Rising Stars Buy: Apple

Yesterday I announced my intent to buy both EMC (NYSE: EMC  ) and Qualcomm (Nasdaq: QCOM  ) as part of my "Bits Portfolio," and hinted that there were more buys to come. Both of those companies are large leaders in their respective growth fields of technology, and in both cases I piggybacked off a previous recommendation.

Well today's buy recommendation is no different. I'm going with Apple (Nasdaq: AAPL  ) , a company I previously recommended, and the Fool purchased as part of our "11 O'Clock Stock" series. Apple's $300 billion market capitalization might scare investors off, but I think the stock has plenty of room to grow. In fact, it's my top conviction selection to outperform the market in 2011. I don't think you'll see another year of 53% returns like Apple saw in 2010, but at today's price levels there's plenty of room left to run.

Why Apple has room to run
First, let's go back and revisit my original buy recommendation on Apple. I highlighted four key themes that should keep Apple outperforming. I'll paraphrase them below:

  1. iOS Scales: Apple has proven its ability to scale iOS to different devices, which unlocks opportunities in connected living room devices (think Apple TV) as well as advertising.
  2. Software is the new kingmaker: Unlike the age of Motorola's (NYSE: MMI-WI  ) RAZR when phones were differentiated by slick designs that were easy to copy, phone dominance is now dictated by the software. That's a much more defensible position, especially when Apple controls its App Store and the media platform (iTunes) its users have adopted.
  3. Consumer Behavior: Apple collects $610 for every iPhone sold, yet consumers normally only pay $200 for the device. The subsidized model of smartphones naturally shifts spending away from devices like PC's to smartphones. Beyond that, it benefits high-end sellers like Apple. Consider, Research In Motion (Nasdaq: RIMM  ) collects $315 on average for each phone sold, yet the price point difference between Research In Motion phones and the iPhone is often around $100. While the companies cost the carriers a $300 difference in costs, the consumer only has to pay $100 more to receive a much more popular phone with more advanced features. This capping of prices from major carriers like Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) at around $200-$300 benefits the high-end sellers the most.
  4. Underappreciated smartphone growth: Last year Gartner projected compounded smartphone growth of 28% (in sales, not units!) between 2009 and 2014. That's a tremendous shift that's still not appreciated by investors. I'll have more on this below.

The amazing transforming Apple, more than meets the eye
Still, a lot has changed from that original recommendation. First off, Apple itself has put on a little weight. It's now $60 billion more expensive, a 22% gain in the company's value.

Am I scared about these continuing gains? Not really. I'd always love to get a stock as cheaply as possible, but at the same time, I don't want run-ups or sheer size to sway me away from a stock for which nearly all signs suggest continued growth.

For example, my original buy recommendation focused almost solely on the iPhone's ability to drag Apple to its current valuation, with the kicker of growing product sales in other areas like the iPad and the Mac able to provide the growth rockets to shoot Apple even higher. Well, just six months later, and the iPad has become a force on its own.

Consider that estimates of iPad sales during calendar 2011 reach as high as 65 million! If that figure actually became reality, it would equal 65% of Apple's revenues last fiscal year. One bit of solace for Apple skeptics, I think that 65 million figures is way overstated. Conceivable, and I've been wrong about the iPad before, but it should prove incorrect.

However, let's consider a more reasonable (or, overly bearish) scenario where Apple sells 20-25 million iPads this calendar year. That would account for between $13-$16 billion in revenue from iPads alone.

The iPhone, still the main event
Now we're going to focus on iPhone growth. Apple managed to grow iPhone sales by 93% in both 2010 and 2009, expanding the phone's sales to $25 billion last fiscal year. That growth has to slow way down, right? Not so fast.

Yes, the law of large numbers and market saturation will begin catching up with Apple, however there's still a long ways to go in smartphone growth. More to the point, since smartphone growth rates recently started seeing explosive growth rates, investors still aren't fully aware of how strong this trend is. Take a gander at this chart showing year-over-year growth for smartphones in general.

