Rethinking Apple and Amazon – All About The Cash

This article also appeared on The Motley Fool.

Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN) could not be more different in their corporate philosophies regarding profits and cash. Amazon spends almost every dime it earns, keeping the net profit down as close to zero as possible. Apple, on the other hand, keeps most of it as cash that just sits around doing nothing. As an investor, one would like some kind of balance of cash hoarding, returning that cash to investors, or reinvesting it in the business. So these two extremes make an interesting comparison considering the market reaction after earnings season: Amazon continues to rise, while Apple continues to drop.

So far, I’ve been of the opinion that Apple is a better investment, because it makes money — lots of it. However, Apple just hangs on to it, and then it does nothing for the company. Apple just started giving a minimal amount of that cash back to investors via dividends and buybacks, but not enough.

Also, Apple invests less in R&D (notice how even troubled Nokia outspent Apple) than most of its competitors. So it’s not even investing seemingly enough of its money back into its own business.

In fact, every few days someone writes an article on how Apple can use their cash better. Even I can think of a few suggestions, like doubling its dividend, becoming vertically integrated like Intel, or investing more in different lines of products or faster product update cycles. Not pursuing this latter strategy, and sticking to its guns on fewer product options, had been costing Apple market share to Android devices, which offer more size, storage, screen, and technology options.

Now, Amazon, on the other hand, has relatively little cash on hand. It chooses to invest heavily in expanding its infrastructure. Logically, the primary reason to run a business is to make money. If you are running a business for that purpose, the best thing to do with money earned would be to invest it back in the business — exactly what Amazon has been doing, and exactly the opposite of Apple. Most quarters, Amazon revenue is growing faster than the growth of overall online retail, which means it is taking market share.

Looking at both the stocks from this perspective, Amazon can look like a better investment, because it seems to believe in its business more than Apple does. Of course, Amazon is an extreme case. Most tech companies hoard cash. But almost everyone seems to be managing it better than Apple.

Just to see whether this theory held water – I made a chart looking at gross profits instead of net — because as far as Amazon goes, its microscopic net margin doesn’t seem to matter to investors. I’m generally all about the net profit, but to offer some insight into Amazon’s meteoric stock price, maybe the gross profit will work better.

Looking at the chart, Amazon looks like it is increasing revenues and gross profits, while consistently keeping constant gross margins. Amazon doesn’t look bad at all until you factor in the net income.

So Apple has Amazon beat in everything except stock price. This means that as far as Amazon is concerned, this extreme spending for expansion at the expense of current profit is desirable to investors, because Amazon is doing something useful with its cash. And that means that everybody expects Amazon’s strategy to pay off at some point. Amazon does have a lot of room to grow, which might be true considering their revenue is still only 12% of that of Wal-mart.

So even though subjectively there might be some logic to “Amazon misses but stock soars“, there is relatively less logic, looking at the chart, to Apple’s stock drop. However, looking beyond the chart. Apple can be seen as the opposite case of Amazon.

In spite of having more cash than it could ever need, Apple is losing marketshare to the plethora of Android devices. Apple possibly needs to spend more and get ahead, instead of resting on their existing laurels. So you could say that their cash is mismanaged. They have too much, and are neither giving it back to investors, nor investing it in their business.

I’m still long Apple for now, and avoiding Amazon, though. I’m not sure how long Amazon can continue making no money . It has been going at this strategy for a long time, and it is time to start making more money. Apple seems to learn its lesson, just like it did with the iPad mini. There’s still plenty of market for Apple to enter into, even with existing products.

Disclosure: Long AAPL, INTC, NOK

A Techie’s Guide to the Future of Tech Stocks: Google

This is a part of a series of articles that covers the biggest names in technology from a dual perspective of an advanced consumer and an investor. So far I have covered Microsoft, Apple and Amazon. Next up is Google (NASDAQ: GOOG). This article also appears at The Motley Fool.

