Brian Grosso's  Instablog

The Most Followed Company in The World

Most of you who are reading this article scrutinize Apple (AAPL), keeping up on the company on a daily basis. Apple is the most heavily covered company in the world. One doesn't have to go very far to figure this out. Right now on Seeking Alpha, about 145,000 people get email alerts for Apple.

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The next highest is Google (GOOG) at 60,000 subscribers, less than half that of Apple.

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As far as analyst coverage, Apple also wins by a long shot. A quick look on Yahoo Finance revealed that 48 analysts' estimates were included in Yahoo's analyst consensus for Apple versus 36 for Google.

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All these people watching the company have been pretty bored for the past month and a half as very little new information has come out about the company. The company hasn't filed a report of any kind with the SEC since March 1st and it is well known to be one of the most secretive companies out there today. Apple started becoming very secretive under Steve Jobs to protect leaks of innovative information and possibly delay copy-cat product development from rival tech firms. The strategy has been very effective and so the company continues to operate that way.

The lack of factual information has led to hardcore rumor spreading and speculative discussion among Apple followers. I find this unsurprising. I figure when 150,000 people have interest in the same thing and are all easily able to communicate with each other through a medium (Seeking Alpha), they are bound to find something to talk about.

No News Is Good News

My problem is not that rumors are being spread, its the contents of some of these discussions. I've read various articles that claim that for Apple, no news is bad news. The support for such claims is that Apple needs an innovative product now or it will be doomed to declining margins and profitability.

While I agree that Apple does need a new product to continue to grow, I think it is ignorant to think that the company isn't working on something big right now. Apple spends $1 billion on R&D per quarter; the company better be working on something or I want my money back! CEO Tim Cook also gave a few tip offs of innovation to come in the company's Q1 earnings call. In response to a question about innovation at Apple in general, he said the following:

We are working on some incredible stuff. The pipeline is chock-full, I don't want to comment about a specific product, but we feel great about what we have got in store.

Later on, Gene Munster from Piper Jaffray asked Cook specifically about innovation in the TV market. His question and Cook's complete answer are below:

Gene Munster - Piper Jaffray

Hey good afternoon. Tim, you made comments in the past that the Apple TV experience is dated and Apple wants to fix that problem, if we can take a step outside of the form factor debate whether it's a box or can you just talk in high level how important this market is to Apple, number one? And number two is can you accomplish what you ultimately want to accomplish with the reality of where content is today, and how content is distributed?

Tim Cook - Chief Executive Officer

Gene you're asking me all questions I don't want to answer but let me see if I can find some comments to make that productive. In terms of the product that we sell today, the Apple TV we sold more last quarter than we've ever sold before, eclipsing 2 million during the quarter. It was up almost 60% year-on-year and so there is actually very, very good growth in that product and what was the small niche at one time the people that loved it is a much larger number some of it, I have said in the past this is an area of intense interest for us and it remains that and I tend to believe that the, there is a lot we can contribute in this space and so we continue to pull the string and see where it leads us but I don't want to be more specific.

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I had heard rumors about the 'iTV' up until then but when I heard Cook say, "You're asking me all the questions I don't want to answer," I really began to take them serious. I think Cook side-stepped the question because, as I mentioned before, he and the rest of executive management at Apple are committed to keeping their mouths shut on innovation. They're probably legally bound to do so. The company is that serious about it.

Given that the company has always been secretive of what it is working on, along with the increasing R&D expense and certain tip offs from CEO Tim Cook, I think it is very likely that the company is on the verge of something huge and that those of us that are long just need to be patient and not let the negative rumors sway us from our convictions.

There Was News After All

As I said before, very little factual information has come out of Apple in the past 6 weeks or so. There has been news though, it just didn't come from Apple.

On March 14th, nearly a month ago, Samsung presented the much anticipated Galaxy S IV in New York City. There has been much argument as to whether the S IV is better than the iPhone 5, but one thing is for certain: it could have been a lot worse. Many investors sold out of Apple before the S IV release expecting the new phone to blow the iPhone away and steal market share. Clearly that is not the case. Regardless of which phone you prefer, it seems clear that the phones are both competitive with each other; the iPhone is far from a complete loser. The Friday following the Thursday night of the S IV release, Apple stock jumped up and Samsung stock fell. That's Mr. Market's opinion on the debate.

The Blackberry (BBRY) Z10 release was very similar to the S IV presentation for Apple. The Z10 was finally released in the US on March 22nd. Sales were initially less than expected and the product received less than stellar reviews. According to CNET, the Z10 is "not quite enough to draw committed iPhone or Android owners." On the day of the release, Blackberry stock dropped nearly 10% and hasn't rebounded since. Apple stock also jumped on this day. Another hint from our good friend Mr. Market.

Conclusion

Despite very little factual information regarding Apple coming out in all of March and April until now, there have been several bullish signs for us investors to pick up on. It seems that in March and early April, no news was good news for Apple. We'll have some news coming soon though in a few weeks on Tuesday April 23rd after the markets close as Apple will release its Q2 earnings results. I look forward to the day. It's about time we got something to get excited about!

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Google (GOOG) and Apple (AAPL), two of the most well known public technology companies in the world, are routinely compared without hesitation by investors these days. Sure they are similar to a degree, but equating the two is a dangerously ignorant mistake that could really hurt investing performance. I believe that the best investments are often made in businesses that the investor thoroughly understands. Thorough understanding is hard to come by, but you know when someone possesses it. When someone is read up on a company's annual reports and can summarize the company's lines of business and most recent events in a few minutes and act on all the information, I become convinced of their knowledge. This is the kind of understanding I have sought in my investments and tried to develop of both Google and Apple. In my search, I have found that the two companies are very different and probably are compared way too often. In this article I will begin to go about differentiating the two companies to aid fellow investors interested in both.

Google

Google is a company that seems determined to do just about everything (or at least try). The following is in the company's 2012 annual report:

Our product development philosophy is to launch innovative products early and often, and then iterate rapidly to make those products even better. We often post early stage products at test locations online or directly on Google.com. We then use data and user feedback to decide if and how to invest further in those products.

The company has no problem releasing a product that still needs work and then perfecting it once it is already out there for consumers. A good example of this is Android. Android is an open source mobile operating system developed by Google. It was first released in late 2007 and several new versions have been released (iterations) since then. Android versions are named using code names of dessert foods that begin with sequential letters of the alphabet. The first widely commercialized version was Android Cupcake and the current version is Android Jelly Bean. The version naming system indicates that Google anticipates more improved versions in the years to come.

Maybe an even better example of this ongoing process of product improvement is Google Search. Originally created in 1997 by Larry Page and Sergey Brin, Google Search is what started the company. To this day Google Search is still the central product in Google's portfolio. Since being created the product has been changed countless times and perfected while being used by consumers at the same time all along.

Google also has a case of 'corporate ADD'. The company exists in many different segments. The following is a comprehensive list depicting the company's various products and segments:

1. Google Search
2. AdSense
3. AdWords
4. Google Display
5. DoubleClick
6. YouTube
7. Google Mobile
8. Google Local
9. Android
10. Chrome OS
11. Google Chrome
12. Google+
13. Google Play
14. Google Drive
15. Google Wallet
16. Google TV
17. Gmail
18. Google Docs
19. Google Calendar
20. Google Sites
21. Google Maps
22. Google Earth
23. Motorola Mobility
24. Google Glass

I believe the reason for this multitude of products is the nature of Google's development process. Google understands that it doesn't need every one of its products to be a hit for the company to succeed. 5 to 10 big winners is enough. Because the company releases products earlier on in the development process than other tech companies, we know about more of them. The company doesn't usually sink too much money into any one idea. Rather it makes many small bets, hoping for a big winner. Google is the equivalent of a diversifying investor with plenty of resources and an open mind. The strategy has worked so far. Through its strategy, Google has discovered Android and Chrome, both of which are probably underestimated for their contributions to the company's bottom line. Although they don't contribute much on their own, they both have been vital to Google Search's continued popularity on new technological platforms.

Apple

Apple has a very different development strategy. When Steve Jobs rejoined the company in 1996 he immediately worked to eliminate the company's plainest products and narrow the company's focus to its best ideas. Below are a few quotes from Walter Isaacson's Steve Jobs that illustrate the wind of change Jobs brought:

"What are the five products you want to focus on? Get rid of the rest, because they're dragging you down. They're turning you into Microsoft (MSFT). They're causing you to turn out products that are adequate but not great."

"Jobs insisted that Apple focus on just two or three priorities at a time. "There is no one better at turning off the noise that is going on around him," Cook said. "That allows him to focus on a few things and say no to many things. Few people are really good at that."

"So that's our approach. Very simple, and we're really shooting for Museum of Modern Art quality. The way we're running the company, the product design, the advertising, it all comes down to this: Let's make it simple. Really simple." Apple's design mantra would remain the one featured on its first brochure: "Simplicity is the ultimate sophistication."

In Apples Q1 2013 earnings call, Tim Cook signaled that Jobs' philosophy is still alive at the company, saying, "We could put the Apple brand in a lot of things and sell a lot more stuff, but that's not what we're here for. We want to make only the best products."

If we look at the segments and products that Apple offers, the list is significantly shorter than that of Google, despite Apple being the larger company:

1. iPhone
2. iPad
3. Mac
4. iPod
5. iTunes
6. App Store
7. iCloud
8. iOS
9. OS X
10. Application Software
11. Displays & Peripheral Products
12. Apple TV

Apple continues to focus on a few products to prevent dilution of efforts, resources, and the company's brand image on subpar ideas. The company's development process is equivalent to a focus investor, almost like Warren Buffett. Buffett, through his perch at Berkshire Hathaway (BRK.A), is always on the hunt for what he calls 'elephants,' attractive investment ideas that he can allocate plenty of capital into so that they are worth his time and efforts. Similarly, Apple sifts through the hundreds of ideas that it is inevitably presented with and puts the ones it likes most into production.

The iPhone is proof that the focus strategy works. In 2012, the iPhone alone contributed $80 billion to the company's revenues. A single product driving Apple's success so much shows why the company focuses.

Apple also tends to wait to release a product until it is perfect. Sure they iterate nearly every year but I would argue that Apple's product iterations are more a business move than developmental. The new product versions provide big boosts to sales but are not usually all that different from the products that preceded them due to the fact that the product was largely perfected before the first generation product was even released. A good example of this is the iPhone. The latest version of the iPhone, the iPhone 5, isn't all that different from its predecessor, the iPhone 4S. It has a slightly larger screen and a new charging adaptor but not many other material differences and the same basic appearance and functionality. In the company's latest earnings call, an analyst grilled Tim Cook about iPhone screen size. Cook replied: "The iPhone 5 offers as you know a new 4-inch Retina display.. for iPhone customers without sacrificing the one-handed ease-of-use that our customers love." Cook mentioning one handed ease of use and customers is evidence of Apple's strategy. The company will make slight variations to products like the increase in screen size, but not do anything drastic that would make the product less appealing to the majority of its customers. If no change is worth making, the company won't make a change solely for the sake of change. This is why most of Apple's products look so similar. The design works so there is no reason to change it.

Conclusion

So what is the use of all this information. Well as an investor, I want to own a company whose vision and strategy aligns with my own. Since I am a focus investor and a perfectionist who advocates optimal capital allocation, I own Apple. Other investors who sport a strategy of diversification and an open mind may find Google more attractive.

The other use of this article is to begin to differentiate the two companies. Far too often, they are equated to each other when they are really quite different. I see no harm in basic comparisons but the comparisons I've been hearing have been more than just that. I also think many will find that even if you only are interested in Google or Apple, reading about how one is different than the other will be more effective than if I were to just say something like "Apple focuses on a few products" or "Google diversifies." The qualities are strengthened through differentiation. I hope to follow this article up with more focusing on other points of differentiation. Stay tuned.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

It's Apple picking season! Apple's (AAPL) recent fall from its high of $700 in September is something to get excited about if you're a value investor. This is a quality company at a cheap price. It has many of the characteristics that Peter Lynch, Warren Buffett, and David Dreman- three of the most respected investment strategists of our time, look for in a company. So what do they look for exactly?

Peter Lynch

Peter Lynch is an earnings guy. He focuses on the bottom line and how it has changed in the past and will change in the future. He looks to buy companies that sell at a P/E that is significantly lower than the historical and projected EPS growth rates. In the past 5 years, Apple has grown earnings 60% annually. In the next 5 years, Apple is projected to grow earnings at 19% annually, a conservative estimate given the company's track record, but because of the loss of Steve Jobs, the sheer size of the company now, and the fast-paced, unpredictable industry that Apple operates in, we will go with 14%. Apple trades at a P/E of 10.43, lower than both these growth rates. From this, one might see Apple as somewhat undervalued, but maybe not providing a large enough margin of safety to warrant investing. That's not the whole story though. Peter Lynch also subtracts net cash and investments from market cap in his P/E calculations. Since the investor is essentially getting these resources as a bonus and can expect the money to either be reinvested to grow earnings or distributed in the form of dividends or stock buybacks, it makes sense to calculate stock price in such a way as to favor companies with tons of cash. Apple certainly has tons of net cash and investments, $137 billion to be exact. When we subtract this number from market cap and adjust P/E as a result, we get a P/E of 7. That's half the fair value of Apple if we were to price it based on estimated earnings growth at a P/E of 14. You'd be hard-pressed to find another company the size and quality of Apple priced with a 50% margin of safety.

