As former market darling Apple
) has seen its stock price continue to fall, it has increasingly piqued the interest of value investors. At a market cap of $450 billion and twelve-month earnings of over $40 billion, Apple's P/E is barely over 10. Considering the company has no debt and cash equivalents of almost $140 billion, the valuation appears very compelling indeed.
But Apple is now officially growing slower than its market, suggesting others (including rival Samsung) are eating some of its lunch. Could this be a temporary situation, allowing the long-term investor the opportunity to purchase a company with a moat at a discount?
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It wasn't long ago that Research In Motion (RIMM) found itself in a similar position. I know this from first-hand experience, because I started buying shares in the maker of this once ubiquitous product far too soon as they fell from grace.
What happened to RIM and what may be beginning to happen to Apple appears to be a characteristic of this fast-changing industry; one has to continually innovate just to stay in the same place.
Contrast this with the industry Microsoft dominates: operating system and the Office suite of products. Microsoft hasn't innovated much in the last 15 years, but it has still shown enormous profit growth because of the nature of its industry. Network effects take massive precedent over innovation. Many companies could probably (and some have) created more intuitive, faster designs. But without a network of existing applications (or documents) that can run on such a platform, most users have shown an unwillingness to switch from Windows (or Office). As a result, breaking Microsoft's grip on this industry has thus far proven impossible.
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Does Apple enjoy the same kind of moat? Certainly it does to some extent. The range of apps available only to Apple products undoubtedly offers some advantage, along with the brand appeal that this company has cultivated. But absent substantial innovation, it may not be enough of a moat to ward off future declines. Samsung is already demonstrating that the Android platform is proving good enough for an increasing number of new phone buyers/upgraders.
Also consider that RIM enjoyed some very similar advantages when it dominated the scene. I overestimated the strength of these advantages when I purchased shares far too early. Specifically:
1) The network effects of BBM were easily overcome by the features and functionality that the iPhone offered over the clunky Blackberry (at least they did in the US; in countries where network charges represent a higher share of income, BBM has helped RIM hold its own)
2) Security and corporate customers did not force professionals into keeping their Blackberries; in fact, the opposite occurred, with BYOD advocates pushing corporations to open up to different platforms.
3) Economies of scale in the form of R&D and marketing spend per unit that market leaders usually enjoy appears to have been worth little; in this industry, the innovations appear to come from superior processes, not dollars.
The one competitive advantage that existing firms do appear to enjoy in this industry is barriers to entry. It has proven very difficult for newcomers to innovate their way into a decent market position, as this requires simultaneous relationships with carriers, developers and consumers, something that appears difficult to build-up all at once. This feature of the industry has likely saved RIM from bankruptcy, and even kept it in a position where it may once again succeed if it can out-innovate its limited number of competitors in its next product cycle.
While I don't expect Apple to fall behind technologically to the same extent as did RIM, risks to Apple's strong current position remain. In this industry, the market leader can be toppled to "also-ran" in a hurry. So while Apple is clearly cheap compared to its recent earnings and earnings capacity, a value investor may require more of a margin of safety than normal, considering that downside risks are particularly high in this industry.
Disclosure: Author has a long position in shares of RIM