In my coverage of Amazon (NASDAQ: AMZN), I mentioned considering it a retail company as opposed to a tech company. On the opposite end, Google is a real technology company. Their primary business is selling eyeballs on the Internet. To do that, they provide you with the best in class free services on the Internet: the best free search, the best free email, the best free maps, and also the most widely used and, in many eyes, best mobile Operating System – Android.

On the plus side, unlike Amazon, Google makes lots of money doing this, and their income is growing steadily:

This is despite significant investments over the years in products and services that go nowhere and giving employees 20% time to work on whatever they wish. Maybe the growth comes thanks to, and not in spite of, those two factors. Just like a venture capital company throwing money at several promising companies in the hopes that one of them will make it big, Google throws it at several projects and employee ideas.

Google’s thought process is also fundamentally different from other large companies. Get the audience for a product first. Money will come later. Now that’s what I said about Amazon, but the difference lies in the fact that Google is not primarily in the business of shipping products to customers.

Looking at Google’s Financial Statements will clearly signify what I mean. They break down their financial statement by: Google.com, Partner Network, “Licensing and Other” and now Motorola. The Licensing and Other makes up a minor component of the business, and the Motorola business is further broken down into Mobile and Home segments. Essentially, other than the Motorola component, Google primarily makes money by either selling ads on its own sites or on partner websites. And it doesn’t break it down by site or service or product which, in my mind, means that it doesn’t matter; eyeballs are eyeballs after all. Google will keep on making its services better and offer more services so it gets more eyeballs and visitors and clicks. That is also the reason that it gives away Android. More services, more products, more eyeballs.

Looking forward, my expectation is for Google to keep growing steadily. The competition in online services like search (Bing), maps (Bing, Nokia, Mapquest), email (Hotmail, Yahoo) etc. might be competitive, but Google is still the king. Yahoo is slowly dying. Their lack of care even for their prime properties shows clearly. Microsoft is constantly playing catch up in online offerings and is yet to make any money on those. Apple is on the warpath with Android and Google, but the maps debacle shows that competing with Google is not easy in online and mobile service offerings. Android has been steadily improving faster than iOS and even though Google makes very little money on it presently, that is bound to improve. There are places where Google is playing catch up, like in social networking with Facebook. However, overall Google is the king of the Internet.

Google also invests in various tangential and unrelated products like making a self driving car, fiber to the home, potentially selling power etc. My hope is that eventually some of these wil be viable, money-making additions to Google’s portfolio of products. I’m sure none of these are money making operations yet, and under normal circumstances companies would have been penalized for non-core efforts like this. Investors do not like “wasting” money after all. But this is Google. Remember: customers first, money later.

I’d say the stock is fairly valued with a TTM P/E of 22, compared to Microsoft at 14.5 and the Vanguard Technology ETF at 15 because of comparatively faster earnings growth expectations. I would also like to issue one warning about Google: dropping margins. So far earnings have grown despite this, and my personal opinion is that the situation will improve once the dust settles on the Motorola acquisition and insane competition in the mobile and cloud space.

A Techie’s Guide to the Future of Tech Stocks: Amazon

See my Apple coverage here. This article is also available at The Motley Fool.

There are very few companies that are as universally loved as Amazon (NASDAQ: AMZN) by both consumers and investors. The consumer love is much deserved – getting amongst the best, if not the best prices on everything you can think of and combined with great customer service. Adding Amazon Prime to that and getting free two day shipping, online streaming and more for only $80/year is a steal especially if you buy lots of stuff from Amazon.

And here is a chart that shows what I mean by Investor love:

Can you imagine any other company that has razor thin margins with almost no profits have a consistently high P/E. Currently, the TTM P/E is over 3000. The Forward P/E looks better at about 150, but Amazon is known to make huge investments in hopes of future payouts. How long can this go on?

As Amazon’s net income fails to impress can the stock keep on rising? Personally I wouldn’t take the risk. Maybe the current investors only look at revenue?

So it can be seen that the stock price rise sort of moves in tandem with revenue. I’m always more concerned with net income than just revenue. Price/Sales may be a good metric for startups, but Amazon is far from that. Amazon’s TTM revenue was $57 billion. That pales in comparison to Wal-Mart’s (NYSE: WMT) $464 billion, but at the decent growth rate puts Amazon within spitting distance of Target’s (NYSE: TGT) $72 billion. But both Wal-Mart and Target have better margins than Amazon.

