind of understands that business, but it's pretty much all the hardware revenue. And I'll talk about gross profit in a little bit, but the services segment is their second largest revenue driver. And this accounts for 19% of the top line. And so this is comprised of advertising. So search ads

in the app store, ads in Apple news. There's some other areas where they have advertising as well. And then they have Apple care. So this is their fee-based service and support products. They also have cloud services. So customers can buy additional storage for all their data and then digital content. This is a big one. So, and a controversial one. So they, this includes app store fees, Apple music, Apple arcade, Apple news, plus Apple TV, plus all that stuff, all the digital content gets wrapped up in there. And then lastly is their payment services. So Apple pay an Apple card. We're probably going to talk about services a lot because it's sort of, it's the highest margin portion of their business. And so it's really kind of important. And it's also been one that's

under the most regulatory pressure. So one thing I'll add into that is the Google deal for search gets included into services. So I think it's 15 billion or either $18 billion a year. Google pays them to be the search engine on iPhones and all, well, I guess all Apple products. So yeah, that gets included in that. That gets munched in there too. Okay. And then the third one is wearables, home and accessories. So this is about 10% of revenue. This segment includes AirPods, the Apple Watch, Apple TV, Beats, HomePod, and the iPod Touch. I did not know that that still existed, but it does. And then the fourth largest is the Mac. So this is also 10% of revenue. This is their line of personal computers. It includes the MacBook Pro and the iMac, which I believe is

the bigger desktop version and not really the personal laptop. And then the fifth is the iPad. That's also around 10% of revenue. And this is their line of tablets. It actually runs on its own operating system called the ipad os and then the four big ones here are the ipad ipad air ipad pro ipad mini um quick question if you guys i i know brett i think you still have an apple product which of these products do you like the most seems like the ipad's pretty good i don't know i like that one but i got one for free i think i haven't compared it to other tablets but that it's very useful yeah i'd say that's probably the most useful one for me as well kind of works as a good reading tool yeah what about you ian i think i'd have to go with the iphone just with how much

i use it every single day and how you know how seamless it is with working with all the technology it's um that's probably my favorite personally i say they're too connected like uh i don't want the notifications on every device going to every device we've had that debate internally but uh you know to each his own remember the inverse brett consumer goods that's good that's good Yeah, yeah, exactly. Well, Peloton, so far, okay, I'll give you, you know. All right, you're right on one. So I guess that's a boost there. But I guess any other important information is that majority of their sales still comes from the Americas. China is the fastest growing geography for them on a percentage basis. And their hardware for

the most part is manufactured in Asia, which is relevant given some of the shipping issues. that isn't the shipping issues. I don't think are as big of a problem for them as the chip shortage, which they talk about. And if you go onto the last conference call, they mentioned this a lot, but they have their higher end chips. Isn't necessarily a problem for them. It's where the lower it's when they use the lower end chips that they're having constraints. And that had an impact on their revenue in this last quarter, a pretty big impact as well. Six billion. I think it was the number. Yep. And then history. I think a lot of people have heard the story about their founding. So I'm probably not the best one to tell it. You could probably just go watch

one of the movies or something. But Jobs, Steve Jobs, Steve Wozniak were the founders. They founded it in 1976 in Jobs' garage. It was kind of this visionary slash engineer dynamic that they had. And then Jobs eventually, Woz left, then Jobs left. And then Jobs started his own company called Nex Software. And he also bought Pixar. And then Apple was struggling around 1997, if I'm getting these dates correctly. They bought Jobs' software company, brought him back in. He became CEO in 2000. And that's when they really started to hit their stride and launch a lot of new products. They had the iBook, the iPod, and then in 2007, the iPhone. And then since that point, Apple stock has grown 42-fold since 2007. So really good returns over the last decade or

last 15 years. Jobs did die shortly after in 2011, which at that point, Tim Cook took over and he had been the COO prior and he's been CEO ever since. So it's kind of a little quick timeline there. Do you want to talk about the industry and landscape? Yeah, this is an easy one. Everyone knows they operate in the electronic devices and information technology industry, but let's go through each unit or each segment that Ryan described. And we'll talk about kind of what the global demand for that is. So smartphone units are projected to be about 1.38 billion worldwide in 2021. 1.38 million just means total unit sales across the globe. iPhones cost around $400 to $1,000 or higher. So the target market for them is huge, although they only play in more of

the wealthier part of that target market of the 1.38 billion smartphone units that are sold. Smart watch industry, there is a projected to be or estimated to be about 69 million units sold in 2020, and that is expected to hit 230 million units in 2026. Watches cost around $400 to $750. So this is hopefully, and we'll get to this later, the big growth driver for them going forward. PC and laptops are a very stable industry, about 80.6 million PC units, 275 million laptops, and 160 million tablets sold worldwide. Apple has a much smaller market share here. I think tablets, they have a pretty good market share. But in PCs and laptops, it's a lot smaller. So even though there's a ton of units for these, and they're quite expensive, Apple is just a sliver

