4 Questions Apple Must Answer

• Apple Inc. AAPL shares have been volatile in 2015, and are down 4 percent since November 10.
• FBR & Co’s Daniel H. Ives maintained an Outperform rating on the company, with a price target of $175.
• Ives addressed the potential of Apple Watch, Apple’s size, continued success of the iPhone and the company’s capital allocation plan. 

Apple’s strength has been defined by its devices, particularly the iPhone. This highlights the benefits of the company’s tightly integrated software ecosystem.

Analyst Daniel Ives expects Apple to benefit from “(1) increased services business focus, (2) ramping penetration of the Chinese mobile market, (3) the 6s upgrade cycle, and (4) upside from new device categories (wearables, augmented reality, streaming, enterprise market).”

Ives mentioned the four areas of debate for Apple:

1. Can Apple Watch succeed as a new device product category for the company?

Given the Apple brand and its unmatched consumer base, “we think the wearables category potentially has a “silver bullet” product that can start to move consumers toward this new avenue of technology growth and drive adoption of the Apple Watch,” the analyst wrote.

He added that it could also provide Apple another opportunity to become a leader in catering to enterprises looking to create applications, services, and solutions around the wearables market.

1. At its size, can Apple continue to deliver solid execution/growth?

Tim Cook has been able to double Apple’s revenue and EPS since he took over as CEO. Ives expressed optimism regarding Apple continuing to generate healthy growth over the coming years. The company is well positioned in several key areas, such as China, wearables, streaming music, and Apple Pay.

Apple’s iPhone segment is massive, contributing to about 55 percent of total revenue. This segment is vulnerable to “fickle consumer preferences.” The analyst pointed out, however, that Apple’s core advantage lies in its “tightly integrated software ecosystem and services segment” and this could boost gross margins and profitability over the next 12 to 18 months.

1. Can the company continue to garner success with its all-important iPhone product cycles?

“We are confident that Apple can continue to generate solid demand for its all-important iPhone product line given the benefits of its tightly integrated ecosystem of devices, leading innovation, and strong secular growth trends (mobile/BYOD),” the FBR report stated.

Although it has been eight years since the first iPhone was launched, iterative updates to the hardware and software “continue to drive strong demand in developed markets, with new/potential features (e.g., Apple Pay, Force Touch, etc.) and developing markets (China) in the very early innings of another major growth opportunity,” Ives added.

1. What is in store for investors around Apple s capital allocation plans?

Apple has raised its capital return program from $130 billion to $200 billion through March 2017, with a dividend hike and increased share repurchase authorization. Till now, Apple has raised its quarterly dividend 11 percent to $0.52, and share buyback plan from $90 billion to $140 billion.

Ives mentioned that company is expected to generate more than $60 billion in FCF in FY16, and more dividend hikes and share buybacks could be expected in the next 12 to 24 months.