Even though Amazon has technology offerings like cloud services, I primarily consider them to be a retail company and even though they directly compete with Google, Apple, Microsoft and other device manufacturers, Amazon’s primary goal is to move products. And Amazon is very good at it – so good that they are responsible for the death of the bookstore and eventually the electronics store.

In spite of the serious revenue growth, I feel the high P/E is unjustified. What would be a reasonable P/E for a company like Amazon which sits between the high tech and the retail segments? Something in between high-tech and retail? Or is there something special about Amazon? Will they have a massive boost in profits once they reach a certain size? It hasn’t happened yet and I’m not betting on it.

Let’s say for argument’s sake that Amazon deserves a forward P/E twice that of Wal-Mart. That would put Amazon’s price under $50/share. So what is propping Amazon up to 11x the P/E of Wal-Mart? One explanation is that Amazon’s 5 year revenue growth is 10 times that of Wal-Mart. Unfortunately, earnings is a different story. Maybe when Amazon gets to the scale of Wal-Mart, the earnings will catch up. Just maybe.

For now, this is one tech stock where I’m staying on the sidelines.

Disclosure: Own GOOG, AAPL, TGT

A Techie’s Guide To The Future Of Tech Stocks: Apple

As a developer who constantly works with technology, I follow all the happenings in the tech world, especially the mobile world. I also follow the major players’ stocks and I look at them from the perspective of both an advanced user who often needs to support these devices and an investor.

With this series of articles that I will write in combination at this blog and at The Motley Fool (an updated version of this article is here). I’m going to present my opinion on the state of technology at the largest tech companies and the future as I see it. Let me start with Apple (AAPL), the largest player in this market.

I’ve been sorely disappointed by their latest product announcements. Apple has been showing only marginal progress in device specifications and new devices, pig-headedly avoiding standards (e.g. Lightning connector) and iOS is becoming stagnant in comparison to the progress made by Android and features native to other devices such as Windows phones. Also Apple’s legal shenanigans are causing a negative impact on brand image amongst geeks. It is hard to imagine Apple shooting themselves in the foot to spite others but they are doing just that by moving away from Samsung, launching a half baked map solution, low resolution but still very expensive iPad mini. The other thing is Apple artificially restricting the availability of software on older devices like Siri on the iPad2. If the iPad mini has the same guts as the iPad2, what is the problem with getting it on the iPad2?

I have no problems with Apple’s annual launch schedules for devices as long as the devices they launch leapfrog the competition in available features. But their current patterns, initially missing LTE, then missing NFC, missing on the iPad mini screen resolution etc. are not what I would expect from a company with so much cash.

In spite of all this, the correction in the stock was overblown. Looking at the positive, the iPhone is soon to be available on China’s largest carrier and the supply issues will eventually be sorted out. Also Apple has now seemingly no existing product announcement to make in spring thanks to the iPad mini, iPad 4 and iPhone 5 all being recent. This would be an indicator that Apple might possibly announce a brand new product (an actual television) or focus more on their “hobby” – Apple TV. It could also be an indicator that they are moving to shorter product cycle updates.

Apple finally settled with HTC. I am hoping the same happens with the rest of their lawsuits and they finally see the light and get back to making good products. Maybe iOS 7 will have widgets or “live” icons and they will be a “revolutionary” invention and bring iOS into the modern world.

No matter what happens, in the near term I expect Apple to keep growing as they work out supply issues and expand the iPhone to more carriers worldwide. However longer term, the growth machine might slow down unless Apple starts improving their product lineup drastically either by introducing new products or by offering multiple variations of their products like offering top of the line hardware in 3″ and 4″ iPhone and the iPad and iPad mini and not keeping the smaller sized hardware with lesser features.

