Apple the Most Valuable Company in the World? Bet on It.

Apple (Nasdaq: AAPL  ) will become the most valuable company in the world. Bet on it. In fact, go out and sell all your personal belongings, liquidate your 401(k), and buy Apple stock with every last dollar you own.

OK … on second thought, I wouldn't advise that -- it's a bit rash. But there are ample reasons to believe that the company's rise is just starting and that Apple will continue blowing past expectations.

Big Oil, meet Big Phone
You've heard the standard "bullish" reasons before: Apple has $45 billion in cash and trades at only 12 times forward earnings when netting out cash.

Yet investors are rightfully nervous about the stock. It went from the brink of irrelevance to the top of the tech world in less than a decade. It built its $236 billion market cap by selling to consumers, a notoriously fickle crowd. Investors have been burned in this area before; they watched Motorola (NYSE: MOT  ) rise to prominence only to be cut down to size as its designs lost favor. People are afraid to hear that "it's different this time." For many, avoiding Apple is the safer play.

This changes everything … again
Well, it truly is different this time. I'll give you four reasons that the iPhone, and smartphones in general, are a whole new ballgame.

1. Software is the new kingmaker
Apple went into one of the most hypercompetitive markets in the world and created a product that was technologically years ahead of all its competitors. It entered a market that everyone knew would have vast potential -- hence the reason telecoms such as Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) built out massive data networks to support smartphones -- and Apple still managed to destroy a powerful group of competitors.

How? By virtue of a sea change within the mobile industry. The only difference between older "feature phones" -- you know, like that old flip phone sitting in your closet -- was hardware. The mobile companies loaded their own software onto the phones and pretty much controlled the software experience.

In spite of the iPhone's phenomenal hardware designs, software created the difference and the lasting competitive advantage. The user experience, the apps, and the iTunes integration were the factors that created Apple's long-term success. Other handset makers can easily replicate the touchscreens and the slim design, but the App Store, the clean operating system, and the iTunes integration? Well, everyone else is still catching up on those fronts.

2. iOS scales
Apple's mobile operating system, known as iOS, is optimized for a mobile experience. However, it scales extremely well for other high-growth markets and creates both a uniform experience and an app market for users. Although many were hesitant about the iPad's potential (me included), Apple is now reportedly cranking out 2 million of the iOS-based tablets a month to meet demand. Furthermore, even though the current Apple TV is underwhelming, it manages to keep Apple involved in the battle for the lucrative home-entertainment market, and future models of Apple TV could easily incorporate iOS to provide better media, gaming, and other apps right into consumers' televisions. The point is that even though iOS started on smartphones, it's now a dominant platform on tablets, and it could make further inroads into the home.

3. Consumer behavior on its side
Smartphones are growing by leaps and bounds, but few take the time to examine the dynamics. How many people would pay the full, non-subsidized $600 average selling price Apple receives from AT&T and other carriers? Obviously, the number of users would be far lower. Smartphones take advantage of consumer behavioral traits; as consumers, we're far more willing to pay a low upfront cost if future payments are obscured. In many markets (the U.S. included), carriers subsidize the cost of smartphones, and doing so artificially boosts sales figures.

Not only that, but smartphones also encourage people to do things like collect a series of apps that work on only one system. And since people like keeping what they've already collected, most who have a proprietary system will stick with the same proprietary system for their next upgrade. Thus, 89% of iPhone users want their next phone to be another iPhone. That figure falls to a mere 42% for users of Research In Motion's (Nasdaq: RIMM  ) smartphones.

4. Underrated smartphone growth
While consumer-electronics sales are expected to be flat this year, smartphone sales are expected to boom. Last quarter, the smartphone market grew by nearly 50% over the previous year. Researcher Gartner believes that over the next four years, smartphones will see 28% annual revenue growth.

Smartphones clearly present an enormous opportunity, yet there's plenty of evidence that the opportunity is actually underrated. Companies that can profit immensely from the spread of smartphones -- Cirrus Logic, Marvell, and even Qualcomm (Nasdaq: QCOM  ) , to name three -- still trade at pretty low valuations for a field with such tremendous growth rates.

