Why Does Apple Seem Worse Than Amazon Now?

| About: Apple Inc. (AAPL)

Often, there are times that the stock market does not make sense to people. There are several good examples, just in recent times. The flash crash is one of them. You could even look at David Einhorn's crusades against Green Mountain (NASDAQ:GMCR) and Herbalife (NYSE:HLF). The stocks each got crushed when he questioned them. To many, Einhorn is just one guy. They may ask why he has so much influence on individual stocks. Regular people and investors don't understand how events like these happen. All they see is the impact on their portfolio(s), which usually, is after their stocks have dropped.

Now, there is something today that investors may look at and question, Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN). These two companies are going in completely different directions right now. One is rapidly growing both revenue and profits, while the other is struggling just to be profitable. One has sky-high margins, the other doesn't. One is beating estimates because of its high sales and cost controls, the other is beating estimates because of investment gains. One is trading at a very low valuation, while the other's valuation is so high, it is close to the temperature water boils at. I kid you not.

Yes, Apple is firing on all cylinders these days. It is selling tens of millions of iPhones each quarter, the new iPad has sold well and it is gaining market share in the product. Margins are at historic highs and growth is plentiful on both the top and bottom line. On the flip side, Amazon is struggling just to be profitable, Kindle Fire sales have slowed dramatically, and its recent earnings report was very questionable. So why is Amazon up dramatically since the report and Apple is basically flat? Well, the street would tell you that Apple is worse than Amazon right now. I'm here to tell you that's not the case. Let's look at Amazon first.

Amazon: Going the wrong way?

Recently, Amazon reported its first-quarter results. Amazon beat estimates, but that is only after expectations were lowered so much at the Q4 report. Amazon's quarterly revenue rose from $8.7 billion last year to $11.25 billion this year, but net income plunged from $201 million to $130 million over that time. Even worse, if you take out "equity investment income," something I covered in my recent Amazon article, net income really dropped from $218 million to just $41 million.

This week, research Firm IDC reported that Kindle Fire sales plunged in Q1, falling to about 4% market share from nearly 17% in Q4. Apple's market share from the iPad rose from 54.7% to 68%. Overall tablet sales were lower than expectations, thanks to a steep drop in Android-based tablets offset by Apple's strong sales.

Another hit came this week as well when Target (NYSE:TGT) announced it would no longer sell the Kindle. Target, like many other retailers, is looking to prevent the "showroom" effect. That occurs when customers go into the store, look at an item, like the Kindle, and then buy it elsewhere, perhaps online directly from Amazon. The above mentioned report even suggests that Best Buy (NYSE:BBY) could even dump the Kindle. Don't forget, we found out last year that Apple would launch some mini stores inside select Target locations. Target is making the smart move, going with the company that is doing well.

Despite all that I've just mentioned, Amazon shares have risen from $196 before earnings to Friday's close of $224. In fact, shares nearly hit $234 earlier this week. Amazon earnings estimates have been taken down to $1.18 for this year, meaning that the company is trading at nearly 190 times this year's earnings, nearly double the valuation it was trading at late in 2011. Do earnings matter? I have argued no in the past, that Amazon trades more off price to sales, but seriously, every time I mention the name, the valuation is higher and higher.

Apple - The real place to be:

Ok, so if you didn't see what Apple announced with its latest quarter, I summarized it very nicely here. Apple announced a revenue number roughly $2.5 billion ahead of wall street estimates, and dead on my prediction. Earnings per share were more than 20% ahead of estimates, and a couple of dimes ahead of my estimates.

Apple sold more than 35 million iPhones in the quarter. In fact, Apple sold more iPhones per week in Q2 than it did in the 14 week, holiday Q1. I haven't heard anyone mention that fact. With Apple selling so many iPhones, contributing a higher percentage of revenue, Apple's margins hit new multi-year highs. Apple's gross margins were up nearly 6 full percentage points over the prior year period. That is incredible growth when many other major technology companies are struggling to keep margins just flat year over year. Apple's operating margins were up more than 7.3 percentage points year over year, and net profit margins were up about 5.4 percentage points. Apple is getting close to 50% gross margins, 40% operating margins, and 30% net profit margins. As I have mentioned before, Apple's net profit margins are about 25% higher than Amazon's gross margins.

Yes, Apple does sell more than just iPhones, although iPhones did account for nearly 58% of revenue in the quarter. Apple did show yearly growth in Mac sales, up about 7% despite many appearing to hold off purchases, waiting for newer versions to come out, possibly as early as this quarter. iPod sales were down 15% year over year, but many analysts were expecting a much steeper drop.

Apple also saw iPad sales soar, with the number sold up more than 151% over the prior-year period. Apple released a new iPad late in the quarter, and it sold well. That should lead to a great Q3 for iPad sales for two reasons. First, the device will have a full quarter to sell, instead of just a few weeks. Secondly, the iPad did not go on sale everywhere during Q2. There were a few countries in the Asia-Pacific region that won't get their hands on the device until this quarter. Apple sold 11.8 million iPads in Q2, and I think even the most conservative street estimates have about 13 million being sold in Q3.

Now to be fair, I did mention recently that I expect some margin contraction in Q3 from Apple. I currently expect iPhone sales to be flat to slightly down quarter over quarter, and we know that iPad sales should be very strong. Mac sales should be up too, and we might even see a quarter-over-quarter increase for iPod sales. Because of that, the iPhone will be a lower part of the revenue percentage. That will take down margins a little, but that could be offset if Apple is able to keep the cost of its products low, and it has been squeezing every dollar out of suppliers recently. Despite the fact that margins should contract a little, the increased revenue should help earnings per share be fairly close to the Q2 numbers. Be warned, however, that expectations for Q3 are going to be high. Analysts already are calling for $10.28 and I think that they will get closer to $11 by the time Apple actually reports. Apple will beat, but probably not by as much as it has the past two quarters.

Apple is expected to post revenue growth of at least 50% this fiscal year, with earnings per share growth to rise even more than that. Amazon is only expected to post 32% revenue growth this year, and earnings per share should be flat to possibly even down. Apple clearly is growing faster. Apple is trading at just 14 times trailing twelve month earnings, while Amazon is trading at more than 180 times the past year's earnings. Going forward, Apple is trading at about 0.6 times the expected earnings growth of the company for the next five years. Amazon is trading at more than 6 times that figure. Apple does trade at a higher valuation on price to sales, at 3.82 times trailing twelve month sales (compared with just 2.01 times for Amazon), but since Apple actually has earnings, price to sales doesn't seem like a comparable metric. Is Apple undervalued or Amazon overvalued? I, like many, would say both.

Oh, and don't forget, starting next quarter, Apple will start paying a dividend and repurchasing some shares to stop the impact of executive option dilution. Once those dividends are declared, expect some new money to come into the name.

So to summarize, Apple has much better growth, much higher margins, is making a ton of money, has multiple premier products, a very low valuation, and will soon be paying a dividend. With the Q2 report, Apple reinforced why it is the most powerful name in the market right now. So much for those rumors about the demise of the iPhone after poor activation numbers from U.S. carriers.

But after all of that, Apple is up less than $5 since it reported earnings. Yes, that is less than one percent higher than it was before it reported earnings. The name has been following the path of the markets lately, but it shouldn't be. Apple is the best, and probably should be trading over $600 right now, not near $565. I even purchased some on Friday as I thought the post-earnings pullback was just wrong. Right now, the street is saying that Amazon is better than Apple, and that is clearly not the case. This recent pullback in Apple shares is a tremendous buying opportunity, and I encourage investors to take advantage of it.

Disclosure: Author long AAPL at time of writing, but may exit position at anytime.