Last weekend both the New York Times and Wall Street Journal reported that Apple (NASDAQ: AAPL) was testing some kind of “smart watch.” The reports even suggest that Apple is already in talks with its longtime manufacturing partner, Foxconn, regarding production of such a device.
While rumors of an Apple watch have circulated for years, these appear to be the first credible reports that the new device will be brought to market.
Knowing Apple, the watch won’t be cheap.
It could work as a standalone device for consumers who don’t own other Apple products. But you can bet that it will be best when used alongside other Apple products, adding yet another device to the Apple ecosystem.
The Economics of the iWatch
So what might an Apple iWatch cost? I’m estimating around $300. That amount is less than the price of an iPad Mini ($379), but more than the price of its iPod Touch ($199).
At $300 per watch and with Apple’s current average net margins of 24%, the company could make $114 per unit sold.
Estimating the number of watches that Apple could sell is tricky. An optimistic estimate can be reached by using the number of iPads sold in each quarter. Since the iPad was introduced in 2010, we only have nine quarters of sales data for the iPad. A conservative estimate can be reached by using the number of iPhones sold in its first nine quarters, as the iPhone got off to a much slower start than the iPad.
The table below shows the number of iPads and iPhones sold in the first nine quarters that the products were sold. Using these unit sales numbers and applying them to the potential iWatch, I’ve estimated the possible total profit impact.
Based on these assumptions, an iWatch could contribute $80 – $237 million in profit in its first quarter that it is sold. Since Apple earned $13.1 billion last quarter, an iWatch would only add less than 1.5% to Apple’s quarterly profit.
However, when looking at the 9th quarter that the iWatch is sold, the product could contribute between $530 million and $1.2 billion in profit. This is between 4.5% and 10% of Apple’s most recent quarterly profit.
Based on these estimates, an iWatch could significantly impact Apple’s earnings and, as a result, drive its stock higher. However, I would argue that an iWatch’s greatest impact on Apple’s stock would be much more psychological.
Since Apple co-founder Steve Jobs’ passing, Apple has yet to release a “new” product. Apple has of course released the iPhone 5 and iPad mini, but these products are mere upgrades to existing products.
Releasing a new product would signal to the investment community that Apple can, in fact, still innovate and grow into new markets. Given that Apple stock has fallen roughly 30% from its all-time high, it would seem as if the market discounts Apple’s ability to innovate with new products.
Additionally, Apple’s stock tends to benefit greatly from rumors of new products. Since no “new” products have been released since the iPad’s launch in 2010, there have been few rumors to trigger speculation from investors and traders that hope for another blockbuster product.
Regardless of whether or not this kind of rumor-based stock speculation is based on a sound, long-term investment thesis, it has the potential to fuel a return to the previous levels above $700 per share.
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