What's more, Apple has growth opportunities in mature markets where it already succeeds. The company sells through just one carrier in such major markets as the United States, Japan, and Germany, but it's expected to pursue a multi-carrier strategy in the coming years. That strategy should assure that Apple secures an even larger slice of the pie in growing markets.

Some figures to toss around
In the following table, I've created a set of iPhone growth assumptions, all of which point to a company with significant upside. In the past 12 months, Apple has generated nearly $21 billion in revenue from iPhone sales and products related to the iPhone. If the company can merely match anticipated industry growth rates, its iPhone line should generate more than $56 billion in revenue by 2014. In the past 12 months, Apple's revenue as an entire company was $57 billion.

So let's make some assumptions about the future profitability of the iPhone. Gross margins are estimated using industry estimates, and I'll shrink them in part to reflect a declining average selling price. Operating costs and the effective tax rate come from companywide figures.

Metric

Today

2014

iPhone Gross Margins

Estimates vary between 55% and 65%

50%

Apple R&D and SG&A

11.7% of sales

15% of sales

Apple Effective Tax Rate

27.2%

35%

Source: Capital IQ, a division of Standard & Poor's, and company filings. Gross-margin estimates from researcher iSuppli and industry analysts. R&D=research and development. SG&A=selling, general, and administrative expenses.

If Apple matches industry growth rates, the iPhone alone would produce $23.8 billion in pre-tax profit by 2014. On a post-tax basis, that's still more than $15 billion in profits.

However, that's still not all! The phone also drives a "virtuous cycle" for Apple. As more users buy iPhones, they upgrade to Apple's other products. Even though Apple controls up to 90% of the market for computers costing more than $1,000, the company keeps growing Mac sales at industry-thumping rates. What does that mean? It means Apple is creating a new class of users willing to spend more on its computers. The more iPhones it sells, the more crossover sales it gets to other products. For investors, the ka-ching of cash registers at Apple Stores is music to their ears.

Bottom line
Apple is the king today, and I don't see it being displaced. During the next two or three years, I have little doubt that it will keep soaring. However, in the longer term, there are still some concerns.

For instance, it's almost impossible to do an Apple write-up without mentioning Google (Nasdaq: GOOG  ) . If we see a reduction in the relevance and use of apps over the next few years, Apple could get burned while Google's model of free distribution continues growing like wildfire.

In addition, as smartphones gain increasing penetration rates in developed countries, much of the continued growth will come from emerging markets. Even if the smartphone market grows at the stunning 28% rate I mentioned earlier, Apple might not be able to keep pace as consumers reach for lower-end offerings. The natural beneficiary? Again, Google. Since Android can scale down to extremely inexpensive phones, it should do well in emerging markets.

But hey, every investment has its risks. Apple may not be the king forever, but the next few years should just keep getting better for Jobs & Company.

Eric Bleeker owns shares of no companies listed above. Apple is a Motley Fool Stock Advisor pick. Google is a recommendation of Motley Fool Inside Value and Motley Fool Rule Breakers. The Fool owns shares of Google and Qualcomm. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (54)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 12, 2010, at 3:24 PM, MurphyMacdotCom wrote:

    @millerfallsman

    Wow - hard to argue with all your numbers and facts. I should sell on Monday.

  • Report this Comment On September 12, 2010, at 3:59 PM, alexkhan2000 wrote:

    @MillerFallsMan

    You don't get it and you never will. Sore that you didn't buy Apple stock 10 years ago or 5 years ago or only 2 years ago? Apple (and AAPL) still has long, long ways to go.

  • Report this Comment On September 12, 2010, at 8:15 PM, ConstableOdo wrote:

    I thought the iHaters said that Apple's current worth is a false value and that Microsoft is still the most valuable tech company in the world. Apple share price is supposed to drop to about $100 a share in the next couple of months as soon as Windows Phone 7 is introduced.

