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How Apple Stock Has Benefited From Margin Expansion

Apple stock has been on a tear in the past few years, and improved margins help to explain why.

Since the start of fiscal 2018, which was almost five years ago, Apple stock  (AAPL) -  has climbed a whopping 360%. There are several reasons why shares of the Cupertino company have outperformed the broad equities market — one being vastly improved margins.

Today, the Apple Maven explains why Apple has become more profitable in the past few years, and what impact margin expansion has had on the stock price.

Figure 1: How Apple Stock Has Benefited From Margin Expansion

Figure 1: How Apple Stock Has Benefited From Margin Expansion

(Read more from the Apple Maven: 3 Interesting Facts About Apple Stock In Q1 2022)

Apple’s margins improved greatly

They say that one image is worth 1,000 words. So let’s start with the graph below. The blue line is Apple’s gross margin per quarter, which is the ratio of gross profits (revenues minus cost of goods and services) to revenues. The orange line is operating margin per quarter, which is a similar concept, but also accounts for Apple’s operating expenses.

Figure 2: Apple's gross and operating margins since fiscal 2018.

Figure 2: Apple's gross and operating margins since fiscal 2018.

Notice that gross margin used to hover around 38% until the start of the pandemic. In the past five quarters or so, the ratio skyrocketed to upwards of 42% and reached as high as 43.8%.

Apple does not provide visibility into its margins per product category or geographic segment. Therefore, it is hard to tell with certainty what caused gross margins to expand.

One of the most likely reasons is a revenue shift towards Apple’s higher-end products that probably carry better margins. Notice, for instance, that margins shot up immediately following the launch of the first iPhone with 5G capabilities — the iPhone 12 was unveiled in late 2020.

During earning call conversations, Apple’s management team has consistently spoken of high demand for the Pro and Pro Max models relative to the entry-level devices.

There is also a chance that the launch of Apple’s in-house chip helped to lower the cost of goods. Apple started to equip its Mac computers with the M1 in November 2020, and new models have been rolled out since then.

What did not help to expand gross margin was the revenue mix shift towards products. While Apple’s services carry better margins than hardware, the former went from representing 11.2% of sales in fiscal 2020 to only 10.5% in fiscal 2021.

Operating margin climbed from 24.6% in fiscal 2019 to 29.8% only two years later, and then to 33.5% in the most recent quarter — a three percentage point improvement year-over-year.

Here, gross margin improvement played a role, to be sure. But also, operating leverage has been a key driving factor. Sales between fiscal 2019 and 2021 grew nearly 19% per year vs. less than 13% rise in operating expenses.

The impact to Apple stock

The key question is: does the improvement in margin help to explain Apple stock’s outstanding performance in the past few years — especially since the bottom of the COVID-19 crisis, when share price climbed over 200%?

The answer is likely yes, since better margins translate to increased earnings per share. Think of the price-earnings ratio formula: share price equals P/E times EPS.

Compared to fiscal 2019, last year’s operating margins jumped by more than 5 percentage points. I estimate that, holding all other variables constant, this profitability improvement drove an EPS increase of 21% that is not immaterial.

That said, margins do not tell the full story. AAPL has also been heavily supported by a number of other bullish factors: expectations for robust growth, including from brand-new initiatives like the metaverse and autonomous vehicles, share repurchases, and valuation expansion.

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Apple Maven)