Apple (AAPL -0.48%) stock has been a big winner since the start of the pandemic, soaring in value as the company's market capitalization surpassed $3 trillion. The party may finally come to an end this year, though, as a combination of stagnating iPhone sales, the potential collapse of a $20 billion annual revenue stream, and a lofty valuation come together to put pressure on the stock. While anything could happen in the stock market, it will be tough for Apple stock to keep its rally going throughout 2025.
iPhone stagnation
As much as Apple tries to convince consumers that each year's iPhone models are worth the upgrade, that's increasingly not the case. In the early days of the smartphone industry, smartphones improved drastically each year. As the industry has matured, it's getting hard to tell the difference between this year's flagship smartphones and last year's flagship smartphones.
Apple's big thing last year was Apple Intelligence, the company's suite of AI-powered tools for the iPhone and its other devices. So far, Apple's AI push has been a swing and a miss. One survey found that 73% of iPhone users said the AI features add little or no value. Apple Intelligence will likely improve over time, but for now, it's not helping the company sell more iPhones.
Total iPhone revenue in the twelve months that ended Sept. 28 was roughly unchanged from the previous 12-month period, and iPhone sales reportedly declined by 5% during the holiday quarter. It's not clear how Apple can reverse these trends, and with the iPhone accounting for more than half of the company's total revenue, any sales decline is going to be tough to offset with other products.
A $20 billion problem
Apple currently receives in excess to $20 billion annually from Alphabet in a deal that makes Google the default search engine on the Safari web browser. These payments show up in Apple's services segment, and they're essentially pure profit.
There's a real chance that this gravy train will come to an end as Google readies for an antitrust trial over online search set for April. Apple has asked to participate in the trial to defend its own interests as Google faces the prospect of being forced to divest major assets. That $20 billion annual payment to Apple could end up on the chopping block if it's viewed as anticompetitive.
If you assume this payment is pure profit, it represents around one-sixth of Apple's annual operating income. Losing it would be a significant blow to the bottom line.
Valuation and interest rates
Despite stagnating iPhone sales and uncertainty around the Google payments, Apple stock trades for about 38 times trailing-twelve-month earnings. The last time Apple was this expensive was during the early days of the pandemic when booming demand for PCs, smartphones, and other gadgets lifted sales.
One important thing to consider is interest rates. The stock market doesn't exist in a vacuum, and valuations that investors are willing to pay are ultimately a function of the alternatives available. Since the Federal Reserve began cutting rates, the yield on the 10-year U.S. Treasury has been soaring, and it's now closing in on 5%.
Why are rising bond yields potentially bad for stocks with lofty valuations? The 10-year Treasury is often considered the risk-free rate. The higher the risk-free rate is, the higher the return other assets must offer to compensate. For a stock like Apple, where revenue growth is sluggish and profits may come under pressure this year, a price-to-earnings ratio of nearly 40 becomes much more difficult to justify as the risk-free rate rises.
Shares of Apple have tripled in the past five years despite revenue growing at a far slower rate. With the valuation at elevated levels, a correction could be in the cards for the tech stock this year.
