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How the hell is Apple worth $2 trillion?

While you’ve been busy battling the pandemic, sorting out your child’s school year (or lack thereof), and cautiously watching the return of major league sports, Apple has become – okay, that’s on become – the very first $2 trillion company.

Its market cap topped $1.9 trillion yesterday, closed just below that level, and as of this writing is around $1.88 trillion. It overtook Saudi Aramco on Friday to become the world’s largest publicly traded company. The stock is up 50% this year – and that’s not even a pandemic game per se. There were analysts back in december say yes, it could be a 2 trillion dollar business…by 2024!

So what is driving Apple to such unprecedented heights? Quite simply, its benefits. This is not a speculative, Tesla-changes-the-future game. It’s not an Amazon-worthy home stay. On the contrary, Apple has been hampered by the coronavirus. Bernstein’s Toni Saconagghi estimates iPhone revenue will be 10% lower this year than they otherwise would have been between the pandemic hitting demand and the delay in launching its iPhone 12 this fall.

And yet, Apple is expected to post about $280 billion in revenue this year and $58 billion in net revenue, or profit, according to Barclays. These are the benefits that set Apple apart; it will bring in only about half of Walmart’s projected $545 billion in revenue this year, according to UBS, but four times Walmart’s projected $14 billion in profit. That, plus a higher expected growth rate of future earnings, is how Apple is worth five times what Walmart is currently worth.

Investors are definitely paying more for Apple profits these days. According to Bernstein, it has traditionally traded at a discount of around 15% to the market, but it has narrowed that gap significantly over the past 18 months and now trades at a premium of around 15%.

Why the switch? Consider the case against Apple for years now that the smartphone market is saturated and the company will eventually become the next IBM. IBM, after all, was the biggest component of the S&P 500 for much of the 1980s, exceeding about 6% of the value of the index – only to have practically declined since. Today, Apple (and Microsoft) also make up around 6% of the S&P.

But Apple is desperately trying to avoid becoming the next hardware dinosaur by shifting gears to become a services a company that can count on recurring and constantly growing revenues and which, therefore, is trading at a higher valuation. (To quote The Verge: Apple wants to sell people constant and continuous subscriptions for things they can do on their phone.)

And that’s where its latest results come in. Apple’s services business accounted for as much as 39% of gross profit in its July quarter, according to Bernstein, meaning it could soon derive the majority of its profits from this segment. Oh, and the service industry has twice profit margins currently as the product business does. Services posted gross margins of 67% last quarter, compared to less than 30% for products.

Finally, Apple isn’t just working to ensure strong future earnings growth; it adds a little extra oomph by buying back shares so that profits per share grow even faster. It has been repurchasing about $15 billion per quarter lately, according to Wells Fargo, and it now has nearly $200 billion in cash that could also be returned. (The recently announced stock split is purely cosmetic and will not dilute BPA.)

And that’s how you (soon) get the world’s first ever $2 trillion company.

That doesn’t mean it stays that way, of course. I’m very curious to see how the App Store battles play out, whether regulation or competition forces Apple to keep cutting downloads and purchases. This is all reserved in the service sector, so there is a lot at stake on the bottom line.

Still, I never thought we’d get here. I’m still amazed that $1 trillion isn’t more of a cap for American companies (Apple, Microsoft, Amazon, and sometimes Google now exceed that size). But there is nothing magical about crossing the 13-digit mark. These companies just make a ton of money, continue to grow by leaps and bounds, and are priced accordingly.

See you at 1 p.m.!


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Twitter: @KellyCNBC

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