Source: Gartner

Just this week, the Consumer Electronics Association released their projection for 56% growth in smartphones in 2011, that's better than the combined 51% growth seen in 2010. Despite all the hype about smartphones, the segment is growing faster and faster!

Now, there are a couple notes here: shipments of smartphones might be accompanied by falling prices, especially as carriers are swarmed with Android models. However, that was a trend that peaked this year, and Apple not only maintained its premium phone selling prices, it grew them.

Take a look out how Apple's revenue share managed to grow despite its total market share by shipments remaining flat (listed as iOS in the chart).

2009 Revenue Share

2010 Revenue Share

Source: Author estimates, Gartner, Apple, Motorola, Nokia, and Research In Motion security filings.

How'd Apple manage to grow its revenue share from about 28% to 31%? By slightly increasing prices while competitors saw their prices sag.

So, with Apple growing sales 93% the last two fiscal years while shipments of smartphones topped out at 51% in 2010, what's to stop Apple from growing by 50%+ again in 2011 when global shipments are expected to grow by 56% from 2010?

I believe the answer is nothing. Not to discount the threat from Google's Android entirely, it's just that Apple has proven its alternative can stand up against the Android and continue growing. Growing shipments at the industry level would leave Apple with $39 billion in iPhone sales during calendar 2010.

Combined with the iPad, that's around $54 billion in sales. If you assume all other parts of Apple remain flat from their previous year's sales total (a conservative assumption, Mac sales grew 26% last year), that's $89 billion in sales for Apple during calendar 2011. Up from $65 billion today.

The bottom line
Looking at Apple estimates, we see that analysts have predicted that the company's sales will come amazingly close to that total; they're calling for $88.69 billion. What's amazing is that this estimates calls for 1) iPhone sales in line with general trends, which Apple has consistently blown away,  2) iPad sales well below most expectations, and 3) are expecting little growth from Apple's other businesses, which have consistently grown along with iPhone, iPod, and iPad sales (the much talked about "halo effect").

I know people are scared about buying into Apple at this time, since its market cap is almost as much as ExxonMobil's, but as crazy as this sounds, everyone is underestimating Apple! I'm placing such a high conviction behind Apple's continuing strong performance in the year ahead that I'm putting around 14% of my "Bits Portfolios" assets into the company. That's a strong statement on my belief that Apple is the strongest pure play on a trend that I believe will define 2011: the growth of converged devices like smartphones and tablets.

In the coming days I'll continue digging into Apple and taking a bit more focus on its long term prospects as opposed to its strength in the year ahead. If you'd like to follow along please subscribe to my Twitter feed. Along with my weekly Apple columns and information, I post other newsworthy tech information and buys from my "Bits Portfolio."

Eric Bleeker owns shares of no companies listed above. You can follow his tech stories and musings on Twitter. Google is a Motley Fool Inside Value pick. Google is a Motley Fool Rule Breakers recommendation. Apple is a Motley Fool Stock Advisor selection. The Fool has written puts on Apple. The Fool owns shares of Apple, Google, and QUALCOMM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (37)

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 January 06, 2011, at 3:51 PM, barilro wrote:

    Unfortunately Android is now gaining speed. In two quarters, Android will start eating into Apple market share while Apple margins will erode as that same time. The growth for Apple will not meet expections in twelve months. Don t get me wrong, Apple will make money but their growth rate will drop a bit.

  • Report this Comment On January 06, 2011, at 3:58 PM, MusiCali wrote:

    barilro, android is doing well and is here to stay but AAPL growth rate will accelerate. did you read this article? or just write a comment after seeing the title?

  • Report this Comment On January 06, 2011, at 4:02 PM, sk8ertor wrote:

    Can Fool.com be any more Apple Fanboyish than they arleady are? I didn't think so until I read this article. Terrible commentary and advice on Fool.com. This site says only positive stuff about Apple and negative about its competitors. I'm starting to think that like BGR, Fool.com is also paid by Apple to only say positive comments.