    Microsoft is just catching its second wind and Microsoft Windows OEM licenses will be selling by the tens of millions as soon as the Microsoft's special project, the Bill Gates Tenth Anniversary Windows Slate launches. You see, Microsoft was just resting and is now putting on some new track shoes to overtake the field and pass them.

    By early next year, Microsoft stock should soar to about $30 and will again be the richest and most powerful tech company on the planet.

  • Report this Comment On September 12, 2010, at 9:21 PM, ranchrfl wrote:

    ConstableOdo, I hope your comment is tongue-in-cheek.

    Back in July 2004, I sold half my AAPL at $30 and bought Microsoft at roughly the same price. When AAPL went to $34 and MSFT was still $30 I sold softee and bought back the AAPL. Since then it split and is now $264 and Softee is still hovering around $30. Said differently, the shares I bought at $34 are now $528 and softee is still $30 ummmm I'll take the share price gain over the dividends any day!!!

  • Report this Comment On September 12, 2010, at 10:31 PM, demodave wrote:

    I'm with Ranchrfl. I sold some Apple stock just after the split in order to be "responsible" and to not "overweight" and to "diversify". I put that money in J&J. It seemed like that was where the market should go, what with all the Boomers out there.

    Do the math. I f*cked up. But that's life in the rear-view mirror.

    MillerFalls, you may read poor analysis by other commentators correctly as being poor analysis, but Apple isn't going down from here unless the economy totally craters. The stock is *not* overpriced. That's the most clear indication of the failure of *your* analysis.

  • Report this Comment On September 13, 2010, at 3:00 AM, PapayaChunks wrote:

    Everybody knows the stock price but only few understand how much it worth and the other investors do not even care. If you are one of the intelligent investor, consider these valuation models in your next purchase.

    Discounted Cash Flow is probably the most common model that you ever heard when it comes to stock valuation. However, I found it a bit tough to do it. Simply because the discounted cash flow model have to consider revenue growth and the escalated cost at the same time, which can be too difficult to estimate and forecast as an outside investor.

    Nevertheless, you can use this method in valuing stock by projecting future cash flow; from the sales and costs, and discount back to current value with Weighted Average Cost of Capital (WACC).

    Dividend Discount Model is best for income investors. The idea is to project future dividend distribution based on the average historical dividend payout ratio and discount it back to present value. Although this is the simplest among all, it works best for high dividend yield stocks.

    Nonetheless, the stocks must have very strong business performances that can guarantee the dividend payments 10 years down the road. And normally, penny stocks cannot be evaluated this way.

    Earnings Growth Model is my favourite method as it is very practical and easy to do. Initially, I project its future earnings using constant or variable growth rate. Either constant or variable growth rate is depends on the expectation of its business performance within that period. Often than not, I normally use the historical business performance as a baseline provided its fundamental value remain intact. Then, I discount the future earnings with the expected return on investment (ROI).

    ----------------------------------

    Money without intelligence is like a car without a road.

    http://www.intelligentinvestingtips.com

  • Report this Comment On September 13, 2010, at 3:28 AM, xmmj wrote:

    "they watched Motorola (NYSE: MOT) rise to prominence only to be cut down to size as its designs lost favor."

    What you miss in your analysis is something very important. Motorola is a fine company with good engineers. You are right to say "... as its designs lost favor." They are a tech company that had a run with some good designs. Still, all those designs were evolutionary, never any truly revolutionary ones.

    Apple, however, is different. It has a track record of revolutionary designs that make major leaps in the user experience: the original Mac OS, iPod, iPhone and now iPad. The reason is that Apple has **vision** they see how to satisfy a "need" before users are even aware of it.

    While this is due to the leadership of Steve Jobs, it is not completely bound up in him alone. Jobs has built a culture of creativity and excellence at Apple and this drives them at every level (Not that I do not have my issues with them!) This is why they will continue to thrive and grow - because they continue to surprise us.