of this. As Ryan said, they're only about 10% of their overall revenue. Mobile operating system industry, this is an easy one to go over as well, because there's two. And I think Samsung is 0.02% market share. iOS, which is Apple, has 30% market share worldwide. And Android has 70% market share worldwide. Android is owned by Google. So they're the number one competitor for Apple. Well, maybe Samsung too. Those are definitely the big ones. So yeah, the big competitors are Samsung with devices. I think they're the second biggest device maker. And they run with Android for their operating system most of the time. And then Google, they compete with Android versus iOS. They also have some hardware with phones, watches. I think they have an internal one

plus Fitbit watches. And then there are many other competitors for the services industry. Netflix, Amazon Prime, Disney, Spotify, whatever. I don't need to go through all of those because they're a lot smaller, but the big ones are definitely Samsung and Google. All right, Ian, do you want to hit management and ownership? Yep. And I'm going to focus on Tim Cook, who, as Ryan was mentioning, took over as CEO in 2011. So I want to give a little bit of his backstory because he's been the CEO for over 10 years now and looks to probably be the CEO for a number of years going forward. So like I said, he succeeded jobs as CEO in 2011. He started at IBM after graduating from Auburn and worked his way up to become the director of North American

fulfillment of its new PC division. So right at the beginning of when people started kind of buying personal computers, he was at IBM, the director of the North American fulfillment. So after that, he worked at a company called Intelligent Electronics, I believe is its COO. And then he worked at Compaq, which was a computer manufacturer at the time and was really hot in the mid to late 90s. Steve Jobs returned to Apple in 1997. And as part of that, he quickly hired Tim Cook as senior vice president of worldwide operations to be part of the new Apple that he was redesigning and redeveloping. Tim Cook came to play a vital role in the executive office. A little bit of background on some of what Cook actually did.

He was behind the move to contract manufacturing instead of Apple manufacturing all of its own products in-house, which allowed Apple to build faster, build more products, and develop the relationships that have really created a competitive advantage over the past number of years and being able to have the best manufacturers manufacture Apple products and be able to predict or be able to fulfill demand because they've got these strong relationships with the contract manufacturers. And Tim Cook is really known as an operational efficiency mastermind. That's really his skill set is being able to come in and just make things as efficient as possible. When he joined Apple, it wasn't necessarily a no-brainer. The stock price was below what it had been in the late 80s. Michael Dell, who is the founder of Dell Computers, was suggesting that Steve Jobs should just return money to shareholders. And so I have to imagine that it was a little bit of a tough decision for Tim Cook to actually join Apple at that point. But I assume that part of it was his interactions with Steve Jobs and seeing Steve's vision for what it could become.

Cook is now 61 years old, and the rumor is that he wants to launch one more product category before retiring. Probably AR glasses is kind of the idea that he'll kind of push through that and then after that, maybe assess whether he wants to retire. And so that's kind of the backstory on Tim Cook. All told, insiders own only about six basis points of Apple stock, but with a nearly $3 trillion market cap, that's still a significant amount. So, for instance, Tim Cook has about half of his net worth in Apple stock, which is $568 million worth of Apple stock. One last interesting point on ownership is that the largest holder of Apple stock by far, I think it's the only institution that owns more than 1% of Apple, is actually Berkshire Hathaway that owns over 5% of shares outstanding, which that's been much talked about in the recent

months and weeks as it's become clear how much that's... What a great investment that was by Berkshire a number of years ago. So, uh, but yeah, it's, it's the largest, largest shareholder of Apple by, by far. Yeah. That's been, yeah. One of the best investments of all time for sure. Um, really, really large investment that's worked out well for them. I'll hit valuation quick market cap. Like Ian said, it's about 2.7 trillion hit 3 trillion, which is quite fun. Um, I guess, uh, it's kind of astounding to see something worth that much. Ticker is AAPL Enterprise value is slightly lower, about $2.63 trillion. That's approximate. EV to sales, 7.2. EV to gross profit of 17.2. EV to operating income of 24. So you can see how

big they are. They have that operating leverage where that EV to gross profit and EV to operating income are not that different. EV to free cashflow, this is probably the most important one for them since they're such a mature company, is 28. Dividend yield, 0.53%. So it's there, but it's not that meaningful for them. But the most important thing for them from a capital return standpoint is buybacks. Share count has gone down consistently since 2014. You have no worries from dilution there. Well, I mean, they have stock-based compensation, but the buybacks offset that significantly. And it's definitely a positive for this one, unlike a lot of other companies we've covered where you probably have to price in 2% to 3% dilution on your share base.

you could probably count on a 2%, maybe around a 2% reduction in share count, maybe three. Well, at their valuation, I think it's slowed down a bit, the rate. I know, but recently, they were able to reduce it a lot easier when it was PE of 10. At this one, it's going to be tougher because at an EV to free cash flow of 28, but you're closer to free cash flow of three to to 4% paying out the dividend. But they're, I mean, they're retiring. And I guess this is part of my, uh, both faces, but they've got, they returned a hundred billion dollars this year to shareholders at a $2.7 trillion.

