Is Apple's Epic Run Over? Hidden Cost Advantages You Must Watch

Apple (NASDAQ: AAPL  ) has gone from Wall Street darling that couldn't miss to a contrarian play trading at earnings multiples well below the broader market. 

With iPhones still flying off the shelves and the Mini an early hit, many investors are left wondering whether there are deeper problems with Apple that they're missing, or whether the current sell-off makes Apple a screaming buy. 

We've created a brand-new report titled "Is Apple's Epic Run Over?" that gives investors a comprehensive look at Apple. It answers whether the bears are right, or whether Apple has huge advantages investors are overlooking. Following is a sample section of the report that focuses on Apple and its hidden cost advantages compared with its competitors. We hope you enjoy this preview content from our premium Apple report.

Apple's critical cost advantage, added up
Adding up Apple's cost advantages in both SG&A and R&D, we arrive at a 10-16 percentage point advantage in cost savings relative to sales. Apple's relative advantages in these two areas led to added profits of anywhere between $12 billion and $19 billion last year.

To review tablets we've looked at earlier in the report, here is Apple's 3-6 percentage point advantage in low R&D costs relative to competitors.

Company

Percent of Sales

Absolute Total Spend (Millions)

Apple

2.2%

$3,381

Samsung

5.9%

$10,169

HTC

4.3%

$488

Nokia (NYSE: NOK  )

15.8%

$6,507

Research In Motion

9.6%

$1,447

Dell

1.7%

$1,001

Lenovo

1.7%

$545

Microsoft

13.8%

$9,942

Google

13.1%

$6,208

Source: S&P Capital IQ. All values for the past 12 months as of Dec. 1, 2012.

And here is the company's SG&A relative to peers. As you can see, Apple has anywhere from a 6-10 percentage point advantage over its general peer group.

Company

Percent of Sales

Apple

6.4%

Samsung

16.7%

HTC

12.5%

Nokia

13.9%

Research In Motion

14.6%

Dell

14%

Lenovo

7.9%

Microsoft

25.5%

Google

18.9%

Source: S&P Capital IQ. All values for the last 12 months as of Dec. 1, 2012.

These cost advantages go a long way in helping to explain why competitors were initially unable to undercut the iPad's pricing even as Apple reaped in huge profits on the device. Much ink is spilled about how Apple can charge a premium for its products. However, the real storyline is that the "premium" Apple is charging has been decreasing in areas like tablets. In its place, Apple's margins are bolstered by its outstanding control of expenses relative to peers.

The iPad's gross margin (the difference between revenue and cost) is generally considered to be in the 30% range in any given quarter. Let's use this to illustrate how Apple's cost advantages allow the tablet to be such a formidable threat to competitors.

Below I've assumed that Apple and a group of competitors are all selling tablets for $500, and I've generously assumed that their cost of goods sold -- or COGS -- is equal to that of Apple. (We'll have more on Apple's COGS advantages below.) Using the figures from above for each company's SG&A and R&D spend as a percent of sales, here's their profit potential:

Company

Tablet Price

COGS

SG&A

R&D

Op. Profit

Taxes (Assumed at 25%)

Profit

Profit Margin

Apple

$500

$350

$32

$11

$107

$26.75

$80.25

16.1%

HTC

$500

$350

$62.50

$21.50

$66

$16.50

$49.50

9.9%

Samsung

$500

$350

$83.50

$29.50

$37

$9.25

$27.75

5.6%

Nokia

$500

$350

$69.50

$79

$1.50

$0.38

$1.13

0.2%

Source: S&P Capital IQ.

Is this a perfect example that encompasses all nuances of tablet costs? Of course not; the incremental SG&A and R&D spend on creating a tablet might differ from wider company totals. Also, retailer mark-up may differ by product and company. However, this is an excellent broad example of Apple's cost advantages in action, which led to competitors being unable to undercut the iPad's pricing until the introduction of the Kindle Fire and the Nexus 7 -- two products not making any money directly, that will be discussed in more detail later.

The obvious question: Can Apple maintain this kind of structural cost advantage over the long run? As we see in the table below, aside from its 2009 fiscal year when economic turmoil stunted growth, Apple has managed to grow sales far in advance of expenses like cost of goods sold and research and development. That is, its scale has only increased its advantage in these areas.

Line Item

2008

2009

2010

2011

2012

Sales

53%

14%

52%

66%

45%

SG&A

27%

10%

33%

38%

32%

R&D

42%

20%

34%

36%

39%

Source: S&P Capital IQ.

At the end of the day, these savings are an inherent bonus of being Apple. If the company stops receiving gratis product placement that saves on advertising costs, there are bigger problems regarding Apple losing its brand cachet and design lead over competitors.

If R&D spins out of control, the company is likely losing focus and has lost a strong central decision-making team that's making the right bets on what consumers want next. If Apple ever has a $15 billion research budget, it's time to sell the company for reasons bigger than a margin hit from increased R&D spending.

Bottom line
Apple investors should feel secure in these cost advantages continuing in the coming years and staying well below industry averages. That leads to a key and underfollowed competitive advantage, especially as Apple continues building out a tablet market which has no shortage of growth potential in coming years.

Get the full report
We hope you enjoyed this sample of The Motley Fool's newest report on Apple. My report offers a comprehensive analysis diving into what's causing Apple's sell-off -- and whether the company is poised to bounce back. To get instant access to his latest thinking on Apple, simply click here now.


Read/Post Comments (4) | Recommend This Article (2)

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 December 24, 2012, at 12:13 AM, kgineobr wrote:

    The latest iOS is six months old.

  • Report this Comment On December 24, 2012, at 2:41 PM, EmergingGrowth wrote:

    I think Nokia stock has a better upside opportunity.

    China Unicom: December 23,

    Long queues in China for the Nokia Lumia 920, sells out in two hours

    http://www.ithome.com/html/win...

    China Mobile: to offer Lumia 920T for just 1 Yuan for a 2-year contract, supply arriving after Christmas and in January.

    360buy.com, China’s leading direct e-commerce company, announced that it has formed a strategic partnership with Nokia Corporation (NOK) and signed a procurement agreement worth RMB 2 billion for 2013. As part of the cooperation, Nokia’s latest Lumia 920 handset has made its debut on 360buy.com, with the release of the Nokia 2050 soon to follow.

    Lumia 920 and 820 arriving India at the beginning of January and Lumia 620 at the end of January.

    Latest Kantar report shows global WP phone growth, strong Nokia comeback in the UK.

    BGR reports on KantarWorldPanel’s findings and concludes that Windows Phone is gaining traction in Southern Europe. As Nokia is finding it nigh on impossible to meet the demand for the 920, bringing down prices of the previous generation handsets has at least been able to attract a lot of first time buyers or those looking for budget friendly smartphones.

    Mexico launched Lumia 505

    Lumia 920 and 505 confirmed in Chile.

    iSuppli: Nokia can still beat Samsung and take the crown back.

  • Report this Comment On December 24, 2012, at 2:59 PM, EmergingGrowth wrote:
  • Report this Comment On December 24, 2012, at 3:04 PM, Tsinky wrote:

    Looked at another way, is Apple underspending on R&D, creating an opening for competitors to develop better, or altogether new, products?

Add your comment.

DocumentId: 2167386, ~/Articles/ArticleHandler.aspx, 4/24/2014 3:40:10 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