    IMHO

  • Report this Comment On September 13, 2010, at 11:01 AM, stustanton wrote:

    I hear a lot of people repeating arguments that say nothing more, in essence, than that stocks are a risk and volatile, and then something about good or bad about their favorite stock, Apple or Not-Apple. That's good cheering, but not much help. Of course stocks ARE risky - that's why we're doing them - risky means that they flop around in value and we hope to make money. The questions worth pondering are systemic, internal, and fundamental, and not helped much by mere cheering. There seems to be an systemic "essence" of why Apple can or can't continue to thrive, like: (1) why or why not Apple can continue to sell innovation at a rate that outpaces fade in its current products, at a rate at or above what it has been able to do so far, (2) how, why and if, Apple can continue to thrive in the economy in spite of evolving economic threats, and (3) if, how and when any company or technology can catch, block or cancel Apple's advantaged position?

  • Report this Comment On September 13, 2010, at 3:19 PM, disposableident wrote:

    @ stustanton, the above analysis isn't a deep dive through all of the challenges and opportunities facing Apple in the coming years (lots of people have done that elsewhere).

    What it does provide is a succinct reason why, with widely accepted market growth rates alone, Apple is set to grow substantially.

  • Report this Comment On September 13, 2010, at 3:28 PM, Aeoran wrote:

    I'm not sure that AAPL will be able to keep iPhone margins from dropping less than 5-15% by 2014, as the article suggests.

    If 89% of iPhone users will buy an iPhone anyway, why should AT&T bother subsidizing the sale of each new iPhone to the tune of $400-$500 each, as they currently do?

  • Report this Comment On September 13, 2010, at 3:41 PM, Aeoran wrote:

    @disposableident: as an investor, I have found that it pays very well to take anything "widely-accepted" with a extra few grains of salt.

    And I see that @InfoThatHelp has outdone himself again in a rush to predict ever-lower prices for RIMM shares. All I can say is that all of the real investors and "people in the know" that I know, would never call attention to themselves like that - and that everyone I know that does, get burned much more often than not.

  • Report this Comment On September 13, 2010, at 3:48 PM, disposableident wrote:

    @Aeoran, absolutely. But do you think that smartphone sales are not going to grow by 25-50% over the next several years? Do you think Apple will hang on to their current share during those years?

    In addition to being widely-accepted, the assumptions are also just plain easy to accept.

  • Report this Comment On September 15, 2010, at 4:26 PM, roguesisland wrote:

    I'm sorry but I have been around long enough to understand that hyping a stock above and beyond the hype is a recipe for disaster. But as a smart investor I will make money on the ascent; and then I'm going to make money when Apple crashes.

  • Report this Comment On September 16, 2010, at 3:24 PM, Aeoran wrote:

    @disposableident: I think smartphone sales will grow at a decent clip, but the worldwide market for phones in total will not. Apple will not capture more than 8-10% of that market. This is still a huge number (80-100M / a), by the way.

    That said, the 8-10% of that market will only come if Apple reduces the average selling prices of its units by at least $200 within 3-5 years.

    Apple cannot compete and refuses to compete in the value category. This is not an admonition, this is an observation. However, phones are a commodity. Smartphones will be too. Margin compression - especially at the top end - is inevitable.

    Android's biggest boon to the world will be allowing commodity makers to drive down the margins/subsidies to the iPhone, very very quickly. To the consumer, there will be no difference - the phones will be at $199. There will be a "lite" version at a lower price. But, carriers will not be paying $400-$500 subsidies per unit to Apple; it will be closer to $200. Investors need to beware overly-optimistic projections for Apple's future iPhone earnings.

  • Report this Comment On September 17, 2010, at 2:00 PM, INoFoolin wrote:

    AAPL is the best consumer product company AND the best retailer in the world right now. Their infrastructure for applications and channel to media is a HUGE barrier to competition and source of synergy and revenue. AAPL has sustainable differentiation that protects growth and margins.