And 15% of that was dividends. 85% of that was Sherry purchases. So at 2.7 trillion, it's like, yeah, it's around 3.7%. In, in all. Yeah. So it's probably around 3% just in the buybacks. Yeah. I think it's possible they could do 3%.

Yeah, 3%. But I think it'd be closer to 2% based on their current valuation. But that's speculative. I think it'll be around. It'll be close to either of those numbers. Ryan, you want to hit earnings? Yeah. And so they already reported their Q4.

So their 10K is out. They had $366 billion in total net sales. That's up 33% year over year. The iPhone was the fastest growing segment for them. but all segments grew their top line by more than 20%, which is, I thought that was really impressive to see. And Apple's aggregate gross margin was 42%. So they break it up into hardware and then,

or products and then services and products is around 35%. And the gross margin on services is at about 70%. So while services only accounts for 19% of revenue, it accounts for like 31% of gross profit. So it is a pretty sizable portion of their actual income. And then operating expenses as a percentage of revenue declined from 14% to 12%. That left them with $109 billion in operating profit or about 30% operating margins. They had $104 billion in operating cash flow.

That grew 30% year over year and about $93 billion in free cash flow. I thought it was fun to look at their retained earnings column just to see how much Apple's actually returning to shareholders. And so they paid about, they paid $14.4 billion in dividends for the year and $85.5 billion in repurchases. That's $100 billion in capital return to shareholders on $93 billion in free cashflow. So really shareholder friendly approach as of late. I wonder if that was inspired by Buffett coming on. No, I think he was inspired to – they started it before this, so I think he was inspired by that. That was probably part of his thesis. I'm guessing.

I don't know. I don't talk to him, obviously. They did issue some guidance, but it wasn't very specific. So the outlook, they said they expect year-over-year revenue growth in the first quarter, but it will be a deceleration from Q4. In Q4, it was growing at about 29% year-over-year. They said the only area where they're expecting negative year-over-year comps is iPad. So I guess it's a little hard to know kind of what the go-forward growth rate is going to be.

Yeah, if it's like 20%, you're like, okay. But if it's like 5%, people might get skittish. Yeah, and that's obviously an important part moving forward. But the gross margin and operating expenses look like they're going to stay consistent. That's what they said. They did say that they had supply constraints and that it will continue to impact revenues. So in the last quarter, they lost $6 billion in revenue from supply constraints. If that's going to be a problem going forward, just keep in mind it's going to limit potentially their, I guess, just top line.

But obviously, that's factored into their outlook. I don't like that they said positive comps. Like, what is that? Is it 5% or is it 25%? I'd rather give you out specific guidance than if you're going to do this, I'd rather have no guidance at all. If you're going to get what I mean, like this just creates too much speculation in between people and the focus gets lost.

Yeah. Just be vague. Just be like, things are looking. Yeah. Just say demand is looking robust. Yeah. Well, I mean, how could you not buy a stock where demand's robust? Come on. Anyway, balance sheet liquidity, Ian. Yep. They've got, I think still the largest cash balance of any company in the world right now with $190 billion in cash to marketable securities. The largest bucket of that is about $85 billion in corporate

debt securities. I have to imagine that that puts them as one of the top holders of corporate debt in the world. I think I looked it up and there's something like, maybe it's now I'm forgetting, but somewhere between 10 and 20 trillion in corporate debt, I think. And at 85 billion, I would imagine I'll find that number in a second, but I'll basically a bank at this point. Right. And so then after that, they're invested in treasuries, mortgage backed securities, non-US government securities, about 20 billion each in that a little note that from 2020 to 2021,

they appear to be getting out of some treasuries and into some corporate debt. So take that as you may. um, including about $12 billion of leases. Apple has debt of around $137 billion. And so a net cash position of 53 billion ish. And this primarily consists of fixed rate term notes with interest rates, um, ranging from zero to 5%. The more, the majority of this debt is due after 2026. And one of the reasons for this debt, and you're alluding to them being kind of like a bank is they actually earn more in interest than they pay um on their debt so they earn more from the securities they own than from uh the interest on the debt that they owe and so that there's a little

bit of um it's just for them it makes the capital structure makes sense and they're actually earning a little bit of income off it so uh and they've got the business to back it up and then as you as you noted brett they've got uh a share count that's steadily declining it's down almost 25 since 2016. So pretty incredible, I think, for a company the size of Apple to have retired almost a quarter of its shares since 2016 in the last five years. Bought back over $90 billion in stock over the past 12 months, which is around 3% to 4% of shares outstanding. So really impressive, strong balance sheet. They do have, like I said, they own debt, they owe debt. So there's some dynamics going on there but it seems like um everything is uh above board yeah they run they