  • Report this Comment On January 06, 2011, at 4:04 PM, TMFRhino wrote:

    Don't expose our secret sk8ertor! All that money from Lord Jobs is keeping food in my belly!

    ;)

  • Report this Comment On January 06, 2011, at 4:19 PM, artlaz wrote:

    People underestimate the importance of the satisfaction rate of different brands of smart phones. In all surveys I've seen, Apple blows away the competition in this key metric. I believe Apple will continue to achieve higher growth rates than the category in general, expecially now that they will be selling a CDMA version of the iPhone. I can't tell you how many people I know who are waiting for Verizon to get the iPhone so they can buy one.

  • Report this Comment On January 06, 2011, at 4:52 PM, midnightmoney wrote:

    skype is a blessing and free the world over, macbook or not

  • Report this Comment On January 06, 2011, at 5:00 PM, TMFRhino wrote:

    midnightmoney,

    I'm not a heavy VOIP user, but curious how you feel it compares to Google Voice. I should really take more time get on these services.

    -Eric

  • Report this Comment On January 06, 2011, at 5:27 PM, gcor1952 wrote:

    When the iphone gets to other carriers, if ever, won't AAPL it shoot up again? I want one but I am really happy with Sprint. Hear too many things bad about AT&T especially in downtown areas. Seeing a lot of people getting EVOs now because of carriers.

  • Report this Comment On January 06, 2011, at 5:39 PM, mmargolies wrote:

    And we can't forget that at some point Verizon will come on line with iPhones and that will open a whole new market of buyers who refused to use AT&T, not to mention slowing Android adoption that many people see as a second choice option to the iPhone for those stuck with Verizon for whatever reasons.

  • Report this Comment On January 06, 2011, at 9:50 PM, TMFRhino wrote:

    gcor,

    Thought I'd already commented, so apologies if this is a double post. The Verizon bump will happen this year, but the important thing to remember is that the iPhone is a global product. I don't have figures readily available in front of me, but I believe the figure is ~70% international sales. If Verizon added -just pulling a figure out of the air - 10 million iPhones next year, not all of those would be additional sales, some would be AT&T customers switching.

    Also, its important to remember that Apple scored a sweetheart deal with AT&T, so the fear has always been that by bolting to Verizon their phone selling prices (which is very important and I focused on quite a bit in the buy rec) would see pressure as that deal expired. That fear has been mitigated to some degree as it appears Verizon is desperate enough to be cutting Apple some major concessions.

    Long story short, the Verizon iPhone will be a good booster, but not hugely meaningful. Hope that helps!

    -Eric

  • Report this Comment On January 06, 2011, at 10:26 PM, Blueman1000 wrote:

    Hey I'm not one of the big wigs, I'm just a regular ol' Fool. I've got a hand full of Apple stock, but there's not a day that doesn't go by that I'm not reading and researching more on Apple. The bottom line is regardless of what the numbers are some people, many many people go by their gut when evaluating a stock. When I think of Apple I think of innovation, something new and different and while the competition are busy trying to play catch-up Apple is already working on something different. It's Apple's creativity that is it's strongest selling point and that means "Confidence" to investors, and Confidence is what drives the market.

  • Report this Comment On January 07, 2011, at 3:31 AM, quaternion2 wrote:

    Revenues like those mentioned for the iPhone are true in the U.S. yet Apple should be looked at as an international player. For instance, in many European countries the iPhone is sold at full price, there is no discount related to buying a telecom plan. How does this compare to Android phones?. I have a son and a daughter whom both have an iPhone, my wife uses a Blackberry curve, and got myself a new android HTC Wildfire. The HTC costs about half the iPhone and offers pretty much the same user experience as an iPhone. What do you believe an average buyer is going to shop?

  • Report this Comment On January 07, 2011, at 4:26 AM, Accreator wrote:

    Dear Eric,

    Allow me to share with you some of my skepticism about AAPL (APPLE).

