- Alphabet's market capitalization has gained serious ground in 2015 catching up with Apple.
- Apple still remains a cash cow, but continues to sit on their money while debt is growing even as competitors are outspending them on R&D.
- With a 30% cut in latest iPhone model production and a projected growth rate of less than 4%, can Alphabet overtake Apple as the most valuable company in 2016?
After an exceptional year for Alphabet stock and a poor performance for Apple stock, Alphabet Inc-A (NASDAQ:GOOGL) has gained serious ground in catching up with Apple (NASDAQ:AAPL) as the most valuable company. Apple had started off 2015 on an impressive note, exceeding a market capitalization of $770 billion, and sparking conversation about them becoming the first company to break a $1 trillion valuation. But will Alphabet beat them to the number?
Apple stock price struggled in 2015 shedding about $60 billion off its market cap but a lot of investors think it was unwarranted. The stock is now trading at a PE of 10.6. Given the low PE and poor stock performance in 2015 compared to competitors, many investors are expecting 2016 to be a big year for Apple. While I agree that Apple's low PE should give investors comfort on getting a fair price for their money, I don't think we will see it double or triple like investors keep anticipating. Apple has not seen a PE of 25 since 2008, so it is time for investors to get used to the stock sitting at a ratio around the low to mid double digits. Therefore the catalyst to move Apple's market capitalization is going to have to come from good old fashion growth - growth in sales and earnings.
Alphabet on the other hand created huge separation from Apple in their PE ratio. It began in 2014 and continued through 2015, and the stock is now trading at a PE of 31.2. If you look at the chart below you can see that Apple has historically traded at a higher PE until recently.
So why does the market value Alphabet more like a tech company than Apple? If we look at the trailing twelve months we can see that Alphabet has invested 44% more money into research and development than Apple has. To put that in perspective, Alphabet has invested 16% of their revenue in R&D versus Apple's 3%. And although Apple has more than 3 times the operating cash flow of Alphabet, their capital expenditures are nearly identical.
Apple's Balance Sheet Is Not That Much Stronger
One of the big attractions to Apple is the massive pile of cash they are sitting on. They have long-term investments of $164 billion. But unfortunately, Apple's cash is not growing nearly as fast as their long-term debt, which has accumulated to over $53 billion and continues to grow. Alphabet has been working their balance sheet in the opposite direction by slowly reducing their long-term debt down to below $2 billion.
Now while Alphabet does not have that $164 billion of long-term investments, but rather a miniscule $4.8 billion in long-term investments, they do have quite a bit of cash. Their cash and cash equivalents are only $2 billion less than Apple's and their short-term investments are $35 billion greater. That gives Alphabet total current cash of $73 billion compared to Apple's $42 billion. Apple faces significantly higher liabilities than Alphabet, so if we take a macro view of their balance sheet and deduct total liabilities from total assets, Apple's total book value is only $3 billion more than Alphabet's. And while Alphabet's book value has consistently grown YoY, Apple's has moved up and down over the past 3 years.
Source: Yahoo Finance
While many investors feel that Apple's cash is enough to differentiate themselves from Alphabet, I don't believe that is true. Both companies have very sound financials. The question is, who can create the better return with it?
I believe Google X has investors more intrigued on future innovation than Apple's research and development, and it should because it is better funded than Apple. However, Apple is performing better now with revenues and earnings more than 3 times that of Alphabet. But investor perception is becoming clearer, they believe that Alphabet will be the company to create the next game changing technology, hence the premium valuations for the stock as compared to Apple. Whether it's Google Glass, self-driving car technology, Project Ara, etc. people are excited to see what Alphabet can come up with as they shoot for the moon. And while technology projects fail many times, it only takes one big idea to hit a home run and be on top.
With the recent news that Apple has cut production of their latest iPhone models by 30%, investors were hit with a little bit of concern. However, other investors are seeing the recent drop as a green light to pick up more shares. It wouldn't surprise me to see Apple's reign as the most valuable company last another year, but with revenue projected to grow less than 4% compared to 28% in the prior year, I believe 2016 could see Alphabet become the world's most valuable company.