Why Is Samsung Dirt Cheap?

If you thought Apple (NASDAQ: AAPL  ) was dirt cheap at 13-14 times earnings, would it shock you to learn that Samsung (NASDAQOTH: SSNLF  ) trades at just 6.42 times earnings?

The world's largest smartphone vendor, second-largest tablet vendor, largest DRAM/NAND vendor, largest display vendor, and up-and-coming system-on-chip vendor trades at a market capitalization of just $166 trillion Korean won, or around $154 billion. Why is Samsung so darn cheap?

The two big profit drivers: semiconductors and smartphones
Take a look at the most recent earnings report from Samsung Electronics:

(Source: Samsung)

For fiscal 2013, the company did $36.79 trillion won, or about $34 billion, in operating profit -- 67.8% of that profit came from smartphones and tablets, 28% of it came from semiconductors, and the final 4.6% came from consumer electronics. In particular, the large operating profitability in mobile devices has been due almost entirely to the success of its Galaxy line of smartphones and, increasingly, to the Galaxy Tab and Note line of tablets. The semiconductor success appears to be principally from the boom in DRAM and, to a lesser extent, success as a logic foundry, mostly for Apple.

The problem here is that the barrier to entry to develop a solid Android smartphone is quite low. So unless Samsung can find a way to perpetually command 30% market share and a big portion of the profit share, and do so while commanding the roughly 40% gross margin it now does, this profitability is tenuous at best and a significant risk at worst. That argument also somewhat applies to Apple, although Apple's ecosystem and brand do insulate it to some degree from a long-term perspective.

Are investors expecting significant margin compression...or is it something else?
At 6.42 times earnings -- and even cheaper, ex-cash -- are investors expecting some pretty significant margin compression? Almost certainly, although this is nothing new. Investors may also be concerned that a larger iPhone could take away fairly meaningful high-end share, which would hurt the bottom line harder than it would the top line. On top of that, other handset vendors could finally begin to make progress, which could either hurt margins or the top-line, and probably both in the long term.

However, there's probably more to the picture than this. Another possible reason Samsung trades so cheaply is that the shares are so difficult to buy if you're an investor in the U.S. Samsung has no ADR, making it very difficult for investors to actually buy company stock. If the stock were more easily purchased in the U.S., it could be worth significantly more than it is today, even if it commanded a sub-market multiple.

Foolish bottom line
The same worries that plague Apple also plague Samsung. While margin compression is likely to take effect as the smartphone and tablet markets mature, Samsung's problem likely goes beyond these worries and represents the fact that much of the investment capital that would be interested in actually getting a piece of the action is simply unable to do so.

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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 March 24, 2014, at 8:57 AM, fauxscot wrote:

    Heaven help Samsung if the bottom (sic) falls out of the bidet market!

    Here's a scenario...

    Apple quits buying so much Samsung silicon.

    Samsung falls behind in the single-handed development of 64-bit Android apps, never gets a retail presence, continues to function at the mercy of Google's whims vis a vis Android, and sheds some share points to a vastly superior product line and ecosystem.

    Samsung tanks.

    This is a much more likely scenario than the bears have in mind for Apple. There is plenty of reason, in my mind, for Sammy to worry a lot more than Apple. Apple staked out the Comstock Lode of phones and Samsung has a little and declining placer operation that is one shovel full of dirt away from running out. (They aren't stupid and their products are apparently quite nice,and the user base isn't stupid... I'm just talking about the risk factors relative to Apple.)

  • Report this Comment On March 24, 2014, at 10:09 AM, eldernorm wrote:

    "The same worries that plague Apple also plague Samsung."

    Well, there goes any credibility the author might have had. :-(

    Samsung's biggest ability is to copy Apple and charge a little less. Next comes the Google-like do anything that makes your spec look cool, even if it does not work very well.

    Samsung is making money, but less and less. Its worried. It keeps throwing stuff at the wall and hoping something will stick and make it big sales. Its not.

    Yes, some people like big screen cell phones, but not in the numbers like Apple.

    A good example here is Samsung's brag about going 64 bit. But they use Android and its 32 bit. And Google is moving more to Chrome and away from Android. Who is to help poor Samsung. Hey, maybe some more stupid ads that only impress the Samsung faithful and their paid trolls (yes, convicted in a court of law and fined).

    Samsung is not going away, but its losing most of its lawsuits or dropping them before it loses them. This is not a good sign for a company that says it leads!!

    Just saying.

  • Report this Comment On March 24, 2014, at 10:03 PM, Dvoraak wrote:

    I think Samsung and Apple shares both suffer from the same malady. The certainty...... certainty that the mobile market is fluid and when both companies get the lion's share of their profits from this specialized market that judges what you've done lately far more than your extended track record..... what goes up will go down.

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