    Major risks for this stock:

    - If anything happens to Steve Jobs, I predict the stock will lose 20%-30% of its value in a few days, no matter who is there to replace him. If you buy this stock, you need to buy a life insurance on Steve Jobs too :-)

    - Apple iPhone was a ground breaking product when introduced, but I have to tell you the truth, today the iPhone isn't the coolest thing out there anymore. Competition has caught to Apple and I would say surpassed it, for this for instance, have a look at the video on link below :

    http://www.engadget.com/2011/01/06/motorola-atrix-4g-hd-mult...

    The only remaining big advantage of the iphone is iOS. Even that advantage will progressively fade away, due to the little robot called Android. My prediction is declining sales of the iphone in 2011. Smartphone sales will grow, that's true, but it is mostly the segment of 250$-500$ smartphones without contract that will grow, where Apple is simply absent because it basically has only ONE iphone.

    - I believe that Apple will keep a good market share in the tablet PC market in 2011, but by the end of the year the competition will get very very tough. Honeycomb will do some damage there and in 2012 Windows for ARM tablets will do additional damage.

    - Why did Apple lose the battle against Microsoft 30 years ago? Does anybody remember that story? Microsoft was compatible with any hardware, whereas Apple makes its own hardware. The third reason why I don't believe that Apple has room to grow is its closed model, which means that Apple competes with every body on the market. Diversity helps creativity, that's a natural law.

    Now Steve is a great guy, and Apple will grow in 2011 if he brings another innovative product in a market where Apple is totally absent today (like an i-Car ;-))

    About your remarks in favor of Apple:

    1) "iOS scales"? yes if the hardware is identical (read Cortex-A series processor). Therefore it isn't that simple. iOS on TV? Sure, it is interesting but webTV is far from being really ready for mass market, and Apple can't change that easily (too many players involved). Therefore, what would be ground breaking is if Apple gets into the business of building and selling TVs like it is selling PCs. It would require massive cash flow investment and time before results come out.

    2) Software is the main advantage of Apple. Many of the customers who have purchased tons of apps will be reluctant to switch to any other manufacturer. True. This means no brutal loss of market for Apple.

    About 3) and 4) see above.

  • Report this Comment On January 07, 2011, at 6:07 AM, wbwof wrote:

    On your mark...get set ....GO.ogle....and Google's little robot is great but so is the iPHONE and has a major headstart in the race of margins and growth. What is worrisome to Apple's competition is while they try to catch up they are still playing off Apple's idea.....new smartphones are coming out and then CSE says new "pads" are in the works for 2011.....but what's wrong with this picture of Apple's demise??......we are forgetting about the lead. The competition is offering similar apps and features and at lower cost. Wow...never seen that before in tech. Ask yourself a question...what was the time between the iPHONE coming out and the Android...tick-tock.??What will be the time when there will be a serious competitor to the iPAD?....but this is the most important question....what's next at Apple that they are already and have been working on when everyone else is trying to catch up? Sure you might argue that it better be good or even better then great but when you are number #2 to EXXON

    in market cap...well...you just try harder!

  • Report this Comment On January 07, 2011, at 7:33 AM, simplesim0n wrote:

    I believe you are absolutely correct with this article....people forget that the movement to touchscreen Macs is inevitable and will probably happen within the next year, plus with the iPad 2 coming out with a camera etc etc.

    Just think about how high the stock price will go, when every new Mac computer will be touchscreen.

    The stock price will go through the roof as everyone will want to buy one!

    There is still a long way left to go with this stock...I could potentially see it increasing around an extra $150 over the next few years

    A former Apple employee,

    Simon

  • Report this Comment On January 07, 2011, at 11:28 AM, baldheadeddork wrote:

    Eric, where do you get that "it appears Verizon is desperate enough to be cutting Apple some major concessions"? My read is that Verizon is the one in the driver's seat on this deal.