I attribute at least part of the Apple pullback to growing concern about Apple being able to meet expectations on their devices in the face of stronger and better competition from both device makers like Samsung and Nokia (NOK) and OS makers like Google (GOOG) and Microsoft (MSFT) and Amazon (AMZN).

I am holding onto my Apple stock for a few more years. I might sell small portions if the stock hits 725 in the next 6 months. I think that is quite likely. Let’s look at one rarely used but very useful metric that Apple provides – guidance. Here is a chart of Apple’s guidance vs Reality:

Apple Guidance vs Reality

From the trend it looks like Apple is moving towards more realistic guidance. For next quarter, they provided guidance of revenue of “$52 billion and diluted earnings per share of about $11.75“. So if Apple only meets this estimate, that would imply an earnings contraction from last year where EPS for Q1 was 13.9. Even if Apple beats EPS guidance by 20%, that would imply an EPS of $14.1, which is only a 1.4% increase.

There are two scenarios here:

One Apple is understating EPS and the beat will be higher. Considering that they are saying revenues will be 13% higher than last year, EPS should be 13% higher too putting it at $15.70.

The second scenario would be that Apple has a margin contraction. This is entirely possible if the iPhone5 is more difficult to produce than the reports make it out to be and/or the effect of snubbing Samsung is higher than Apple makes it out to be.

A ratio that I like to look at is how much EPS is improving compared to revenue.

Companies can fake this improvement using share buybacks but Apple is not doing that because their share count has been increasing. Also Apple’s current share buybacks are not expected to reverse this trend only flatten it.

Just a fun statistic a coworker sent me – this year at the University of Virginia there were more Macs (56%) than Windows PCs (44%) amongst moving in undergrad students. So Apple will do fine at least in the short term (next 3 years).

Disclosure: Long AAPL, GOOG, NOK

 

 

Netflix Lunacy Explained

History of Netflix in a nutshell:

  1. DVD By Mail
  2. DVD By Mail with Streaming Added
  3. Streaming with DVD By Mail Added
  4. Streaming and DVD by mail separated

This shows how Netflix completely changed their business model from being a DVD by mail company to a streaming company. Step 3 to Step 4 happened so quickly that Netflix pissed off a lot of its customers and investors and wiped out more than half the value of the company.

Here is my take on their logic. Netflix wants to be a streaming company because streaming is the future. But at this time nobody wants to give them content and those who would give them content want to get paid by number of subscribers.

Netflix: We want your streaming content
Content Provider: How many subscribers you got?
Netflix: 25 million
Content Provider: We want $x/subscriber
Netflix: But a lot of our subscribers don’t stream
Content Provider: But they can
Netflix: But they don’t
Content Provider: Not my problem

At this point a bulb goes off in CEOs head. Ooh what if I could cut that number in half?  What if I can get the non-streaming folk out of the equation? Let’s split the business completely.

Some Customers: We like to do both and you’ve screwed us
Netflix: BooHoo
Customers: Your streaming selection sucks and your DVD by mail is worse than blockbuster and I can also go to redbox. Bye Bye Netflix
Netflix: We’re sorry (read – we’re really not).

A link to someone who explained the customer perspective better than I can

My Take: Netflix had something nobody else had – streaming and DVD by mail and both combined at a reasonable price. Now Netflix will compete with Blockbuster (aka Dish) on the DVD by mail front and Blockbuster doesn’t have a stupid 28 day delay on new releases yet and does not charge extra for Blu-ray either. It will compete with Amazon for subscription streaming and Amazon Prime also gets you free two day shipping on products fulfilled by Amazon. DISH plans to announce a new streaming service on Friday too. Then there are Redbox, iTunes and Amazon rentals. So instead of having no competitors, Netflix now is competing with everyone. And some of those have deeper pockets and more resources than Netflix does. At this point in time the only advantage Netflix has is universal device support but that is nothing a few dollars and a few software updates cannot fix. I wish them luck as I stick with my Blockbuster by mail plan and hold off on streaming. So far Blockbuster has grandfathered me in to my plan and rate even though it is no longer available to new customers. Maybe after Friday DISH will have what Netflix customers had – a discount on streaming and discs combined.