Apple's incredible wearables: AirPods and Watch turn into the next huge hit after the iPhone

Key Points
  • Apple reported stellar numbers in its fiscal first-quarter earnings report Tuesday.
  • The company's wearable devices stood out more than anything, showing strong sales and proof that the company doesn't just need to rely on digital services for growth outside the iPhone.
  • In the near term, wearables show more promise for growth than digital services like Apple TV+, which needs more time to mature.
Apple easily beat the Street on revenue and earnings—Here's what five experts are watching now
Apple easily beats on revenue and earnings—What 5 experts are watching now

Apple reported a knockout quarter Tuesday, showing growth in iPhone sales and improved numbers in China just a year after sales there fell off a cliff.

But the most interesting story at Apple has nothing to do with the iPhone and China. It's all about the massive success of the company's wearables products, which include the Apple Watch and AirPods. Apple may like to focus on its digital services business as its next area of growth, but wearables are turning into the sleeper hit at the company.

And Apple isn't finished either. There were plenty of promising signs in Apple's report that wearable products are poised to have another stellar 2020.

Let's take a look at what we learned about Apple's incredible wearables on Tuesday:

  • Accessories are a bigger business than the Mac. Apple's accessories category, which includes wearables and other gadgets such as the HomePod speaker, generated $10 billion in revenue last quarter. The category is now bigger than the Mac business, which generated $7.1 billion during the same time period. Even though Apple doesn't break down this segment by each individual product, it's clear from Apple CEO Tim Cook's comments Tuesday that the vast majority of accessory sales came from wearable products.
  • Wearables are the size of a Fortune 150 company. That factoid came from Cook on the earnings call Tuesday. He didn't give specific numbers, but the stat implies Apple sold about $20 billion worth of wearable devices in 2019.
  • Supply constraints hint at huge demand. Good luck walking into an Apple store today and finding a pair of AirPods Pro or the Apple Watch Series 3. Cook said Tuesday that Apple doesn't know when it will be able to make enough Series 3 watches or AirPods Pro to meet demand. Last fall, Apple cut the starting price of the Series 3 to $199, and that seems to have driven a surge in sales. And the new AirPods Pro launched last fall to stellar reviews, making it another hot item over the holidays. (Apple does have enough supply of the "regular" AirPods.)
  • Most Apple Watch buyers are first-time owners. Cook said Tuesday that 75% of Apple Watch purchases last quarter went to first-time owners. The Watch has matured enough and gotten cheap enough to attract more first-time buyers.
  • More active Apple devices means more room for wearables to grow. Apple's wearables work best when paired with an iPhone. Cook disclosed Tuesday that Apple now has 1.5 billion active devices in use. He didn't say how many of those devices were iPhones, but it's safe to assume active iPhones are approaching the 1 billion mark. (Apple said a year ago that there were 900 million iPhones in use.) The promising iPhone sales numbers Apple reported Tuesday, driven by the new iPhone 11, is another sign Apple's base of iPhone users can keep growing.

The massive success of wearables signals a shift in the story around Apple.

While the company has been touting its services business over the last few years, its new products in the category — the Apple TV+ streaming service, the Apple News+ subscription news service and the Apple Arcade gaming service — are all too young to have a material impact on the services business. Apple even said last year it doesn't expect a material impact from Apple TV+, and on Tuesday Cook said the company is evaluating Apple TV+ based on the number of subscribers it has, not how much money it generates. Subscriptions are a longer-term play for Apple as it builds out its content offerings. For now, it can build up its subscriber base by offering cheap or free plans, with the hope of converting those customers to paid users in the future.

In fact, Apple's services fell slightly short of Wall Street's expectations Tuesday, reporting $12.7 billion in revenue versus the $13.07 billion consensus estimates, according to Refinitiv. That revenue mostly comes from App Store sales, iCloud storage subscriptions and the hefty fees Google pays Apple to be the default search engine on Apple devices. It's unlikely Apple's newest content subscription products are making a real impact so far.

Meanwhile, Apple's wearables business looks a lot like the iPhone business did when Cook took over as CEO in 2011. Back then, the iPhone had a long runway ahead to grow as Apple cut more deals with carriers to sell the iPhone around the globe. Now that iPhone sales have stabilized and there are at least 900 million in use, there's a massive market for Apple's latest wearable devices.

Apple also has an advantage over the competition. Microsoft, Google, Amazon, Samsung and others have all taken stabs at wearables with middling success. Last year, Google bought Apple's flailing smartwatch rival Fitbit for $2.1 billion in an effort to boost its poor-performing Android Wear platform. Microsoft delayed its AirPods competitor to this year after announcing it last fall. And Google's new wireless earbuds won't launch until later this year either.

AirPods and the Apple Watch have set the standard for wearables that no competitor has been able to crack yet, much like it took iPhone rivals several years to catch up with their own smartphones. Apple keeps showing us that it can leverage its huge base of iPhone users into new wearables customers. And because those products are tied to the iPhone and other Apple gadgets, they help keep customers locked in to the Apple ecosystem.

Apple has found its next act in hardware with wearables. The iPhone is still the most important product at the company, but the Watch and AirPods are poised to usher in a new era of growth.

Apple still has room to grow in its wearables industry: ARK Invest analyst
Apple still has room to grow in its wearables industry: ARK Invest analyst