    The strongest pressure for a Verizon iPhone is coming from Apple's customers because they're famously unhappy with AT&T's network. Verizon also doesn't need the iPhone to catch AT&T. In the last five years AT&T has gone from having a 2 point lead in market share to trailing Verizon by six. Android devices are now outselling iPhones, and Verizon doesn't have to eat $400 on every Android handset it sells. The iPhone gives Verizon the chance to poach a few million unhappy AT&T customers. But the time when they desperately needed the iPhone to be competitive in the smartphone business is a couple of years behind us.

    Apple, on the other hand, is at the end of its rope with AT&T. The market share they're going to get from one carrier hit its zenith over a year ago. Their move last year to sell the iPhone through WalMart and other discount retailers reeked of desperation. AT&T is far from happy with the pricing arrangement where they have to pay Apple twice or three times as much as other handsets, while they have to retail at $199 to compete with Androids on other carriers.

    This pricing structure where the carriers pay a $400 Apple tax on every iPhone they sell is simply unsustainable. I wrote last month that AT&T was likely to beef up its Android line in 2010 to compete at the $200 retail price point instead of eating $400 on every iPhone, and they announced at CES this week that is what they're doing. If Verizon gets the iPhone they have zero incentive to take a $400 loss just to cannibalize their Droid sales. By the time the fifth gen iPhone debuts both carriers will be in a position to price the iPhone at $300 (or more) and let the people who want Apple pay the premium for it.

    I don't expect Apple to lower their wholesale prices, but when (not if) the iPhone carries a 50% premium over an Android at retail it is going to hurt Apple's sales.

  • Report this Comment On January 07, 2011, at 4:11 PM, isaquejr wrote:

    You are clearly biased. Smartphones are not a property of Apple, you know that Samsung sold 10 million Galaxy S phones last semester, and Samsung doesn't have just one phone model (wait for the Nexus S figures). Android will be the dominant OS, if you want to talk about growth, what about the growing share of of android phones? Get real, Apple is a bubble! It can't grow at the same pace that grew for the last 4 to 5 years because now they have real concurrency. 300B... you real think that is undervaluated?

  • Report this Comment On January 07, 2011, at 7:56 PM, TMFRhino wrote:

    Hey Accreator,

    Thanks for all the comments, lots of thoughts to digest here!

    Couple responses

    - No doubt the Steve Jobs factor is huge. However, barring him keeling over this year, I think the company should be fine, notably because the biggest hurdle this year is operational measures like being able to ramp the massive production chain to produce all the gadgets needed to support their growth. That’s less the domain of Steve Jobs and more the domain of Tim Cook. Definitely a long term concern, however.

    - Last year had very capable Android handsets and the iPhone still grew sales by 93%. I personally bought a Droid, and it was seen in many ways as a peer to the iPhone, just as the Atrix will be. Given that smartphone rates are set to rise even higher this year (56% vs. 51% last year per CES), why would the iPhone suddenly decline now, especially with more distribution?

    - Regarding the whole Android as Microsoft 30 years ago analogy: After using both an iPhone and an Android, I’m pretty confident a duopoly situation can exist, namely because while the Android plays the Microsoft role in the mobile world (distributing the OS to many manufacturers), users just wanting the device to work is placed at a premium and due to carrier subsidies the pricing situation isn’t skewed too heavily to the Android alliances' favor. Therefore, unlike the 80’s where MSFT claimed 95% share while AAPL slid down to low single digits, I see the current share as much more defensible. Not as disparate pricing situation, less need to be inter-operable.

    Thanks for the comments, will be fun to see what side wins out. Of course that's all moot when we see that iCar :).

    -Eric

  • Report this Comment On January 07, 2011, at 8:00 PM, TMFRhino wrote:

    Baldheadeddork,

    First of all, I know you've commented on many of my NVIDIA articles in the past, so I have to ask for your thoughts on their resurgence and the thought of taking Intel on in CPU's. Very, very interesting times.

    I guess my "hand" on the subject has been tipped:

    http://www.fool.com/investing/general/2010/12/24/these-compa...

    Second, I don't have it handy at the moment, but I'll get back to you with more information on the VZ/Apple situation tomorrow. Intuitively, Verizon has more power, but some rough stretches of Android sales my have tipped the scale in Apple's favor.