have one of the best balance sheets yeah yeah this was a very easy in terms of like just going through the 10k and looking at the numbers i don't think i've ever seen a prettier a prettier financial statements it was under 100 pages too so for all those companies out there that are way smaller than apple putting out 200 page 10ks i mean shame on you like this is a trillion dollar company and it only takes 87 pages i think the uh the other thing i'll say is if they can borrow at one percent and they can buy back at a three percent yield yeah i mean that's what they used to do it's it's they can only but they're borrowing they're not gonna borrow one percent it's probably like three right ian if i'm wrong yeah it's somewhere closer to three to four percent

you know they've got they they issue so much debt over time that it's um there's a wide range in and their interest rates. But I think the rate on the whole thing is probably closer to 3% to 4%. Yeah, when they're at a 10% free cash flow yield, I mean, that was just machine. All right, let's hit the ad break and we'll talk more about what we think about Apple stock.

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Until all the separate parts of your company are working together it's impossible to achieve your goals without harmony air table can help deeply connect teams data and workflows build apps that adapt as your needs change and give people the flexibility to do great work their way this is how visit airtable.com today okay welcome back next up we have anecdotal evidence this always should be a fun one since i bet even everyone listening has the anecdotal evidence on the, you know, on the products, Ian, um, what's yours. Yeah. I'd just say that whenever I go to buy a new phone, there's no doubt in my mind that it's going to be an iPhone and not that that's true of everybody or that I could never change, but

that is the reality right now for me. And it's, it's going to be my next phone is going to be an iPhone. So, um, that's, you know, I think it's, it's pretty, there's few things in my life where i don't do any shopping for and um my phone is one of them they got a lock on the u.s customer for sure yeah can you port over like let's say i wanted to get a new device could i port over my data you can do it i mean are you talking across going to android yeah i don't think so it's only i think it's only android android or apple to apple all right well i am with i am with apple for life then um i'm sure there's a service that does it but like you might have to pay extra i don't know i bet someone can do it but it might just take a little while also right it's not

going to be seamless it's not going to do it at the apple store yeah i have the iphone i have the ipad i have the macbook or the not the laptop pro um and i have the watch i probably don't like the macbook though or you've complained about it sometimes yeah i mean mine's an old version uh and so sometimes it's just annoying but the uh i don't know if there were any that i would go outside the ecosystem it'd probably be the computer um but the rest of them i think it helps to stay within the ecosystem um just because like with the watch you know i'm getting texts that i can see i've got like maps so i don't have to look at my phone when i'm in the car like it's the interconnected interconnectedness is very helpful with some of that stuff um the computer

not so much but it's yeah i'm i'm pretty much with apple for life and i think most consumers in the us are yeah personally i like how my ipad is not connected because if it's like a reading or watching device you don't have notifications for that i don't think i think most people don't really, they'd rather have the opposite. So, I mean, that works. That ecosystem lock-in is true in this case. For me, I mean, I think their most secure market is obviously the smartphone, but I think the watch is developing to even as just a secure market. I mean, no one is buying, at least in the US from where I see, no one's buying anything else. They won't buy watches that aren't from someone else, even if the other ones are better. So, I like what they're

doing that anecdotally uh they've kind of turned the watch you know the functions are nice it's like probably great and it probably does the same as say a fitbit technically you know or technologically but the differentiation is they made it a fashion statement and that's what they did with the iphone and now they're i think they'll be able to sell a whole lot of those over the next few years all right let's move to future growth opportunities in uh what's yours looks like oh you got some uh some metaverse uh stuff in here Yeah, this was part of my original thesis with Apple before I'd even heard of anything called the metaverse. But I think a great future growth opportunity for them is this AR and VR kind of

world. And so there's been a lot of speculation that Apple is going to get into the AR glasses world. And Google has tried this a little bit. Snapchat has tried this a little bit um and with not very much success basically what these glasses in theory would allow you to do is to see your world and you see through them they'd be clear and they'd be very minimalist and you could overlay things on the world and so for instance you could have your map out in front of you you could see the map as you're driving through your glasses you might be able to um as you're watching a sporting event at an arena that it might have the score and some stats that you were looking through as well as you're watching the game um different things like that so all

sorts of you could play games with them maybe you could see messages pop up instead of looking down your apple watch it would pop up in your view um there's a lot of speculation too much work too much work to look down right well it's it's uh that's the great thing though is when you look down at your watch or you look down at your phone it's like um it's rude right to everyone else in the room when you're just looking through your glasses you know there's nothing you're not being rude at all so anyways um you are no one knows you're being rude yeah exactly um anyways i think there's a lot of kind of interesting applications for it but the question for the question for me is i think i think you could never bet on apple having another success like the iphone as ryan

said it was probably the best product of all time you would never bet that they'd have another one that then became the best product of all time. Do you think the watch, am I being too bullish to say the watch has that potential or is it doesn't cost enough money? I don't think it's, I don't think the watch is as, I think the watch is good because of the iPhone.

