Apple's "profit structure" is undergoing significant changes, Bank of America: This is a reason to support the stock price
Bank of America believes that the era of Apple relying on the iPhone as its profit pillar is coming to an end, and it is expected that by fiscal year 2025, the contribution of the services business to Apple's annual gross profit will surpass that of the iPhone. The bank stated that compared to cyclical hardware sales, the growth of service revenue is more stable and predictable, reflecting an improvement in the company's earnings quality, and that "lower cyclicality should command a higher valuation multiple."
Apple's core profitability is quietly shifting from hardware sales to service business.
According to a report from Bank of America released on August 15, Apple is undergoing a significant transformation. The report predicts that starting from the fiscal year 2025, the service business will surpass the iPhone to become the company's largest contributor to gross profit.
The report estimates that in the fiscal year 2025, the service business will contribute 42% of Apple's annual gross profit, while the iPhone's contribution will be 41%. This marks the historic first time that the service business surpasses the iPhone.
More importantly, this gap is expected to continue to widen, with the service business's contribution reaching 44% by the fiscal year 2027, while the iPhone will drop to 39%.
Two major driving forces are behind this transformation:
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Higher profit margins: The profitability of the service business far exceeds that of hardware. The report cites data from the third quarter of fiscal year 2025, showing that the gross margin for the service business is as high as 75.6%, while the gross margin for product business is only 34.5%.
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Faster growth rate: Bank of America's model predicts that service revenue will continue to grow at a "low double-digit" (approximately 12%) annual growth rate in the coming years, while iPhone revenue growth is expected to be in the "mid-single digits" (approximately 6%).
Bank of America states that the faster revenue growth, combined with higher gross margins, means that the service business should continue to contribute more significantly to Apple's year-over-year gross profit growth compared to the product business.
Given the higher profit margins and lower cyclicality of the service business, the increase in its profit contribution has earned Apple a higher valuation multiple. Bank of America believes this is the key logic supporting its $250 target price and "buy" rating.
Improved Profit Quality: From Cyclicality to Long-term
Bank of America emphasizes in the report that iPhone sales have a certain degree of "cyclicality," making them susceptible to product release cycles and the macro consumption environment. In contrast, service revenue is viewed as "secular," with growth being more stable and predictable.
As the company's overall gross margin steadily approaches 50% due to business mix optimization (hovering around 40% for more than a decade), a higher proportion of profit coming from stable, high-margin service business means that the company's cash flow and profit elasticity will significantly enhance. As the report states:
A higher proportion of gross profit from more stable and long-term revenue sources (i.e., service business) should warrant a higher valuation multiple.
Bank of America analyst Wamsi Mohan's team thus reiterates its "buy" rating on Apple and maintains a target price of $250
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