    Another way to ride the AAPL tsunami is ARMH, who develop and license the processor intellectual property embedded in all AAPL products (except desktop and laptop), and almost all the smartphones and mobile devices in the world from every other manufacturer.

  • Report this Comment On September 17, 2010, at 2:22 PM, Turfscape wrote:

    Ugh. Why even have a comments section when the article is about AAPL (or SIRI for that matter). All you get is:

    comment 1: Apple sux. All people who use apple products are stupid

    comment 2: You suck. You're stupid.

    comment 3: Apple rulz! Microsoft is over!

    comment 4: Everybody's stupid. Stocks are stupid!

    Really, it's not even worth the cyberspace it occupies.

  • Report this Comment On September 17, 2010, at 3:17 PM, harrisonjohn wrote:

    I bought Apple at $81 a long time ago (not a lot, unfortunately). And, while I liked the company, I was SURE that I missed the most of the upside. The smart guys were saying that it was overvalued then too. Let that be a lesson for the new investors. Apple continues to rock.

  • Report this Comment On September 18, 2010, at 1:17 AM, alexkhan2000 wrote:

    @aeoran,

    Your assumption, or observation as you say, is based on things essentially staying static over the next 3~5 years. 3~5 years ago, there was no term called smart phones. No one thought that tablets would ever take off as it did with the iPad. Bill Gates didn't anticipate the Internet back in '95. Before iPod and iTunes, who would have thought that Appel, of all companies in the world, would become the largest music retailer in the world?

    If the past decade has shown us anything, it's that it's futile to predict the future based on recent history, especially in the tech sector. Even without the iPhone and the iPad, Apple had been doing quite well with the Mac business. Macs account for only 4% of the global market share (9% in the US) but Apple makes over 30% of the profits. Meanwhile, Apple's market share in the PC industry continues to grow.

    Apple still has much room to grow. Whether they'll actually "win" remains to be seen but opportunities are bountiful everywhere Apple turns. Now there's the distribution of other media like movies, TV shows, books, magazines, ads, and apps as well as music. There's the social networking scene and who knows what else will develop? Apple will undoubtedly go after the high-end HDTV market as well.

    I wouldn't be surprised if Apple becomes its own carrier and ISP. After all, the way things are going, Apple may soon accumulate $100 billion in cash and investments and go after something really big to control its own destiny from chip design and manufacturing of its own hardware products, OS platform and applications development, content delivery through their own wireless network, and distribution through its online stores, iTunes, Apple TV, and the Apple retail stores.

    Who else can even dream of doing something like this amongst Apple's competitors? But Apple can and Apple will because nobody else can. The more that Apple can do, the more valuable they will become because Apple is so different from any other company out there. It can be argued that Apple's "walled garden" and closed ecosystem is its Achilles Heel, but it's also the main differentiator from the competition.

    The fact of the matter is that there is a very sizable chunk (although certainly not the majority) of the market that finds the walled garden approach of Apple much more appealing than the commoditized, chaotic and fragmented world of Windows and Android. Apple is essentially building and providing a gated community insulated from the masses. It may not have everything like downtown city, but it is clean, neat, organized, safe and very easy to get around in. People are willing to pay a premium for that type of experience. Apple knows this well and I believe Apple will deliver.

    The only question is how big this gated community will get. Is it 10% or 20% or even more? What's for certain is that Apple still has long, long ways to go to even get to 10%.

  • Report this Comment On September 20, 2010, at 12:53 PM, seacraft23 wrote:

    It will be very interesting to see if Apple can launch a mainline product "without" Steve Jobs. And yes, there is a track record for this, and it is not good (cf 1990s).

    This is the same thing as Berkshire without Buffet/Munger.

    A good example is what happened to MSFT (as described by rancherfi) after Gates... stepped sideways.

    I think... those guy may have all "nurtured an environment" but no one will have the decision making skills, and force of personality that drive the value of those organizations.

Add your comment.

DocumentId: 1297729, ~/Articles/ArticleHandler.aspx, 7/25/2014 9:19:05 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement