I knew it when I saw the first iPod ads back in 2004. You may remember the monochrome animation ad featuring the rock band U2 — it was slick. I knew then and there that Apple would have a hit on its hands with the iPod.
Sure, there were plenty of other high-quality MP3 music players. But sales are about marketing, and with that U.S. ad, Apple made MP3 players fun.
Of course, I had no idea just how successful Apple would be…
The iPod paved the way for the iPhone and the iPad. Now, Apple is the biggest company in history. It’s worth nearly $700 billion. And as of July, it had an incredible $203 billion in cash in the bank. So much cash, in fact, that it started to pay a dividend, and it regularly buys back its own shares.
Apple has something like 35% of the cell phone market share. And yet it makes +90% of all cell phone profits.
Over just the past five years, Apple has averaged 22% earnings growth a year, an amazing feat for such a large company.
And yet despite this 10-year run of uninterrupted growth and product success, Apple stock trades with a forward P/E of 11. In other words, it’s valued the same as Cisco, even though Apple is growing three times faster. That’s why nearly all analysts are bullish on the stock and routinely give it price targets between $170 and $190.
At ~$115 a share now, you’d think the potential for a 65% gain would be enough to get investors interested.
But a lot of investors remain skeptical that Apple will still be around and selling 10 million phones a month in 10 years. After all, tech cycles change pretty quickly. Miss just one, and you get left behind.
Is It Really Just a Fad?
Consumer fads are notoriously hard to predict. Take the ugliest shoe ever made, Crocs (NASDAQ: CROX). It started as a curiosity 10 years ago. The stock ran from $12 to $75 as the shoes got really popular. But less than six months later, the shares were below $2. I guess people realized Crocs weren’t cool at all — just ugly.
We’ve seen retailers like Abercrombie & Fitch (NYSE: ANF) go from $7.50 a share to $80 and back to $20 as consumer tastes change. Yep, consumers are both fickle and loyal.
So what’s so great about an iPhone? Fundamentally, it is not that much different from a Samsung phone or an HTC phone. And Apple’s iOS operating system isn’t significantly better than Google’s Android operating system, which powers the vast majority of cell phones.
And remember, too, that both Nokia and Blackberry were dominant when the iPhone came along. Why shouldn’t we expect some new upstart to come along and knock Apple out of the game?
The answer is: because no one can do it profitably.
Take Samsung. It sells 75 to 85 million phones a quarter. And last quarter, Samsung phone earnings were down 28% to $2.8 billion. Apple sells 40 to 50 million and earns 10 times more than Samsung in profits.
Apple is winning by dominating the profits. There is simply no incentive to compete. But why? Why is Apple able to dominate so completely if the product isn’t significantly better?
The answer has to do with a move the company made back in 2008. And because of this move, Apple has the potential to dominate any electronic market it wants to enter: TVs, watches, even cars.
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The Move That Made Apple
In 2008, Apple bought a boutique microprocessor company called P.A. Semi for $278 million. P.A. Semi made chips that were extremely energy efficient.
Then, in 2010, Apple bought Intrinsity for $121 million. Intrinsity was known for making high-speed chips.
Apple then built a chip design and its “A” series of chips, which is essentially the CPU for Apple devices. This chip, now A9 in the new iPhone 6s, now shows better performance than Intel chips.
And the A9 chips give Apple an advantage that no other company has: The A9 chip and the iOS operating system will power all future Apple electronic devices. The R&D has already been paid for. Now it’s gravy. That’s why Apple is winning.
It would cost Samsung billions to design and build its own chips along with the software to run them. Same goes for an automaker…
Back in the spring, an Apple executive said, “The car is the ultimate mobile device.”
Here’s a quote from a recent article by Steve Cheney:
Components from the smartphone market now power almost all other markets, giving Apple’s in-house team a comparative advantage as they enter new product categories, like wearables and electric cars.
Everything smart in the car originates from a mobile device. It will run the same software and use the same chips as the iPhone and the Watch and the Apple TV. An Apple Car could be almost exclusively Apple under the hood—Apple software running on Apple silicon using Apple materials. Other car makers will be effectively running off the smartphone supply chain using a version of Android that Google promotes for cars…
When think about the potential Apple has to dominate new markets from a profit standpoint, you start to see that Apple is not a fad — it’s a company like the world has never seen before. Apple has become almost a monopoly without being monopolistic…
The First Trillion-Dollar Company
There are plenty of analysts out there who think Apple will be the world’s first trillion-dollar company. I am one of them. It’s inevitable.
Consider that in the third quarter, Ford sold $35 billion worth of cars and trucks. GM sold around $38 billion. Operating margins run around 5%, and part of the reason is that automakers have to buy components from third-party OEMs. Apple won’t have that problem, at least when it comes to the electronic systems.
That means Apple will immediately enjoy better profit margins than any of the traditional automakers. And the car can give Apple a meaningful boost in revenue.
It’s rumored that Apple wants to have a car ready by 2019. That’s just a little over three years from now.
Until next time,
Until next time,
Briton Ryle
@BritonRyle on Twitter
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
