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Here's My Top Stock to Buy in 2018

Daniel Sparks, The Motley Fool

I've already laid out my top three stocks for 2018 and beyond. But what if I had to narrow these picks down to the single stock I have the most confidence in as a long-term investment to buy this year? Though it's not an easy decision, I'd have to go with none other than the world's largest publicly traded company: Apple (NASDAQ: AAPL)

"But wait!" you say. "Isn't Apple stock already up nearly 50% in the past 12 months? Haven't investors who missed this opportunity already lucked out?"

The reasoning in this question may seem sound at first. After all, how does a company with $229 billion in annual revenue and $48 billion in annual net income keep growing? But a close look at Apple stock reveals there is likely to be more meaningful upside ahead.

Let me show you why Apple stock is my top pick for 2018.

2018

I'm betting on Apple stock in 2018. Image source: Getty Images.

Expectations are low

One of the main characteristics that draws me to Apple stock is its conservative valuation. With its price-to-earnings ratio of 19, investors aren't pricing in any spectacular growth over the long haul. For some context, the average price-to-earnings ratio of stocks in the S&P 500 is 22, well ahead of Apple's P/E ratio.

Or here's another way to look at how conservative Apple's valuation is. Its P/E pales in comparison with tech peers Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) and Microsoft (NASDAQ: MSFT) even though analysts expect similar earnings-per-share growth from all three companies.

Company

P/E

Consensus Estimate for Five-Year Annual Compound EPS Growth

Apple

19

10.7%

Alphabet

37

11.5%

Microsoft

31

11.6%

Data source: Yahoo! Finance. 

While analyst estimates should certainly be taken with a grain of salt, the discrepancy between Apple's P/E ratio and analyst expectations for earnings growth is certainly notable.

Apple has pricing power

Then there's Apple's impressive pricing power -- a competitive advantage that has endured for decades. But what's particularly remarkable about this facet of Apple's business is that it seems to have been getting stronger in recent years.

Consider iPhone pricing. It has steadily risen from a starting price of $649 for the flagship version of the smartphone just over four years ago to $999 today. And despite Apple's higher iPhone prices, iPhone sales have increased sharply during this period, rising from about 150 million units annually when the iPhone 5s was launched in 2013 to about 217 million annually today.

Apple confirmed its pricing power with customers recently when Apple CEO Tim Cook said that initial orders for the iPhone X -- its most expensive iPhone yet -- were "very strong."

Apple is seeing growth beyond the iPhone

Apple's two fastest-growing segments -- other products and services -- currently look like great growth opportunities.

Services revenue, which includes sales from digital content and services, Apple Care, Apple Pay, licensing, and other services, climbed 23% year over year in Apple's fiscal 2017.

Apple's "other product" sales, or sales of Apple TV, Apple Watch, AirPods, Beats products, iPod Touch, and other accessories, grew 16% year over year. The segment notably saw a nice boost from its wearables products -- Apple Watch and AirPods. Wearables revenue was up over 50% year over year in the last three consecutive quarters and was up 75% year over year in Apple's most recently reported quarter.

iPhone X, Apple Watch, and AirPods charging wirelessly

Image source: Apple.

Not only do these segments' strong growth show how Apple can grow its business beyond iPhone, but they also highlight Apple's continued ability to successfully extend its pricing power to new categories. Apple's AirPods and Apple Watch are both priced lucratively compared with similar products in the wearables segment.

Apple is a good steward

Another reason I'm betting on Apple stock is its prudent capital allocation. For example, it's disciplined with its acquisitions, always trying to avoid overpaying for a company. And its research and development spending is less than that of tech peers Alphabet and Microsoft, even though Apple's $48 billion of annual net income more than doubles both companies' bottom lines.

AAPL Research and Development Expense (TTM) Chart

AAPL Research and Development Expense (TTM) data by YCharts

In addition, Apple has managed to pay out a regular, growing dividend while spending $173 billion repurchasing its own shares since initiating a capital-return program in 2012. Better yet, Apple has proved its adeptness at buying back shares opportunistically, spending more when the stock is lower.

The risks

There are risks to owning Apple stock, of course. Chief among them is the possibility that Apple's iPhone sales slow amid heightened competition. After all, Apple's iPhone business accounts for 62% of the tech giant's trailing-12-month revenue. With its business so dependent on one product, headwinds for iPhone would translate to serious problems for Apple stock.

Another possible risk is that Apple's pricing power erodes as peers such as Alphabet, Microsoft, and Amazon.com ramp up their hardware efforts and level the playing field with existing and new product categories.

Last, it's possible that some of Apple's upcoming catalysts, including services and wearables, don't play out as nicely as investors hope.

Apple CEO Tim Cook greets a customer at an Apple Store on the iPhone X launch day

Image source: Apple.

But I'd argue that Apple's conservative valuation appropriately prices in this risk. It's not very often investors can buy a company with such a great track record and strong pricing power at a good price. Apple stock is one of my biggest holdings going into 2018 -- and I'm happy it is.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Daniel Sparks owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.