A Brilliant Company, Behind on AI

All figures in US dollars. Apple reports in USD with a fiscal year ending late September; the tear sheet shows earnings per share in cents (746 = $7.46).

Apple designs and sells consumer electronics — principally the iPhone, plus the Mac, iPad, and a wearables line (Apple Watch, AirPods) — alongside a fast-growing, very high-margin Services business (the App Store, iCloud, Apple Music, AppleCare, advertising and payments). The hardware creates the installed base; Services monetises it at much higher margins.

The investment case rests on two things: the stickiness of the ecosystem (once you're in, you tend to stay, and you keep buying), and the shift in mix toward Services. The central vulnerability is the reliance on a single product — the iPhone — for roughly half of all revenue.

Apple last year saw a significant upward movement in earnings per share, which grew by 22.7%. But over the last two years it grew only 10.3%, and over three years just 6.9%. Turnover growth has also been lacklustre recently: FY 2025 saw 6.4%, FY 2024 just 2.0%, and FY 2023 actually −2.8%. One reason earnings per share rose in FY 2025 is that the share count fell by around 2.27%, which aided some of that growth.

Six-year financial history ($m unless stated)

They've maintained their very high gross margins — in fact extended them slightly to 46.9% in FY 2025. Despite the weaker earnings per share and turnover growth of recent years, total profitability remains enormous: $132.7 billion of pre-tax profit in FY 2025. The share count has fallen steadily from 16,977 million (FY 2020) to 14,773 million (FY 2025) — a continuous buyback story that flatters earnings per share.

Q2 revenue was up 17% year-on-year to $111.2 billion — a March-quarter record — with diluted earnings per share up 22% to $2.01. This was driven by high demand for the iPhone 17 lineup. This year they also launched the MacBook Neo, a cheaper laptop range powered by chips similar to those used in iPhones — a new push at the lower-price part of the market. Other than that, nothing materially new was reported.

Q2 FY 2026 revenue by segment

Gross margin was 49.3% in the quarter. A new $100 billion buyback was authorised and the dividend was raised 4% to $0.27. Notably, management flagged that memory-cost inflation will increase in coming quarters — a margin headwind to watch.

In the FY 2025 annual report, products were $307 billion of net sales and services $109 billion, for $416 billion total. Product gross margin was 36.8%; services gross margin was 75.4% — very high, as you'd expect services to outpace hardware. By product line, the iPhone is the overwhelming driver:

FY 2025 net sales by category

Pretty much half of all revenue comes from iPhone sales. Such reliance on one product opens them up: the iPhone is the anchor point, and should genuinely better devices from other manufacturers come through — especially with the advance of AI — the company could see weakening in its product range. I don't think that's imminent, but over the next three years Apple really has to keep a very strong grip on the handheld market — and they have been left behind so far by other companies' AI-driven platforms.

By region, of the $416 billion: the US accounts for $151.7 billion, China $64 billion, and the rest of the world $199 billion. A reasonably good mix — unsurprisingly the US dominates, which is the market you'd most want a strong foothold in.

Apple spent $34.55 billion on research and development in FY 2025. They do not publish R&D guidance, but the trajectory is steeply up — Q2 FY 2026 R&D alone was $11.4 billion, up 34% year-on-year and a record, now running at 10.3% of revenue (the highest in at least 30 years). On that run-rate, FY 2026 R&D is tracking toward roughly $44–48 billion. Tim Cook has explicitly tied the surge to generative-AI investment, signalling Apple is finally putting real effort into AI — but this is still far short of competitors.

Balance sheet position

Interestingly, they reduced term debt from $85.7 billion to $78.3 billion and lifted cash from $29.9 billion to $35.9 billion — I'm positive about that. It's a healthy company, and inventories are down to only $5.7 billion, which is remarkably lean for a company this size.

In other news, CEO Tim Cook will step down on 1 September 2026, with John Ternus (currently SVP of Hardware Engineering) taking over and Cook becoming Executive Chairman. It's not too surprising, and it's good that the company is retaining Cook as Executive Chairman — it shows he isn't simply jumping ship. This is the first CEO succession since 2011.

The company faces some big headwinds, and there are unknowns about the next iteration of devices: what will they look like, and how strong will consumer pickup be? It's been a long time since Apple brought out a flagship product that didn't work — you might point to the Vision Pro, but that wasn't really a flagship and wasn't expected to sell much at over $3,000.

There's a possibility of smart wearables on the fringes: if they can produce AI glasses at around $2,000 that are genuinely wearable in public, that could be very successful. Apple has historically managed — with headphones, watches and phones — to hit the mark of being visually acceptable to wear in a way other electronics brands haven't. They have a good chance of making something significant work, though such efforts are likely to impede profitability in the shorter term.

Lacking fuller information on capital expenditure for the coming couple of years, and on plans for AI integration into their handsets (which has not worked well thus far), I've gone down a more conventional valuation route. I am keeping earnings per share growth at 22.5%. The current quarter was very good and the last twelve months have been good — they came off the back of a couple of weak years, but that weakness isn't present in the current figures.

VALUATION SNAPSHOT

The value opportunity is around −34.7% — so I don't think they're worth investigating at this price; they are currently meaningfully overpriced. The 36% risk factor is elevated: while there are major opportunities, there are real risks for the top brand in its area, and they are not currently showing a strong ability to deploy AI just as many AI devices are about to come out.

Apple is still a well-run company generating huge profitability, large revenue and very good margins, with consumers heavily sticky to its operating model. That gives them a significant moat and the capacity to change operations. I don't think they're badly run — even if you might ask whether they're really moving ahead of things — and a well-run operation is likely to get its act together.

• iPhone dependence: Roughly 50% of revenue comes from a single product. Any stumble in the iPhone franchise — competitive, AI-driven, or cyclical — hits the whole company hard.
• Behind on AI: Apple's on-device AI has not worked well so far, and it is well behind competitors just as a wave of AI-driven devices arrives. The R&D surge is catch-up spending, not leadership.
• Valuation and momentum: The shares are up ~55% on the year and trade at ~42x earnings — roughly 35% above my valuation. Buying after such a run, well above fair value, is a poor entry point.
• Memory-cost inflation: Management has flagged rising memory costs in coming quarters — a direct margin headwind.
• Leadership transition: The first CEO succession since 2011. Retaining Cook as Executive Chairman is reassuring, but a transition always carries execution risk.
• Growth-from-buybacks: A meaningful slice of earnings-per-share growth comes from share-count reduction rather than operating growth — which can't continue indefinitely.

• A meaningful share-price pullback: After a ~55% run, a substantial pullback toward my $203 valuation would create a far better entry point.
• A credible AI offering: Evidence that Apple's generative-AI investment is translating into genuinely useful, differentiated on-device features would reduce the key strategic risk.
• A successful new device category: Wearable AI glasses at a viable price, or another category hit, would diversify away from iPhone dependence.
• Services acceleration: Faster growth in the very high-margin Services business would improve the mix and justify a higher valuation.
• Smooth leadership handover: A confident, continuity-focused transition to John Ternus would reassure on execution.