Over the past year or two, the tech and finance world have seen a massive debate over the future of the smartphone landscape. Some think the flexibility of Google's (GOOG) Android OS will allow it to increase its already large market share. Others think the integrated experience of Apple's (AAPL) iPhone will continue to gain market share, while maintaining a near-monopoly on profits among smartphone vendors.
Then there is the continuing controversy over the prospects of Research in Motion's (RIMM) Blackberry franchise. Some investors believe that the company has a good chance to reignite sales with its upcoming Blackberry 10 OS, leading to a turnaround in the next few years. Others are convinced that the company is dead (as is the new operating system).
Similar stories abound regarding Nokia (NOK) amid its shift to Microsoft's (MSFT) Windows Phone OS, even though U.S. sales of the new Lumia 900 have been quite strong.
As an investor, I don't want to get too wrapped up in these debates. I know that I don't have a competitive advantage at predicting what the 2017 smartphone landscape will look like (let alone the 2025 smartphone landscape), when there is no consensus amongst industry watchers on this question. Based on the available data, I can make pretty good guesses about what will happen over the next year or so, but beyond that the future is quite hazy.
Fortunately, you don't need to have perfect foresight to make money investing in the smartphone sector. This is a market where it's hard to judge how the horses will perform over the long term, but easy to know that they're going to run quickly! IDC predicts that the global smartphone market will total nearly 1 billion units in 2015. Thus, I follow (and recommend) an "all of the above" strategy regarding companies with significant smartphone exposure. There's no need to bet all of my money on one "horse", when I can pick several companies and have the same exposure to the industry with less risk.
Today, I'm recommending three stocks that have significant exposure in smartphones, but very different market positions: Apple, Nvidia (NVDA), and RIM. Each of these companies has significant growth prospects and trades at a compelling valuation today. While one may underperform the market, I am quite confident that an equal-weighted basket of the three will outperform the market over the next several years.
Everybody knows the Apple story, so I won't belabor the point. Apple has shown phenomenal growth in sales and earnings over the past few years, primarily due to the iPhone (and to a lesser extent, the iPad). It seems like analysts always see a slowdown in the growth rate right around the quarter. This simply allows Apple to continue beating expectations, fueling further growth in the share price. The primary catalyst I see for Apple is the likely addition of China Mobile as a carrier partner at some point during FY13. As the world's largest wireless provider, China Mobile is a huge opportunity for Apple to maintain strong revenue growth. Additionally, most analysts expect a very strong iPhone 5 upgrade cycle beginning this fall.
Nvidia has exposure to the smartphone market through its Tegra line of mobile processors and its new Icera line of software-based modems. If Tegra fulfills its promise, the mobile business will overtake Nvidia's graphics chip business a few years from now. Tegra has grown rapidly to date, but is still considered a relative disappointment, as Qualcomm (QCOM) has maintained a dominant share in the third party processor market, while top smartphone vendors Apple and Samsung seem content to make their mobile chips in-house.
However, by next year, Nvidia will be offering an integrated modem/processor, which will open a much larger market segment to the company. Furthermore, the company recently scored its first design win for a standalone modem, in the ZTE Mimosa X. Nvidia seems to realize that it needs to offer integrated solutions in order to compete effectively with Qualcomm.
While Apple and Samsung seem to be out of the picture as potential customers, more than half of Android smartphones are made by other manufacturers, and Nvidia has one or more design wins at the vast majority of these vendors. Since the company trades at a very low valuation currently (40% of its market cap is cash), there is huge upside here as Tegra and Icera evolve to compete in the mainstream smartphone market.
RIM is a very controversial story at this point, with most industry watchers feeling very bearish about the company's prospects. However, I do not believe that carriers will be satisfied with a duopoly in the smartphone market, and that gives RIM (as well as Nokia) some breathing room to execute its turnaround. I'm willing to admit that there's some chance RIM will go under in the next few years (though that's not what I expect). Even in that scenario, stockholders should be able to recover the company's tangible book value (currently about $13, nearly 20% above the current stock price).
On the flip side, RIM shares have tremendous option value, because the stock has been so depressed lately. If the new BB10 OS is successful and manages to stabilize RIM's smartphone market share at a relatively modest 10%, that would still equate to 100 million units annually by 2015 (based on IDC's forecast). Even with ASPs substantially below those for the iPhone, that sales level could push EPS back above the historic highs of FY11 towards $10/share. Even if this is a relatively low likelihood scenario (5% chance? 10% chance? It's hard to say.), the possibility of a very high return (as much as 10X in the next 4-5 years) justifies a small position in a balanced portfolio. I would not bet the house on RIM, but I would include it in a bet on the smartphone industry as a whole.
The broader point here is that you can position your portfolio to benefit regardless of who "wins" the smartphone wars. By maintaining some exposure to each of the top three ecosystems (Android, iOS, and Blackberry) - and possibly also Windows Phone - you can mitigate the risk inherent in a fast changing industry, while still capitalizing on secular growth in smartphones.
There are, of course, other stocks that you could pick rather than the three I have highlighted here. However, I like Apple, Nvidia, and RIM because they each have room to expand their market share from present levels, and because they have strong balance sheets.
