Key Takeaways

  • EPS was $2.58 vs. the $2.21 analysts had expected.
  • Revenue also significantly surpassed expectations.
  • Services revenue matched expectations, but the large sales surprise came from significantly higher-than-expected iPhone sales.

What Happened

Apple smashed earnings and sales expectations this quarter when it reported its results on July 30, 2020, as the continuing antitrust investigation does not seem to have slowed the tech behemoth down at all. A second surprise came from the fact that the large revenue surprise didn't come from Apple's services segment, which it is working to shift its focus to, but from its iPhone revenue. iPhone revenue substantially surpassed expectations whereas services revenue merely matched it. iPhone revenue has declined substantially since the beginning of Apple's fiscal year 2019, so seeing this segment in the spotlight is a change of pace. In addition, Apple announced a 4:1 stock split, meaning each investor would get four shares for each one they currently own. This will bring the price of each share back down to around $100 from its current $403. Shares of AAPL are up sharply in after-hours trading.

(Below is Investopedia's original earnings preview, published July 23, 2020)

What to Look For

Apple Inc. (AAPL)'s resilience during the coronavirus pandemic is reflected in the company's stock price. Apple's shares have climbed about 73% since mid-March amid growing optimism after plunging earlier this year on initial market concern about the virus. Investor confidence was fueled further when Apple beat expectations in its quarterly report in late April.

Investors will be looking for more signs that the company can withstand the COVID-19-induced economic shock when Apple reports earnings on July 30, 2020 for Q3 FY 2020. Analysts estimate both earnings per share (EPS) and revenue will decline year over year (YOY). Apple's latest fiscal year ended in September, 2019.

One key metric investors will focus on is Apple's services revenue. Apple CEO Tim Cook has focused on growing services rapidly in recent years, but services still comprise less than a fifth of Apple's overall revenue. In Q3, analysts expect services revenue to post healthy gains, although slightly slower than in the prior three quarters.

Investor enthusiasm about Apple's longterm services strategy, along with the introduction of new products, has helped Apple to dramatically outperform the broader market. The tech giant's shares have posted a total return of 89.6% over the past 12 months, nearly nine times bigger than the S&P 500's total return of 9.5%. All figures are as of July 22, 2020.

One Year Total Return for S&P 500 and Apple
Source: TradingView.

Apple's shares fell slightly after reporting earnings for Q2 FY 2020 ending in March. But the underlying fundamentals were strong. Apple exceeded analysts' estimates, and also reported growth in both the bottom and top lines during a spreading virus that was the biggest shock to the global economy since the 2007-2008 financial crisis. This helped the stock to quickly resume its upward trend. In that quarter, EPS grew 5.7% on revenue growth of 0.5% amid lockdowns in China, where many of Apple's major suppliers are located, and subsequent closures of many of its consumer stores across the globe. These trends reined in both product supply and consumer demand for many Apple products.

For Q1 FY 2020, announced in late January before the COVID-19 outbreak, Apple reported record revenue of $91.8 billion. EPS grew 19.4% on revenue growth of 8.9%, marking the fastest growth for both the top and bottom line since Q4 FY 2018. That growth was driven largely by sales of Apple's newest iPhone as well as its services and wearables businesses. The company's shares rose higher on the report, but traded mostly sideways over subsequent weeks before the market crashed as fears over the spread of COVID-19 mounted.

Analysts don't expect that growth to continue in Q3 FY 2020. They estimate a 10.1% decline in EPS and a 3.7% decline in revenue. This would mark the largest EPS decline since the fourth quarter of FY 2016, and the first drop in revenue since Q2 FY 2019.

Apple Key Metrics
  Q3 FY 2020 (estimate) Q3 FY 2019 Q3 FY 2018
Earnings Per Share ($) 2.21 2.46 2.58
Revenue ($B) 51.8 53.8 53.3
Services Revenue ($B) 13.2 11.5 10.2

Source: Visible Alpha

As mentioned, a major focus for investors this quarter may be on Apple's services revenue. The company has been pivoting towards services as sales of hardware devices, including the flagship iPhone, have slowed. Apple's services include streaming services such as movie and TV entertainment provider Apple TV+, video game seller Apple Arcade, news services, and digital content stores including the iTunes Store and the App Store, as well as Apple Pay, and AppleCare. It also includes a variety of other services that support Apple's hardware devices. Revenue from Apple's services business tends to be more stable and predictable than its product revenue, and services also have much higher margins. Apple's gross margin for services has been between 61-65% over the past two years, almost double Apple's gross margin for products has ranged between 30-34% over the same period. This means that every dollar of services revenue contributes about twice the gross margin, and thus potentially twice the profit, of other Apple businesses.

Services currently comprise about 17.8% of Apple's total revenue but that share has increased rapidly in the past couple of years. Services revenue comprised just 14.3% of the total in 2017. The major source of the company's strength during the latest reported quarter, Q2 FY 2020, came from service revenue growth, which rose 16.6% to hit an all-time record $13.3 billion despite the pandemic.

Analysts expect services revenue to remain resilient, forecasting growth of 15.4%. This shows that Apple's strategical pivot to services is still working even as global economic demand continues to falter. But there also are warning signs. The estimated growth rate of services in Q3 also would be less than half of its 40% growth rate at its peak in Q2 FY 2018 and it's also the second-slowest growth of any quarter in about four years.