Investors focused on Apple's disappointing iPhone sales are missing the company's hidden goldmine (AAPL)

Tim Cook

Apple's stock has fallen sharply this month.
Investors have been spooked by the company's decision to discontinue reporting the number of iPhones it sells — and by indications of weak sales of the latest phones.
Investors are right to be upset about Apple's decision and concerned about iPhone sales, Wedbush analyst Daniel Ives said in a new report in which he cut his price target for Apple.
But shareholders who get too caught up in the iPhone news are missing a big reason to be bullish about Apple's stock, he said.

Daniel Ives wants you to know that he's still bullish on Apple.

But even his outlook on the iPhone maker isn't as rosy today as it was just a few weeks ago.

In a research note on Wednesday, Ives, a financial analyst for Wedbush and a longtime bull on Apple's stock, slashed his price target on the company's shares from $310 to $275 and cut his earnings estimates for its current quarter and fiscal year. The updates reflect reports that sales of the company's iPhones have been lower than anticipated and his expectation that they may not get better anytime soon.

Still, he's sticking by the company, maintaining his "outperform" rating on its shares and trying to reassure shareholders made nervous by the recent plunge in Apple's shares.

"The key question we keep getting from investors is, do you stay bullish on the name or just throw in the towel on the stock till the dust clears?" Ives said in the note. "It's a good and valid question."

In his opinion, the selloff has only made Apple more attractive.

"Apple still remains of our favorite tech names heading into 2019 despite the horror show over the last month seen out of Cupertino," he said.

Apple's stock has been plunging since its earnings report

The tech giant has been reeling since it announced its latest earnings report at the beginning of this month. Although the company's sales and profit results topped Wall Street's expectations, it sold fewer iPhones than expected and projected that its holiday results may come in below analysts' forecasts. Worse, it announced it would no longer report the number of iPhones it sells each quarter, stoking fears that it was trying to hide an expected sales decline. Those fears have been amplified since with reports that indicate weak demand for the company's latest phones.

Wedbush financial analyst Daniel Ives, who covers Apple On top of all that, President Trump indicated this week that Apple may be hit with a tariff on the iPhone and its other products that are manufactured in China.

Since November 1, when it reported earnings, Apple's stock has fallen 18%. Thanks to that drop, the company's market capitalization has fallen well below the $1 trillion mark it topped in August and even briefly fell below that of Microsoft.

Read this: Microsoft's surprising comeback over Apple is the outcome of two new CEOs with radically different game plans

All the bad news out of and surrounding the company has been a "perfect storm" that has bolstered the pessimistic — or bear — case on Apple's stock, Ives said. Those bears have argued that Apple is a maturing company and, as such, should trade at a lower multiple to its earnings than it has in the past when it was growing rapidly.

"Many of those bears have come out of their caves after hibernation, arguing the iPhone upgrade cycle will continue to decelerate and multiple compression is on the horizon," Ives said.

iPhone sales have been a "disappointment"

Apple bears some of the blame for the selloff, he said. Sales of the latest iPhones have been a "clear disappointment," and the company needs to rethink its pricing strategy and the design of its upcoming phones, he said. What's more, it bungled the way it communicated its decision to stop providing unit sales of the iPhone, he said.

"It is extremely frustrating and perplexing the way Apple communicated the 'metrics move,'" Ives said.

Even so, those who are focusing on the bearish case are missing some important trends, he said. While Apple's move to hike prices on the iPhone may have depressed sales, the decision has meant that its revenues have held up and likely will continue to do so.

While the company's decision to stop reporting iPhone unit sales was disappointing, the company had a legitimate reason for doing so, Ives said. Apple is no longer just a hardware company. Its services business — which includes both its AppleCare warranty and subscription offerings such as Apple Music and iCloud storage — is now its second biggest segment and one of its fastest growing. The company's revenues aren't just determined by how many iPhones it sells, but also how many additional services for which it convinces customers to sign up.

Apple's "underlying goal [in discontinuing reporting the unit-sales numbers] is to get the Street to start valuing the entire business as an overall services business with hardware/iPhone purchase the first step," Ives said.

Apple is becoming a services company

The services business has huge potential, Ives said, and it's ultimately what keeps him bullish on Apple. That business posted more than $37 billion in sales in the company's last fiscal year, which ended in September. It should easily hit $50 billion in annual sales by 2020, Ives said.

Even better for Apple and its investors, that segment's gross margins — which represent the difference between what a company charges consumers for its products and services and its direct costs of making and providing those products and services — are about double that for its hardware sales. So, if Apple continues to see more of its revenue coming from services rather than from selling phones and computers, it should start posting even healthier profits.

Apple's services revenue grew 24% last year, and Ives expects it to continue to grow by at least 20% a year for the foreseeable future. Because of that growth and the revenue it's already posting, he thinks the services business alone is worth $400 billion to $450 billion. By way of comparison, Apple's overall market capitalization at the close of trading on Wednesday stood at $859 billion.

"The services business represents the linchpin of Apple's future," Ives said. He continued: "Now it's about Cook and [Apple] navigating through this white-knuckle period and proving that Apple's ability to monetize its billion [-plus] devices sold to date and unparalleled installed base is still on the horizon and not in the rear view mirror."