I think it's good because it's tangential or supplemental to the iPhone. I don't know. They're pretty expensive. Do you think? I think it's a good product for sure. I don't think it's had the impact the iPhone has had. Yeah.

I don't think the AR glasses are going to have the impact that the iPhone is going to have, but i think they've got the best shot at that of anything and um i just i think that apple has a unique ability especially with its ecosystem and the way that the watch has kind of proven this that if they can build a good product and it ties in with everything else that they do i think apple wins the ar glasses um space now that'll be it'll be interesting to see i think apple has a good chance of that a couple of quick numbers there's they're also reportedly working on a VR headset that would be more similar to the Oculus, that's supposed to come out sometime in

late 2022 or early 2023. And that is what's being said is that that's going to be the first product that's out. And then the AR glasses are going to be out sometime after that. So probably late 2023 and to 2024, 2025. And so we're probably from Apple, the rumor is we're going to see a VR headset before we actually see these AR glasses. Yeah. No, those numbers are good and the technology is great but i think apple will sell these ar glasses if one they look stylish and two they just blast us with commercials where people that are attractive are using them that seems to be their product strategy it works for airpods oh yeah i mean i think that's will convince people to wear them um but yeah i mean that seems like the ar glasses in a more serious note has a lot

of variance like could totally be a bust could be a huge growth driver for um all right what about you ryan yeah i would i think the ar glasses is kind of the big um potential that would be definitely like a needle mover um but i guess it's less certain mine's i guess already happening which is apple pay um the problem is apple's really discreet about their economics on the services side and what is actually going like how much revenue they're generating from the different components. And so I can't really give too much color on that. And so I don't really know if this will be a needle mover, but anecdotally I'm seeing a ton of adoption among peers with Apple pay. And it's not just, I'm seeing a lot of people opt out of like Venmo or a cash app

and just send texts with Apple pay. Right. Especially in the U S when majority of people are iPhone, it's very easy, right? Cause they already have that quote unquote network effect. Yeah. And more so lately. And then the other thing I'm seeing is a lot of people um, like when they forget their wallets or something like that, they, I hear people ask all the time, like, Oh, do you guys accept Apple pay? Which I wasn't really hearing that three years ago. And three years ago, I would have said, honestly, that, uh, us is going to be primarily like card indefinitely, but now I'm starting to see more mobile payments. Um, and so I think Apple pay, I'm not sure what percentage they get of each transaction. I know they probably get

something uh but they're uh i could see that being a i guess a revenue driver for them the other one that is a little more fun is if microsoft and activision if that deal doesn't go through i think apple should bid to spin off king games like well it doesn't even games that doesn't even fit king doesn't even fit in with microsoft because it's console so like it could all they could say like hey you know we'll take that like king doesn't even work with you i mean it'd be perfect for uh like the apple arcade plus subscription to just throw candy crush in there regulators would never have this but uh i mean apple arcade plus is a is a as i've seen it seems like it's like a really not robust i guess you're unsuccessful it seems yeah they don't have enough

products on that but maybe they don't report on it that's true so it's like and i think they don't report on it intentionally. So regulators don't have something to point their finger at for like, let's say, uh, 50% of their revenue was coming from app store fees and they had like a nominal figure to point their finger at that would probably hurt in, uh, um, it'd be a little more regulatory pressure or just social pressure in general. Um, but there isn't that much color throughout the 10K just in general. Yeah, I think they also don't like to highlight that lucrative Google deal

that is the majority of services profits, $18 billion pure cash. A lot of companies would highlight that, but they don't want to because honestly, that's one of the most anti-competitive things they've done in conjunction with Google. I'll let my future go for the opportunity. I've talked about the watch.

It's the thing I like the most about their business going forward. I think it has a lot of room to run, so to speak. They've executed brilliantly with the product and it's becoming a fashion statement even more so than the iphone did i was checking out what they have i mean you like it gives it that brand differentiation in the united states for anyone that's middle class or higher they're not buying fitbits anymore you are buying a watch and if it doesn't make any sense but it does when uh when people buy it because it makes them feel good

and even if the technology is the same it seems like they have great technology on the watch i don't know i i i don't know if everyone is going to have a smart watch in the future but i think in the united states and the western world and probably china as well apple will have the majority of the market share and however large that market gets um it'll be great and what about those new ads have you seen those ads they've been running on football sundays which ones basically if you don't buy an apple watch you're gonna die that one they're think about that ad they're saying if you don't buy an apple watch you're gonna die i mean that's pretty convincing marketing it is it is genuinely a helpful safety thing to have i know but people

we've had a lot of people live without apple watch i think i'll be fine definitely but i think it does actually highlight something that we're not going to touch on in future growth opportunities but there's been a lot of speculation that um apple wants to get more into kind of health care right and fitness and that type of stuff. And I think that the Apple Watch, especially with these new ads, we're seeing more and more of a emphasis on that, that look at an Apple Watch makes you healthy. An Apple Watch helps you live longer. An Apple Watch is safe. And I think that we'll continue to see features with the Apple Watch that makes it seem like a necessity as you were alluding to. And especially for, you know, you start thinking about your, you know, it's like