Warren Buffett

Warren Buffett is more of a qualitative investor. He looks for companies with a durable competitive advantage; what he calls an 'economic moat.' The moat surrounds and protects a company's business from competitors. I believe Apple certainly has a competitive advantage. Some qualitative proof of its competitive advantage is the app ecosystem Apple has built up. It serves as a barrier to entry into the smartphone and tablet markets for other technology companies like Microsoft (MSFT) and BlackBerry (BBRY), because these companies lack app ecosystems to unlock the usefulness of their products. More people own iPhones and so it is more profitable for app developers to develop for iOS because their apps will get more publicity and downloads, and they as a result will make more money for their efforts. Apple also makes many apps in-house and has been very successful in doing so. Google's (GOOG) Android operating system also has a vast app ecosystem but Apple has proven that it can be quite profitable even with a small percentage of the smartphone market, roughly 21% in Q4 of 2012. While were talking about Google, it seems relevant to mention that the company pays Apple approximately $1 billion per year to remain the default search engine on iOS devices. Even Google is investing in Apple's future. Going forward it looks like the smartphone market will continue to be a duopoly between Android and iOS and I think Apple can continue to be profitable in that environment. Another competitive advantage of Apple's is their other digital content stores. ITunes recently sold its 25 billionth song. The biggest competition to iTunes is Spotify, Amazon (AMZN) Music, and illegal peer to peer file sharing. The Federal government has made many efforts recently to reduce illegal file sharing. The efforts have had some success, but it's important to recognize that consumers have been doing this since before iTunes existed and yet still the store has risen to the tremendously profitable level it exists at today. Users of torrents and Amazon Music also typically still use iTunes software to manage and transfer their music. This is what really gives iTunes some staying power. As long as iTunes is still the preferred content management software it will have a competitive advantage on other content stores because it is easier to download straight through iTunes without having to transfer content to another service. Spotify does pose a threat to Apple, but not as much as many people think. Spotify is pretty different from Apple in that it is a subscription service whereas iTunes is structured so that you pay only when you download new content. With Spotify, when users stop paying for the subscription service, all of their downloaded content is deleted whereas with iTunes, the content is permanently owned by the user. This fundamental difference has split the market by payment preference. Users like one or the other. There are barriers to entry because iTunes, Spotify, and Amazon Music have such massive collections of content that other competitors cannot compare with and will not be able to without throwing tons of startup money into their service and negotiating with plenty of musicians and other content creators. I see this situation as very similar to the iOS vs. Android situation in that these services will probably continue to profit and maintain their market share. Another moat of Apple's is provided by the ecosystem of Apple products. Through iCloud and Apple TV, the consumer can view and transfer content across Apple products very easily. Many Apple products also operate very similarly. If you know how to use an iPhone, you will have very little difficulty operating an iPad or iPod Touch. No other technology company has a hardware ecosystem comparable to this. Microsoft has tried to do so by making Windows 8 the operating system on both PCs and their mobile devices but the attempt hasn't been very successful. The final competitive advantage I think Apple possesses is brand power. Customers associate the Apple brand with quality and ease of use and the brand has a very loyal consumer base. People swear by their Apple products. What's amazing is how successful the company has been in building up its brand with very little advertising expenditures. Apple did not pay for Super Bowl ad this year like Samsung and Microsoft. You don't really see too much Apple advertising today. That's not to say they don't advertise, just not all that much compared to their competitors. The company spent $1 billion on advertising in fiscal 2012 compared to $156 billion in revenues. Compare that to Samsung who spent $4 billion on advertising in 2012. (click to enlarge)

The numbers speak for themselves. Apple also enjoys a higher net profit margin than its competitors, including Google and Samsung. Warren Buffett has always said that a higher profit margin is a fundamental sign of a competitive advantage. Many investors believe Apple is just another technology company living from product to product, but these competitive advantages suggest the company is in a much more powerful, stable position than people think. Warren Buffett also is big on free cash flow. He disregards earnings in his valuations, preferring free cash flow, the money that goes into improving the value of a business. Based on fiscal 2012 FCF, the company trades at a P/FCF of 10.1. Whether you value Apple through EPS of FCF, its undervalued.

