Will Alphabet Inc dethrone Apple Inc. ?
- Apple may lose the 'most valuable company' tag to Alphabet.
- What are the next steps for Apple to reclaim the throne?
- What is the viability factor for future iPhones?
There is plenty of reason to believe that Apple (NASDAQ:AAPL) might lose its No. 1 market cap status to second-placed Alphabet (NASDAQ:GOOGL). Apple’s market cap at the time of writing the article is $614.01 billion, while Alphabet is at $559.77 billion.
In the last twelve months, AAPL stock is only marginally up by 0.11% whereas GOOGL stock is up by 7.66%. The problem is that Apple’s revenue in 2016 declined by 8%, while Alphabet’s revenue in the first three-quarters of the year increased by 19.65%.There’s a valid reason why the positional switchover might happen. Let's take a closer look.
Market Segments and Valuations
The problem for Apple was that the bulk of their revenue, 63.4%, came from iPhone sales. With smartphone sales growth showing signs of plateauing around the world, the odds of iPhone sales picking up pace over the next few years is quite slim. Compare that to Alphabet’s continued double-digit growth and the fact that online advertising has plenty of room to grow in the future, the difference in the fortunes of both the companies is quite stark.
At this point, one might argue that the valuations of both these companies have already priced in these growth factors, as Alphabet is trading at 29 times its earnings, while Apple is trading less than half of that valuation, at 13.69 times. Clearly, Apple’s valuation looks extremely depressed compared to Alphabet’s, but so do the fortunes of the respective segments they compete in. The market can remain irrational much longer than we can remain solvent, and there is no guarantee that the situation will reverse soon.
Apple’s depressed valuation makes it a great buy at this price point, and the biggest factor that an investor needs to consider is the slowdown in smartphone sales. Though it might sound preposterous, the lack of growth opportunity in smartphone sales around the world is possibly the best thing that happened to Apple and its investors. This has already pushed Apple into a corner, and with smartphone penetration in developed markets at record levels, there are very few new hands left for the company to push their iPhone into. (See Also: AAPL Stock: Apple Inc. Hints At Its Next Disruptive Product )
What Next for Apple?
As a result, Apple has certain options in front of it. The company can now shift its focus to emerging markets, where smartphone penetration is still low. Though the return might be a lot lower than what you normally see in developed markets, this will at least provide some room for growth, albeit at a lower margin level. Apple has already started pushing its low cost model iPhone SE to address this market segment, and it will continue its push in that direction.
Though analyst Ming-Chi Kuo has indicated that there’s no iPhone SE refresh coming in March 2017, there’s no reason for Apple to discontinue the model. His argument is that Apple wants to maximise margins and prevent the SE from cannibalising potential iPhone 7 sales, but markets like China and India will still have room for SE sales through next year, which Apple can’t afford to let go of.
Now that it is acutely aware of the state of the market in developed countries, the company has no choice but to accelerate its innovation process to make its newer models irresistible to buyers in the United States and other developed markets.
In addition, the company may want to make refresh cycles as short as possible, with the possible exception of iPhone SE for early next year. And the only way to do that is by producing better phones than ever before, which will push the company to its limits when it comes to innovation. No more incremental innovations like iPhone 7 vs iPhone 6S, because it is just not going to cut it any more. And we’re not just talking about next year’s iPhone, dubbed iPhone 8. The company must think beyond its 10th anniversary edition of the iconic smartphone.
Furthermore, as the company fights for its smartphone sales numbers, it also will scramble to build its alternate revenue streams that run through its services portfolio.
Case in point is the way Apple started focusing on Apple Pay’s rollout. After the launch in October 2014, Apple Pay was available in United States and United Kingdom by the end of 2014, and then added Canada and Australia in 2015.
But in 2016 when the smartphone sales slowdown shocked the company, Apple Pay was rolled out in China, Singapore, Switzerland, France, Hong Kong, Russia, New Zealand, Japan and Spain. That’s nearly nine countries in twelve months, and it's clear that a lot more will be added in the next twelve months.
Apple’s services revenue was the only bright spot in the company’s financial reports last fiscal, growing by 22% from $19.909 billion last year to $24.348 billion. It still accounts for little more than ten percent of their overall revenues, but a proper ecosystem that can add value to its loyal customers will go a long way in keeping those customers inside Apple’s world, eventually making sure that the company’s moat is as good as it can be.
The Edge Remains
Now throw in the fact that Apple captured nearly 91% of the smartphone industry’s profits in 2015, it’s amply clear that a lot of companies that are selling smartphones today won't be around five years from now.
Apple has a cash generating machine in the iPhone, and the innovation and applications that it brings to the table will be unbeatable in the market, creating a huge lead for the company over time. If such a company is selling at 13 times earnings, the best play would be to add them to your portfolio because the market hasn’t valued these strengths into its current pricing, which seems to reflect the current revenue growth rate and not the inherent strength of the company that will serve them well over the years.
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