all the fallen and I can't get up ads, right? This has become something that starts serving that market as well. Um, yeah, I mean, advertising extremely smart move, uh, to do it like that, or let's move into highlights and lowlights. Ian, what do you like and dislike? We should caveat again is your largest position. So, uh, what do you like? Take everything. Yeah. Take everything I say with a grain of salt for sure. But, um, I think it starts for me with Tim Cook reviewing for this podcast. Again, I was just impressed by how well he followed Steve jobs, but also didn't try to be Steve Jobs. Tim Cook is clearly a different leader

and has a different style than Steve Jobs and even different emphasis. But the company has performed remarkably well. And it's pretty rare to see a great leader like Tim Cook follow a great founder leader like Steve Jobs. For there to be a smooth transition and then for it to be as successful as it's been has been really impressive.

I also think the transition towards services is good for the business. It's higher margin and more predictable. as Ryan was talking about 70% gross margins versus 35% gross margins on the hardware sides. So it just, Apple has always been following the stock for a number of years. Apple stock price goes up and down a little bit as iPhone sales tend to be a little bit lumpy. Some years are better than others. Some, some years they have more innovation than others. And so it has become over the last couple of years, it has become less a story of how good the iPhone

is this year and more of a services story. And so I think that's been good. A couple of low lights for me, I think with a company, obviously of Apple size, you always worry about antitrust and even breakup potential. I think, um, whereas there's some other businesses like Amazon, where if you broke them up, they might be more valuable. I think it's hard to break up Apple and it be more valuable. Um, I think the, the, the network and everything being so interconnected is one of the things that's actually so valuable about Apple. And I'd probably be less interested in it if it was broken up. And then I also think there's a growing reliance on China

to fuel particularly revenue growth for Apple going forward. And I'm always a little bit uneasy with companies that rely as much as Apple does on China, both for revenue and also for supply chain. But mostly in this case, on the revenue side, I think that's just, it adds a level of risk to the investment. Do they have, do we have a number on their percent China revenue? Is it like 20%?

Do we have a, we should probably get that. It's the third largest market, but it's the fastest growing. So it goes America's, Europe, China, Japan. I think it's slightly lower than Europe, but I still think America's. Significantly larger, right? It's double the size of the Chinese market. Okay. Yeah, I'll pull up the number, the exact number in just a second here.

okay ryan what about you it's the best run business in the world um and it's microsoft i might still go with apple i think yeah the uh and the other thing is it does it for the largest company in the world i would think that there would be i mean the antitrust stuff it's hard because they really have focused on security and privacy And I do buy that argument from their side. And I think if there's anyone to face those headwinds, it's Tim Cook. Wow. They got to you, huh? They have. I mean, it's... No, they're right. I mean, they are. I mean, it's so much.

It could have been a much more dystopian business with the wrong person at the helm. And Tim Cook's been, I think, the right guy for the job. um the brand loyalty also makes new product expansion a lot easier i think people are more willing to try something out from apple than facebook um low lights for me though there is the app store pressure that's probably the biggest one um there's no there's no really telling exactly where that will go but they're just kind of getting hit from all sides from different uh jurisdictions and different rules and um it just seems like it's favoring uh more democratization of app store uh or app development and less just lower fees yeah there was just a bill today thrown out there in the u.s congress about uh banning companies

from promoting their own banning uh google and apple from promoting their own services in their app store or maybe not banning but like you can't like pump it up to the top of the rankings yeah i mean it's just kind of this consistent barrage of uh headwinds on that front um and then the last one i'll also say china i think we've all said china but as the biggest uh percentage basis growth driver i don't i don't like that for a few reasons um but it just adds a lot of uncertainty yeah yeah to provide a number on that it's about 18 or 19 percent of revenue um is china okay yeah that's pretty big growing 70 year over year right yeah that it might not i don't know if that's normal though like yes this past year it grew more than

it has traditionally it's actually stayed um flat and even declined over the last couple of years but then this in 2021 um it had a big spike the ccp gave the order all right uh uh highlights for me buyback program has been so smart i mean the way they run their balance sheet is great uh i've said this like three times but i think the watch is fantastic execution with services has been better than i expected i think um apple arcade and news plus have been total dogs but everything else i mean pay uh what's that cloud thing they lock everything everyone into music has been solid tv plus has been way better than people thought it would be so i think services overall have been great um low lights though like you guys said china overhang it's geopolitical

and it's also well i guess it's mainly just geopolitical like i don't know what happens if things get more tense like this is a huge they're probably the maybe outside of starbucks the most tied to china um yeah it's already i think heating it's heated up uh a lot in the last year or so. Yeah. Biggest risk, I think, to the company. I think we're all in agreement on that. Another low light for me is they rely on less subscription-y revenue or recurring revenue than Microsoft and Google, which feels harder to predict for me. Microsoft and Google, I am way more confident what the revenue will be in 2025 or that it'll be higher from here. Apple, while they've executed extremely well, it's going to take better execution to run, at least to grow.

