Things Could Get Much Worse for Apple When It Reports Earnings

When Apple (NASDAQ:AAPL) announced on Jan. 2 that its actual results for the first quarter of fiscal 2019 -- the quarter that's supposed to be the company's peak for the entire fiscal year -- would fall materially short of even the low end of its financial guidance, investors received concrete evidence of what all signs have been pointing to. In a nutshell, Apple's current iPhone lineup isn't selling as well as the company had hoped.

Since the bad news for the first quarter is already out, some investors may believe the worst is over. After all, Apple has come clean about how bad the last three months have been, so surely things can't get much worse, right?

Unfortunately, no. While investors already have preliminary results for the first quarter of fiscal 2019, there's another potential landmine that investors need to navigate -- the company's guidance for the second quarter of fiscal 2019. Allow me to explain.

Understanding the expectations game

Apple's performance -- as well as the performance of practically any other publicly traded company -- can fall within a range of outcomes. That's why most companies provide guidance in ranges, not in single values for each relevant metric.

While there's always uncertainty in upcoming results, they tend to fall within these previously issued guidance bands. And if earnings are set to miss management's outlook, companies will often come out and provide updated numbers -- commonly referred to as a "warning."

In these cases, what's generally more interesting is the guidance that a company gives for the subsequent quarter. Many companies -- like Apple -- only issue guidance one quarter out, so analysts and investors alike are left guessing over how the company will perform in quarters beyond the one which falls short.

Have you ever noticed that sometimes a company can "beat" expectations for a quarter but the stock still tumbles because management's outlook falls short of expectations? That happens because investors generally value future earnings more than they do past earnings.

Weak guidance not only lowers investor expectations for the current quarter but it can often cascade. In some cases, both analysts and investors may cut their outlook for a company's financial performance for many quarters -- and potentially even years -- out.

That background leads to the risk that Apple shareholders still face.

How will Apple guide?

As of this writing, analysts currently expect Apple to guide to $59.3 billion in revenue and $2.66 in earnings per share (EPS) for the March quarter, the second quarter of its fiscal 2019. This is down from $61.14 billion and $2.73 per share, respectively, in the same quarter a year ago.

On the EPS front, Apple is likely set to reap the benefit of a substantially lower share count, thanks to its aggressive share-repurchase program. I'd expect Apple's guidance for the March quarter to imply a meaningfully larger year-over-year drop in net income when compared to EPS.

If Apple matches or exceeds those expectations it could lead to an increase in investor enthusiasm and help the stock climb back up. However, if Apple misses even those lowered expectations -- and to be clear, there's a very real risk of that happening -- the stock could drop further from here.

This article originally appeared in the Motley Fool.

Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends 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.