David Dreman

David Dreman is a contrarian investor. He looks to buy quality companies when everyone else is selling them. A true value investor is able to go against his instincts and buy when he is emotionally uncomfortable but logically confident in a company's value. A few good measures of how a stock is being traded are RSI and moving averages. Generally when a company has an RSI under 40, it is considered oversold. Likewise, when a stock is trading significantly below its short term moving averages it is also considered oversold. Apple currently has an RSI right around 40 and trades about 20% below its 200 day moving average.(click to enlarge)

Not only is this stock oversold right now, but it's also very volatile. 3% price daily price changes are becoming typical of the stock. The price has declined 35% in less than 5 months. That is a very big move for a company the size of Apple. The stock price seems to be incredibly dependent on market sentiment, which lately has been changing quickly and often. Normally value stock picks take time and patience to appreciate - sometimes as much as 3 to 5 years. In Apple's case, I wouldn't be surprised if the move up only took a few months. I believe market sentiment will shift dramatically when Apple announces a new product release, which could be quite soon considering the company's large cash reserves and increased R&D budget. We're already hearing rumors that 100 of the company's best designers and engineers are working on the iWatch and the iTV isn't so far away either with those in the know suggesting late 2013 as a time to expect an announcement. In March the Apple TV is expected to be opened up to outside developers through SDKs so it could replace the Xbox and Playstation as the king gaming console.

Concluding Remarks

So what are Apple's critics saying? The biggest criticisms of Apple right now are slowed earning growth, lack of innovation without Steve Jobs at the helm, and increasing competition. It's true that earnings growth will be slower in the future. A company already earning over $40 billion cannot repeat past growth. Yet the company and analysts still believe the company capable of achieving 19% growth in the next 5 years. That's plenty more than the P/E of 7 we calculated before. Even if you don't believe 19% is likely, at 10-14% growth the company is still significantly undervalued. As for the absence of Steve Jobs, he was a very big part of the innovation at Apple, but he didn't do it alone. Much of the credit is due to Jony Ive, the lead designer of all of Apple's well-known hardware, both when Jobs was around and now. Jobs wasn't known for accepting the ideas of others, but he accepted plenty of Ive's ideas and they all worked out wonderfully for the company. CEO Tim Cook isn't much of a product guy, but he is a supply-chain genius and is often not recognized for the fact that he basically was CEO in the last year and a half of Jobs' life. Jobs picked him as his replacement. Plenty of talent is in place. Competition is increasing but as noted before, Apple has plenty of competitive advantages that provide protection against new competitors. The fact is that at a net P/E of 7, Apple is priced for the worst case scenario and then some. I am amazed that a company of this size could become so undervalued an irrationally priced. Some of the most respected, intelligent professionals in the investment community have openly said how undervalued they think the company is. Aswath Damadoran, the Business Valuation professor at NYU's prestigious Stern School of Business, has said that Apple is worth at least $600 per share. David Einhorn of Greenlight Capital has about 13% of his portfolio in Apple and added to his holdings in the most recent quarter before Apple even got down to $450. George Soros bought in as well. I personally think the company is about 50% undervalued and worth as much as $900 per share but it all depends what you assume Apple's growth percentage will be going forward. If you believe the analysts, then Apple deserves a P/E of 19. As previous calculated, Apple's net P/E is stands around 7 now after accounting for all that cash. So if you believe the analysts, then Apple is even more than 50% undervalued. I do recognize that there is some uncertainty here and that the stock is unlikely to appreciate that much, but it doesn't have to go up 100% to provide an outstanding return on investment. Even half of that is more than impressive for a few years. Google trades at a P/E of 25 with a forward P/E of 15. Even Google's forward P/E that is probably based on far from conservative earnings estimates is still over double the net P/E of Apple. There is no way around it- Apple is cheap, really cheap. Its also a really good company. That is what value is all about.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no positions in MSFT, GOOG, AMZN, or BBRY, and no plans to initiate any positions within the next 72 hours.