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

Investing in the Future of Mobile Devices Part 2 – Components and Software

This article also appeared at The Motley Fool.

In Part 1, I covered a couple of device makers along with CPU and graphics chip makers. In Part 2, I’ll cover software and the components that matter the most.

After all nobody cares if they have a dual core or quad core or 1GHz or 1.5GHz processor other than geeks like me. What people care about is how cool the display looks and how easy is it to get to the features they use most or what software ecosystem.

Let’s start with screens. There are few screen manufacturers that can make mobile device screens in large volumes. They are Samsung, LG, Sharp and Japan Display. Japan Display is a jointly owned by Innovation Network Corp of Japan, Sony, Toshiba and Hitachi. Samsung is the largest maker of mobile displays amongst these, followed by LG. Sharp as a company is in trouble but they do have good screen technology and potential investment suitors in the form of HonHai/Foxconn and Apple. Samsung Display was recently spun off as an independent but still wholly owned subsidiary of Samsung Electronics. LG Display (NYSE: LPL) is a publicly traded company but it is 38% owned by LG Electronics.

Next up – memory. This is just one more category (NAND Flash) where Samsung is the largest manufacturer. This is getting to be a theme. Samsung is the world’s largest manufacturer of a lot of things. Anyway next in line after Samsung are Toshiba and Micron (NASDAQ: MU) and SK Hynix. Micron is quickly closing in on second place Toshiba as it breached the 20% market share barrier last year.

As for Flash cards, Sandisk (NASDAQ: SNDK) is the largest manufacturer followed by Samsung, Toshiba, Transcend and Kingston (2011 rankings). Flash manufacturer rankings are a complicated mess which is evident from the glaring absence of Sandisk from the general NAND flash rankings above. So it all depends on how you look at it.

Other than Flash Memory (the quoted number 8GB, 16GB, 32GB etc. for phones), phones also have RAM (which is similar to the memory on your computer). Another top spot for Samsung, followed by SK Hynix, Eplida and Micron. So the same old. Which is strange considering the top spot for all DRAM (including PCs) is held by Kingston.

 

The five year chart for all US traded companies mentioned above shows memory makers faring better than LG Display. However, looking at their income growth doesn’t look promising. The stock prices have been rising a lot faster than income.

 

Let’s look at operating system software next. Smartphones and tablets run mostly on iOS and Android. The other operating systems in the running are Blackberry, Windows, Symbian and Samsung Bada. Nokia still makes Symbian phones but is slowly turning that into the featurephone OS and Windows into their smartphone OS.

As iOS and Android dominate and Microsoft tries to muscle in, the future of anything else including Blackberry is uncertain. So investing in the future of mobile software presents you with the obvious choices of Apple and Google along with Microsoft. I would consider Research in Motion (NASDAQ: RIMM) a risky proposition until Blackberry 10 devices hit the market at which point the response to those would be a good judge of the continues survival of the company. If the reaction is anything like the reaction the Windows Phone 7, that would spell doom for RIMM. Symbian is officially being gimped as Nokia is betting on Windows. In fact as of now even the future of Nokia is uncertain, but they just might make it. I will not bother you with the depressing charts for either of them but lets just say you should avoid them unless you have a tolerance for risk. Let’s just say Apple, Google and Microsoft, all of which I’ve covered previously are your only real choices for investing in software.

In Part 3 I’ll cover more device makers and mobile applications.

Disclosure: Long AAPL, GOOG, 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: Microsoft

This is part of my series on Tech Stocks. So far I’ve covered Amazon and Apple. Next on the list – Microsoft (NASDAQ: MSFT). This article is also available at The Motley Fool.

Windows 8 has generally been positively reviewed on touchscreen devices (Windows Phones and the Surface Tablet). The new breed of Windows Phone devices, such as the Nokia Lumia and HTC 8X are top notch. However, as a desktop operating system, Windows 8 has been mostly panned and the biggest criticisms have been the lack of a start menu and a confusing mix of Modern UI (aka, the interface formerly known as Metro) and traditional Applications. My personal opinion about Windows 8 adoption being slow is that it was to be expected. Many enterprise customers are still just getting used to Windows 7. Nobody wants to switch to a new operating system so quickly, especially one that is more of a radical leap than usual. I have no doubts that eventually Windows 8 or maybe Windows 9 will be a major player across devices, but Microsoft is more than just the desktop.

Looking at the enterprise side, we use SQL Server at work, and with the newest versions from my personal experience, SQL Server is easier to use and manage than Oracle (NASDAQ: ORCL), while matching it in capabilities. Also, Windows is a very capable server Operating System, and Hyper-V seems to be very capable as a virtualization platform compared to VMWare (NYSE: VMW). From a developer standpoint, there is still nothing that beats Visual Studio.

Microsoft’s largest segment, the business division (which is Office and Outlook/Exchange) is doing just fine. There really is no alternative to that combo. The online alternatives to Office such as Google (NASDAQ: GOOG) Docs have some time to go before they can really replace Office/Exchange for the enterprise.

Microsoft’s online division is also gradually reducing losses. The entertainment and devices division still managed to eke out a slight profit in spite of the significant investments Microsoft is making in Windows Mobile devices.

Looking forward, I’d say it will be slower than expected growth for Microsoft on the mobile front. This is based on lower than expected Surface sales and high price of the Surface Pro. Windows Phone sales are a mystery. There is all kinds of conflicting information, with sales ranging from dismal to “strong.” Recently the CEO said the current sales are 4 times sales at launch, but with no real numbers. However, Windows phones are few in number and not so easy to find. Staff at retailers are not familiar with them and there are not enough demo units everywhere for customers to try them. That will change with time, and as Windows 8 propagates and people become more familiar with the Metro interface. Also, Nokia just got a head start on China’s largest carrier against the iPhone5. Windows Phone/RT will be like the XBox, and Microsoft will keep at it until eventually it turns a profit. The Xbox itself is doing spectacularly well, partly thanks to the Kinect.

As for Windows 8 adoption, it will improve as people see the new Ultrabooks. I know I was impressed when I saw the Ideapad Yoga, as were fellow geeks. The flexibility of Ultrabooks is something that Apple (NASDAQ: AAPL) doesn’t have yet.

On the Enterprise front, I believe Microsoft will gain market share. As an Enterprise Application Engineer, I know it is very difficult to switch out Enterprise Systems at any decently sized company, but Microsoft does offer a value proposition. It is not that hard, however, to switch from VMWare to Hyper-V. Also, new deployments might show a propensity to buy the most value for money system.

Microsoft’s online offerings are steadily improving. Maps, Skydrive (which I use regularly), Office 365, Bing, Outlook.com, etc. are all at a point where they are good enough in comparison to the competition.

So all this being said, where do I think the stock is heading? I like the 3.5% yield and I think long term the future is not as dim as analysts indicate. I might open a small position in Microsoft if the stock hits it’s 52 week low of around $25. As such, I see it as a slow growth but good dividend stock. Even though Microsoft’s income has risen, the stock has done nothing for 10 years:

I expect Microsoft to reach $35 in the near future (next three years), with a slow increase in income and consistent dividend growth.

Disclosure: Long AAPL, GOOG, NOK

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