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Why is Apple's P/E So Low, Part 2

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Several readers and bloggers have responded to Why is Apple’s P/E So Low? and have justified Apple’s low P/E.  The following are their views and my commentary.

“Apple P/E is low because Steve Jobs died.” Let’s look at the numbers.  First the stock has appreciated since Steve’s resignation and death.  When Steve resigned on August 25, 2011, Apple’s stock price was $365. On October 11, 2011, when he passed away, Apple traded at $378.  Today, Apple trades at $607.  Although many predicted that the stock would fall apart upon Steve’s departure, it has not.  In fact, Apple has reported its two strongest quarters since.

Apple has many elements that feed into its success, aside from Steve Job’s marketing genius, vision and exactitude.  Apple has developed extremely user-friendly software to interface with its elegant designs.  Apple has introduced to the world an irresistible retail experience, such that going to Apple stores is like going to an event.  And, most importantly to investors, Apple has been able to achieve margins in technology hardware never before accomplished by another technology vendor through persistent, diligent, and relentless supply chain management.  Steve Jobs did not accomplish these feats single-handedly; Steve was the face for the strong and deep management team he assembled and that has initiated and executed on these activities.

What Steve uniquely brought to the table, in addition to vision and exactitude, was his genius marketing to create that magical distorted reality to convince the world it could not live without functionality which it had not previously seen.  That said, Steve Jobs was so far ahead of the rest of the world in his ability to market.  Even if Tim Cook can only ignite 50% of the enthusiasm Job’s did (and I think Tim Cook has exceeded that), Apple is still way ahead of its competition in terms of marketing.  Can you recall a Samsung ad? A Samsung Keynote address?

“Apple P/E is low because the iPhone is trailing off.”  Again, let’s look at the numbers.  Just two years ago, Nokia dominated the smartphone market, yes, the smartphone market not just the mobile phone market, with 39% market share.  (Numbers from IDC worldwide shipments.)  The number two vendor was Research in Motion with almost 20% market share.  Today, as of Q1 2012, those two vendors combined have less than 15% of the market and Apple has 24% of the worldwide smartphone market.  The only other vendor to continue to increase its market share is Samsung, which in the last reported quarter, was estimated by IDC to pass Apple at 29% market share.  Note, other market analysts put Apple at a higher market share in Q1 because Samsung does not release unit sales and these must be estimated.  The estimates vary.   Even the Apple naysayers must agree that Apple and Samsung have taken over a market previously dominated by other vendors.

And, the smartphone market continues to expand.  IDC forecast in March that smartphone sales would grow to 1.16B units by 2016 from 494M units last year.  Smartphones still represent the fastest-growing and biggest segment of the “mobile connected devices” category.   The market is growing and Apple is a leader in it.

Furthermore, it is unlikely that Apple is rolling over.  Again, aside from Samsung, no other vendor is increasing its market share or posing a threat to the iPhone.   There are announcements and rumors of new competing products by Microsoft, Google, Facebook and Amazon.  However, so far, there is no data to show these products will be successful.  And there is one major reason why all of these potentials and all of the existing competitors will have difficulty against Apple, including Samsung:  Apple’s Ecosystem.

Apple product owners on average own 2.6 devices.  This means that the ability to sync contacts, calendars, documents, photos, whatever seamlessly over iCloud or play music and print documents wirelessly over AirPlay is a huge benefit.  It is reasonable to believe that the switching costs of an existing iPhone user are extremely high and that it is unlikely for one to switch unless there is an overwhelming advantage to do so.  So far, the price differential or any “newer” tech features have not been enough to entice Apple users away.  In fact, Apple users are amongst the most brand-loyal consumers.  Gfk reported that 84% of iPhone users would get another iPhone, followed by 60% of Android users would remain loyal.  However, GfK also points out that brand loyalty is enhanced and reinforced by the more services (read ecosystem) of a brand.  Apple appears to be doing all the right things to entrench its position.  In fact, I have written about the impact of the ecosystem in this article. 

“The Market for Apple Products is Limited/Saturated.”  I disagree here also on two counts.  First the markets are growing, and second, there is a replacement cycle.  Smartphone growth was discussed above.  The tablet market is growing exponentially.  According to Gartner, the tablet market was 60M units in 2011, and will grow to 655M units in 2016.  That is over 10-fold, and Apple's iPad is forecast to remain the market leader.  And this only discusses the iPhone and iPad, and does not address potential new products, such as a television-like device or Mac sales.  Apple’s Mac computer was the only brand to increase sales in the US in 2011; all other brands declined.  The same phenomenon held true in Q1 2012, and has held worldwide.  Apple now has over 5% of the worldwide market, remarkable considering the price point.

There are risks in Apple stock, as with any investment.  The questions here are not whether or not there are risks, but whether or not these reasons justify Apple trading at a discount to the S&P.  Apple’s P/E of 10x implies the market believes Apple will grow 10%.  However, Apple is currently the market leader in two of the fastest-growing markets, smartphones and tablets.  Even if Apple grew only at the rate of these categories, or even slightly less (categories in created, by the way), it will still grow at a rate greater than the 10% implied by its P/E.  It remains difficult, in my opinion, to justify the current P/E.

See also Why is Apple's P/E So Low, Part 2 for readers' and bloggers' justifications for Apple's P/E and my responses.