I think Google is something that is kind of a ham sandwich type company for their core stuff that people could run. The Google search deal is a bit of a conundrum for me because I think that could get totally torn apart and the government could say, no, no, no, we can't have Google and Apple in bed with each other and just winning this market. That could be seen as anti-competitive. they could lose 18 billion dollars in cash flow at the drop of a hat um siri has been a big bust although i don't think that voice technology markets really amount to anything for anyone and then app store stuff like you guys talked about the other one and i saw this and maybe it's i guess i don't know what to think of this but i saw something on the back of a product that was

like designed in the apple product designed in the united states where it would typically say made made in china or made manufactured in asia and it's like great it's like they're kind of secret about that and maybe it was sort of a tale but i heard that they had a net around i think that could have been nike oh nike's another one's tied to china could have been nike maybe it's one of those the suicide nets yeah there were suicide nets outside their manufacturing areas in uh asia but that that might be rumored that might be speculation so i don't want to uh, I guess keep it going, but, um, what about bull? What about the bull case? Yeah, the bull case for me is fairly simple. They, one of these new products or growth

opportunities that we talked about, AR glasses, they've talked about coming out with an Apple car, uh, services, metaverse, the Apple watch, whatever it is that those continue to drive consistent growth for Apple going forward and investors benefit from growing revenue and declining share count over the next five to 10 years. Yep. Yep. Simple story. I think we all have the similar ones here. Ryan, what's yours? Yeah. So assuming the buybacks and the dividends stay consistent on a nominal basis, so saying they continue to return $100 billion to shareholders a year, at the current price or at the current enterprise value, that's nearly a 4% yield. That's higher than their annual free cash

with us. So free cashflow is going to have to grow to keep that up. Yeah. Which I don't think it's too bold to assume that it can. But I'm saying if the allocation back to shareholders stays consistent and free cashflow grows 5% this year, then free cashflow would eclipse the $100 billion mark. So I guess there's a 4% yield there. You add in potentially high mid-single digit free cashflow growth, which I think is achievable and shareholders can get near a 10% return, even at today's multiple. I guess the bull case, bear case, there isn't that huge of a discrepancy for me. I don't think the spread is that wide versus some of the other companies we've looked at. I don't think the bull case, and maybe I'm being too pessimistic, but I don't

think the bull case i don't think there's a wildly optimistic bull case out there no uh um multiple compression yeah i mean if you don't think multiples can compress maybe you can get much higher than 10 but that's the big like i don't know multiples i think have to compress um but i guess there's no reason they they have maybe i don't know it seems like it's very likely they will compress but there's no reason they have to their buybacks are more lucrative yeah Yeah. But I mean, that's going to lower your total return from here, from here. I don't know. My bull case is the watch continues the ascent, services continues their ascent, and iPhone, iPad, and Mac demand stays stable. I don't think you need the new businesses to

get positive returns, but the stuff Ian was talking about can help propel them to more market beating returns over the next decade. I mean, if cash flow inches toward about $200 billion a year and share count shrinks, returns should be solid. Um, I think we're all in the, we've kind of all had the same bull case there bear case though. I'm curious to see what everyone's thoughts are. Uh, what are yours Ian? Yeah, I think for the bear case that the real bear case is that growth is non-existent and the market re-rates Apple. And it goes from trading at about 20 times EBITDA today to closer to like six to eight times EBITDA, which is what it was trading at when people were worried about its

growth. And, um, if, if these new products aren't able to get going, or there's issues with the China revenue or whatever there is that, that that's the big risk here is that you are paying up for it. Um, at least compared to historical averages for Apple and that the market could always, you know, rewrite this. I think the, the share buybacks and it's large cash balance, um, provide some ability to, um, to kind of cope with that where you're probably not getting totally shellacked but if it re-rates it to six times ebita that's that's about you know you know 75 down from here almost so um that's it's it is a risk i think yeah oh i mean most i'm going to say most of the returns over the last five years have been multiple expansion

i think i mean they would have still had great returns of that right yes yes the the multiple expansion has been uh has been very beneficial they've also grown revenues and free cash flow and stuff but the multiple expansion has been very beneficial to the returns right positive it would have been positive either way but it was it was nice to have that on top ryan what's your bear case my i don't see a very realist i don't think there's a realistic scenario where revenue is down five years from now. So I'm assuming the floor is fairly high here just because they have that 4% yield on the buybacks and the dividends. I don't know, like 28 times? I don't know. It's traded below 10 before. Let's say they grew revenue at 3% a year

for the next five years? Do you think, what do you think? I think returns would be negative, but not too negative. That's right. I mean, it just seems like they have so much control now over their top line

