Why Apple's doubters might be getting the stock wrong again, according to BofA

By Emily Bary

Investors have underestimates Apple's margin potential in the past and might be doing that again

Spending pressures. Chinese competition. An innovation drought.

Investors have found plenty of reasons to sour on Apple Inc. shares (AAPL) this year, sending them down more than 12% over the course of 2024 to date even as the S&P 500 SPX has advanced 8%.

But what if Wall Street is missing the point on Apple - again? That's an issue BofA Securities analyst Wamsi Mohan explored in his latest note to clients as he looked at how investors have gotten things wrong on Apple shares in the past.

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"Investors have historically underestimated Apple's gross margins and it appears that it is happening again," Mohan wrote.

The company's long-term margin potential remains compelling, according to Mohan, and if you go back a few years, you can see Wall Street's tendency to lowball its projections there. For example, in 2018, the consensus view forecast was for 39% gross margins for fiscal 2023, but Apple recorded 44% for that period.

Now, looking forward, he thinks the company could drive about 180 basis points of gross-margin upside on the product side of the business, as well as 150 basis points of upside in services over the coming years.

Overall financials stand to benefit as services become an even larger piece of the pie at Apple. That's because services - things like advertising and subscriptions to iCloud - on the whole are more profitable than Apple's hardware products.

"As the business continues to scale, we see Apple in-sourcing server chips and reducing reliance on public cloud providers, thereby driving cost savings," Mohan wrote. That could send services margins higher.

Meanwhile, on the product front, Apple could see a lift in gross margins if it were to use its own internal modem. Plus, shoppers have chosen more expensive iPhone models, which are more profitable.

Read: Apple's stock has faltered, but a Steve Jobs moment in AI may be on the horizon

Apple has largely held steady on iPhone prices recently, even as it's rolled out upgraded models. Last fall, the company eliminated the cheapest storage configuration of its iPhone Pro Max in an effective price hike on that model, though it kept other pricing the same. Could greater price hikes be in the cards down the line?

"Consumers are opting for more higher-end devices (higher price), but we also expect Apple to raise pricing of individual hardware devices over time, which can be accretive to gross margin," Mohan wrote.

He has a buy rating and $225 price objective on Apple shares, and he sees them as a play on generative artificial intelligence.

Read: Apple's big AI news is coming - and Wall Street likely just got a date for it

-Emily Bary

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04-11-24 1036ET

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