Apple (AAPL -1.22%) 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 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 if Apple has huge advantages investors are overlooking. Below is a sample section of the report that focuses on Apple and its hidden cost advantages compared to competitors.We hope you enjoy this preview content from our premium Apple report.
Spend less, focus and innovate more: Apple and R&D
| Company | Percent of Sales | Absolute Total Spend (millions) |
|---|---|---|
| Apple | 2.2% | $3,381 |
| Samsung | 5.9% | $10,169 |
| HTC | 4.3% | $488 |
| Nokia (NOK 2.03%) | 15.8% | $6,507 |
| Research In Motion | 9.6% | $1,447 |
| Dell | 1.7% | $1,001 |
| Lenovo | 1.7% | $545 |
| Microsoft (MSFT -1.27%) | 13.8% | $9,942 |
| 13.1% | $6,208 |
Source: S&P Capital IQ. All values for the last 12 months as of Dec. 1, 2012.
Research and development is an area that has a minor impact on Apple's bottom line, but this lack of influence is the very reason it's so important. Apple's unique handling of R&D once again gives the company a key cost structure advantage over rivals.
As you can see from the R&D table above, PC-reliant companies like Dell and Lenovo come in lowest, at 1.7%. That's not surprising, as intense price competition in Windows PCs long ago shifted the focus from design to supply chain management, scale, and marketing. Gross margins in the single-digit range don't leave much space for expense on R&D. Apple has long been the only "PC" company that could collect outsized margins on its designs.
What's surprising, however, is how close Apple is to companies like Dell and Lenovo. HTC, a company whose focus is on selling Android phones -- so there's little R&D expense on the software platform -- spends almost twice what Apple does as a percent of sales. Samsung spends 168% more than Apple as a percent of sales, and 200% more on R&D overall.
It's important to note that research and development can be a differentiator, but only if it's focused on the right area and the company is using it to bring the right products to market. Nokia's R&D is still 15.8% of sales in spite of the company trimming nearly $2 billion worth of annual expenses over the past two years.
Yet, despite having vast R&D resources, Nokia still couldn't bring an iPhone competitor out in any timely matter despite prototyping iPhone-like touchscreen phones early in the last decade. That's the result of two factors: a management team that didn't prioritize the right projects, and an R&D infrastructure that lacked the right focus. By nature, R&D can be scattershot, but in general it should have a viable commercial outcome. Nokia's research arm conducted experiments sawing a 1-ton block of ice into 50-cm slabs with infrared sensors to study heat trails left by hands, and sent anthropologists to Indian villages to observe rural phone usage.
Likewise, in Microsoft's case, the company kept R&D budgets concentrated on areas like giant "Surface" tables (years before the recent Surface tablet was released, Microsoft used the name on touchscreen tables) even while smartphones and tablets took off. The idea of a 4-foot table you can play a small set of games on and manipulate with touch is significantly less cool when you have an iPad on a table at home with hundreds of thousands of apps. Microsoft's research is often woefully out of contact with the commercial realities building around it, and the result is an abundance of waste.
To be fair to Microsoft, it has plenty of enterprise sales, and other companies like Cisco and Oracle have R&D budgets that are well over 10%.
Apple doesn't suffer the same fate as competitors who spend far too much R&D on projects with no viable commercial outcome or have divergent business units with little overlap. In Apple's case, an R&D team looking into mobile advances can be applied across almost its entire revenue base since iOS comprises the majority of Apple's revenue. Throw in the fact Apple maintains very few product lines relative to its rivals, and you can see why the company has been so innovative even with less R&D. Its management saw the right areas of growth, focused its resources there in an outsized way, and is now reaping the rewards.
The challenge to Apple is that Internet services that have accompanied recent iOS launches like iCloud, Maps, and Siri – while all of them did still apply to iOS – begin stretching focus. As Apple looks to control more central parts of its platform, that can lead to an R&D budget that's expanding in size closer to the total absolute spend of a company like Google.
Bottom line
Comparing Apple's R&D as a percent of sales to competitors, it's safe to say the company enjoys an R&D cost advantage that's 3-6 percentage points better than its peer group. Comparing Apple to Microsoft or Google would be unfair, as both those companies' models are light on hardware. However, at the same time, with its development of a desktop operating system, a mobile operating system, and varying adjacent services, it's safe to assume Apple's R&D as a percent of sales should be higher than Samsung and HTC, two companies which save on platform development thanks to Google's creation of Android.
Check out the chart below, which shows the theoretical impact on Apple's bottom line if it were to spend on R&D like two selected rivals, Google and Samsung.
