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Apple’s job just got a lot harder

Apple Introduces iPhone 5Apple Introduces iPhone 5
(L-R) Apple CEO Tim Cook, Apple senior vice president of Industrial Design Jonathan Ive and Dave Grohl of the Foo Fighters look on as an attendee looks at the new iPhone 5 during an Apple special event at the Yerba Buena Center for the Arts on September 12, 2012 in San Francisco, California. Photograph by Justin Sullivan — Getty Images

Does the sharp drop in Apple stock make the iPhone maker a screaming buy? That’s what Wall Street analysts and market strategists are mainly claiming after its shares tumbled around 5% by mid-morning on Wednesday, erasing $38 billion in market value. Apple’s fans ardently believe that the tech colossus will keep making magic for years to come. Hence, these episodic sell-offs amount to nothing more than buying opportunities. And so far, they’ve been right.

This time, it was slightly disappointing sales of the new iPhone, and a forecast of fiscal 2015 revenues that fell below consensus estimates, that riled investors. Still, Apple bulls cited plenty of good numbers to bolster their case, including $10.7 billion in earnings for the June quarter, a 38% jump from over the comparable three months in 2014.

To be sure, nothing about this quarter indicates that Apple’s sorcerous performance is waning. Here’s the concern for long-term investors: Starting with earnings at extremely high levels — both versus its own history and compared to any company its size — Apple (AAPL) must deliver constantly rising profits far into the future. That will require both a continuation of strong revenue growth and gigantic operating margins. This isn’t impossible. But a close, sober look at the numbers shows just how far Apple must climb, from already lofty heights, to deliver good, but hardly spectacular, Apple-worthy, gains.

Let’s assume that investors want 10% yearly returns on their Apple shares — let’s face it, Apple is a relatively risky investment, as shown by today’s action. So how high must earnings rise over the next six years to deliver that 10%? On Tuesday, the day before the selloff, Apple boasted a market cap of $753 billion. That was 14.8 times its trailing 12 months of profits of $50.8 billion. A PE ratio of around 15 may sound cheap, but it still requires significant profit increases to deliver our 10% target.

The necessary numbers flow from two sources: cash returned to investors via dividends and buybacks, and capital gains. We’ll assume for now that Apple’s PE ratio remains constant, since once again, its multiple already foresees good profit growth from already staggering levels. In the past 12 months, Apple paid $11 billion in dividends. Its buybacks, less the value of shares issued to employees, are running at $26 billion a year. That’s a total of $37 billion. So on that $753 billion market cap, it’s been yielding, measured by cash returned to investors, around 5% annually.

To get to our 10% target, the share price must rise 5% a year. At a constant multiple, profits must wax at the same 5% to lift the stock by a like percentage. So by 2021, Apple would need to post net profits of $68 billion. That’s twice what the second biggest earner in the Fortune 500 (Apple was first), Exxon Mobil (XOM), made in 2014. Its three times the profits of numbers three and four, Wells Fargo (WFC) and Microsoft (MSFT). Profits approaching $70 billion would propel Apple to a $1 trillion dollar valuation, likely making it first on the planet to reach that milestone.

Of course, the 5% drop early Wednesday lowered the bar a bit. Apple would need to raise earnings a little over 4.8%, instead of 5%, to deliver 10% annual returns. But by 2021, Apple would still fall short without reaching $950 billion in market value, and posting annual profit increases of $3.4 billion a year, and rising, pretty much forever.

Apple enthusiasts will doubtless say that 5% profit growth will be a breeze. But just look at the size of these numbers. It will require bigger and bigger groundbreaking, wildly popular blockbusters to grow into them. Only an Apple could do it — if indeed it’s really doable.