    I'm quite intrigued to see if Verizon and Apple have a deal to make the next iPhone LTE-exclusive on Verizon and that maintained pricing powers. The next few months will be interesting indeed.

    -Eric

  • Report this Comment On January 07, 2011, at 8:01 PM, TMFRhino wrote:

    And to everyone else out there, yes, it looks like as of tonight we know for sure Apple is going to Verizon. I wouldn't get *too* excited, but still big news.

    -Eric

  • Report this Comment On January 08, 2011, at 10:48 AM, baldheadeddork wrote:

    Eric -

    I'm still bearish on NVDA. I think the stock has rebounded on the strength of its balance sheet and nice wave of speculative trading between July and now. They haven't overachieved in their quarterly performance and the position of the company in its industry hasn't changed in the last year. They're still trailing on discrete graphics, the chipset business is still going away, GPGPU is going nowhere, and their SoC hasn't taken any business from the established players like Qualcomm. I don't think getting into the ARM game is going to turn the company around. nVidia has never, ever been a company that could do good hardware development at a low cost, and that's the key to success in the ARM business.

    And if you love NVDA's balance sheet, you should keep in mind that the move into ARM is going to add another round of R&D that won't see a return for a couple of years, while they're also developing the replacement for the Fermi GPU. They're setting themselves up for a lot of development spending at a time when their current product line is underperforming.

    About Verizon, AT&T, and Apple - maybe I'm looking at this from the wrong end of the telescope but I see the carriers having a radically different perspective on this than we do as consumers and Apple does as a manufacturer. If you choose an iPhone over a Droid, what does it mean to Verizon? Nothing, really. Verizon sells the plans and they cost the same regardless if you choose an iPhone, Android or WP7. The best phone for Verizon is the one they have to discount the least to get you to sign a contract. If Verizon was smart enough to follow this when they didn't have a real competitor to the iPhone, I don't see them losing their minds now.

    There's another part of this that I don't think anyone has talked about: If Apple requires Verizon to sell the iPhone at a 70% loss so it can retail at the same price as Android phones, how long do you think it will take the rest of the smartphone business to file criminal complaints and civil suits against Apple? They'd have a hell of a case, and "they" would include practically everyone else in the smartphone business, from handset makers to OS developers and hardware manufacturers. Apple got away with this at AT&T because AT&T didn't have alternate smartphone platforms. That isn't the case with Verizon, and you can bet that Motorola, Google, Qualcomm, Samsung, HTC, and everyone else involved with the Android products sold at Verizon are going to keep a close eye on pricing and any changes in Verizon's promotion of the Android platform. I'm sure that Apple would love to leverage Verizon into giving preferential treatment to the iPhone at the expense of Android. But the management team at Verizon (or their lawyers) has to be smart enough to see that coming and, again, they don't have to take that risk. They got the broadest network and the top smartphone marketshare without selling one iPhone. I don't see them screwing themselves because Apple tells them to.

  • Report this Comment On January 11, 2011, at 1:02 AM, TMFRhino wrote:

    MillerMan....

    How'd you ever uncover that InfoThatHelps is my alter ego? Please don't tell anyone my dark secret...

    :)

    -Eric

    Baldheadeddork,

    Apologies for not getting that link. Swamped with CES and other news. Tectonic shifts in the semi world and all that. I'll try looking for that in the morning.

    Here's one good look at the possible recent smartphone troubles that have led to this situation:

    http://www.asymco.com/2010/12/13/verizon-strikes-out/

    -Eric

  • Report this Comment On January 14, 2011, at 1:34 PM, courtreporterrl wrote:

    Great article. It opened my eyes to the possibility of adding AAPL shares to my portfolio even though my current shares were purchased at a much lower share price. It was a great deal then. It sounds like it still might have tremendous value even at the current price.

  • Report this Comment On May 26, 2013, at 12:58 PM, jaybird43 wrote:

    So, in all honesty and because we all want to know, how much did you actually pay for those apple shares?

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