that other outside of the app store stuff, which could hurt them because it's 31% of gross profit. Not, well, not all, I guess, services is 31% of gross profit. I think they have a lot of control over their top line i guess if there's like some sort of like recession or depression and no one's spending money on iphones which still i think that's almost like a necessary expense in today's

world yeah i mean have we gone through a true recession though with an iphone at scale you can't function without it like yeah but you can you can function with an old one in some cases i mean if it's functioning yeah yeah the it just yeah you yeah i guess maybe new new sales wouldn't be as good but you still have services you still have a lot of revenue from services regardless of even if there's some fee compression on the app stores true true it just feels almost indestructible at this point um i think the bear case you're getting you're flat over the next five years, which I mean, obviously that's not great, but I just don't see a world where this is a 50% smaller business in five years.

Yeah, true. I can see a world where it's a 50% smaller stock, but not business, just from multiple compression. Here's my bear case that it's possible that their revenue growth in the last play us out scenario that people got whatever trillions of dollars in consumer checks and their savings went up through the roof. And over the last six months, it got depleted basically back to levels like people are spending insane amounts. I think a lot of that went to phones and Apple products.

That could have a negative impact, at least comparatively, over the next few years. Stimulus checks are likely, well, never say never. They could be back. I think the bare case is that that had a one-time impact on growth that isn't repeatable. And that's how it's growth from here. There are only so many consumer discretionary dollars you have out there. And then the other stuff, China is obviously the

bear case if that blows up. And then if app store stuff, Google's contract blows up, that's obviously negative as well, but wouldn't be detrimental. I think the big thing is just consumer discretionary spending. Are people able to afford these, which is kind of depressing to talk about as a lot of people don't have any savings, but are they able to afford these thousand dollar funds? All right. More or less interested in, I think we may know your answer, but I don't know. What do you think? Yeah. So it is my largest position. I think I like Apple. I think they've got some great competitive advantages and I think there's still room for them to grow from here. I will caveat that with kind of what I was saying in

the bear case that, that do I think it's going to be at 20 times EBITDA 10 years from now? Probably not. Right. Probably not. And so that you're probably seeing some multiple compression over that time. I don't like to try and time, um, multiple compression or multiple expansion. That's not generally what I'm trying to time. Um, and so I'm willing to, you know, I, i'm i like the stock but it's uh it's um you know i think there are some some concerns out there especially evaluation wise yeah it's interesting this might be in the boat for a ton of people where they bought before uh whatever say 2015 2016 and they wouldn't buy now but they're not selling now it's kind of in that weird middle ground all right ryan what's your more or less

Unless, unless I think there's better opportunities out there. I think, I still think, I mean, if it's at what, three and a half, 4% free cash flow yield. In between that, I believe. Yeah. Yeah. I just think there's better opportunities out there than Apple at 28 times and grown at 20, the 28 times free cash flow growing it.

It can't grow. guessing it has to be GDP growth at some point. Yeah. I mean, at some point it does. I think if you probably took an average over the next five years, it's going to be less than 10%. I just, I have, maybe I just have a hard time imagining like their ability to grow at size. Um, but that's, I guess my one, yeah, I would just say there's better places out there from your money right now. Yeah. I mean, I'm kind of a similar boat. I'm really like what I was describing as Ian's scenario. That's what I'm at. Like if I bought in 2015, 2016, like what I'd be selling here. I don't know. Probably not, but I'm not buying here. I'm less interested. I just don't think the growth can be that strong. um yeah uh i don't know i mean it's been such a good performer i think people anchor to the returns that it's done but i i don't know it seems like it kind of it seems like it's a hard

place to like lose money but the valuation is too high for me to kind of say that with a lot of confidence i think multiple compression can come in a lot i don't know i'm less interested obviously one of the best run businesses of all time really great story fun to like watch i was like reading the reports but definitely less interested at this point uh we got stock for next week now um i did a poll today so i gotta bring it up yeah who's winning the poll let's see well i gotta figure it out i did uh it was a dang yeah no it was a mix of comment of dms we got so if you want to get on a future poll follow us on twitter at chitchat money and dm us suggestions It was DocuSign, Adobe, Disney, American Tower, no up for American Tower, only 7% of the vote,

but it was a tight race. And even though I voted for Adobe to boost the results, we got DocuSign, got 33% of the vote. So that's what we're going to be doing in two weeks. Should be fun. Down a ton. I don't know. It could be interesting. Kind of a, dare I say, battleground stock. Yeah. Some people think it's a product. Some people think it's a really great company. So we'll have to dig in. All right. That's going to do it for this episode. Thank you all for listening. If you are listening on Spotify or Apple, give us a review. That's the easiest way you can help the show. If you're on Spotify, it takes about three seconds to give a review. So please give us that rating. It's the best way to help the show. Remember, we are not financial

advisors. Anything that we say on this episode is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.