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Apple Hits Peak Profitability

Written By Brian Hicks

Posted July 26, 2010

In case you missed the news, Apple (NASDAQ: AAPL) recently surpassed Microsoft (NASDAQ: MSFT) in market cap.

Revenue is also set to surpass MSFT this year.

It’s even more impressive when you consider the fact that Apple has done it with only 9% of the PC market they set out to take from Microsoft 25 years ago.

The performance of Apple stock over the past decade is enough to make you wish you’d sold your house and piled in. It’s up 3500% from April 2003 levels, when it briefly traded in the mid $6s.

Check out this chart of Microsoft and Apple since 2002:


An impressive run. And there’s no doubt that Apple is a great company with great gadgets.

But the firm’s profitability is likely nearing a peak for this cycle.

iPhone dominance set to fade

The iPhone is Apple’s undisputed cash cow, contributing around 40% of revenue in Q1 2010.

Profit margins are fat — around 60%, according to the New York Times. Those margins are boosted by a deal with desperate partner AT&T, who’s willing to do just about anything to preserve market share (except improve their network, of course).

And so far, Apple has smoked every so-called “iPhone killer” to challenge their dominance.

But all that’s about to change.

Apple has finally met its match with the new generation of Android-powered devices. An army of phones including Motorola’s Droid X and HTC’s Evo are starting to hit the market.

According to Bloomberg Businessweek, Android’s share of the smartphone market is up from 1.6% last year to 9.6% today.

This new generation of phones will finally give the iPhone a run for its money. Motorola’s Droid X, for example, has more computing power and a higher resolution camera. With an app network that can finally compete with Apple’s, the stage is set.

But the biggest factor may be service partners. Verizon and Sprint are betting on phones powered by Google’s Android operating system. They’ve managed to avoid a bidding war with AT&T over the iPhone, choosing instead to focus on building better networks. Now that Droid phones can compete, they’re in a strong position.

Personally, I can’t wait to ditch AT&T. The coverage is miserable, dropped calls are frequent, and mystery charges seem to pop up every month.

For example, a few years ago I looked at my AT&T bill and noticed a $5 late payment fee on the last five statements. Problem is, I use autopay. My credit card info was up to date. Yet they were autocharging my card two days late, every month, and assessing a late fee.

Nice try, scammers.

As soon as my iPhone contract runs out, I’ll be switching to a Droid on Verizon or Sprint.

I’m not saying the iPhone is dead… There are millions of Apple fanboys out there who will never abandon their iPhones.

But the days when it was the only fun smartphone on the market are over.

Higher manufacturing costs going forward

Apple manufactures most of their products in China, where wages have risen 50% over the past five years. Ongoing labor shortages and unrest mean this trend isn’t likely to change anytime soon.

And with the Chinese now allowing their currency to strengthen, it’s only going to get worse.

Companies like Apple — who depend on cheap and efficient labor from China — will see their costs rise. Margins will be squeezed and quality may suffer if manufacturing is shifted to cheaper areas.

Priced for perfection

Like I said, Apple is a great company. I definitely wouldn’t short it, but upside from here is limited.

The competition is finally catching up to them, and their costs are set to rise.

I’d much rather own Google or Motorola. For more on the bullish case on Google, here’s an article I wrote a few weeks back.

Google is up 12% since, and I think it’s got a lot more room to run.

Adam Sharp
Analyst, Wealth Daily