Apple Stays Fresh

For our inaugural issue of Smart Tech Investor in December 2013, we selected Apple Inc. (NSDQ: AAPL) as “The One Tech Stock to Own in 2014.” Our reasoning at the time was that Fed tapering of its Quantitative Easing program would create a very different investment environment in 2014, one which emphasized profitability over revenue growth.

We also said that we thought “2014 would be the year that separates the sizzle from the steak, leaving in its wake an equal number of winners and losers.” So far that prediction has also held up, as the tech-heavy NASDAQ Composite Index is up a meager 2.4% through the end of May as the result of big gainers such as Apple being offset by big losers (see Amazon.com (NSDQ: AMZN), 3D Systems (NYSE: DDD), etc.).

In selecting our one tech stock to own in 2014 we very quickly narrowed the list down to two companies that we felt offered the best combination of income, upside potential, and limited downside risk: Apple and Verizon (NYSE: VZ). We felt their ability to generate huge cash flow would allow them to continue to innograte while many of their rivals could not.

Recently trading above $92 (which equates to a pre-split price of $644), Apple stock is up more than $11 a share (post-split) from the date of that article (12/16/2013). Much of the gain has occurred during the past two months, due primarily to a better-than-expected quarterly earnings report released in April, which confirmed Apple’s dominance in the Smartphone market.

Apple is doing another smart thing in that they had a stock split (7 for 1) this month which has reduced the cost of the stock substantially. For retail investors, the importance of this cannot be overstated. Large mutual funds and other institutional investors are already major shareholders of Apple so the split doesn’t matter to them since they can afford the stock at any price. But this will matter greatly to individual investors who prefer to buy stock in “round lots” of 100 shares.

In the laptop arena Apple has gained market share solidly for the last six years. Its market share was 3.75% a few years ago and just recently topped out at slightly more than 8%. Apple’s plan has always been to integrate all of their diverse products into their laptop and desktop products. At a time when Microsoft’s share in PCs is falling along with overall sales in the segment, Apple is growing.

Apple continues to grow because of the level of innogration surrounding their laptops. Though 8% sounds like a paltry number for overall market share, do not lose sight of the fact that Apple – unlike the PC plug makers like HP and Dell – has a healthy profit margin baked into their prices. Therefore the value of well-integrated products has continued to hold these margins in a market which is getting smaller for all other players in the market.

Apple still holds the major share of the tablet market, despite the onslaught of cheaper and much more poorly integrated tablets from other comers. Though tablets don’t sell for similar prices as laptops, Apple’s domination produces much greater profit dollars than the competition. Apple’s share did decline 1% from the prior quarter but, again with the profit built into their tablets, they don’t have to be in the cut-rate razor margin business. This is all investors need to know.

In the least expensive category, Apple still maintains 80% of the market share in selling music that is  downloaded. Since there is no actual product to be built – only incremental servers are required to be deployed to continue selling music – one could argue that virtually every penny they get is basically profit less royalty payments to the artists.

In the smartphones category Apple maintains its lead as the number one US OEM maker of smartphones with 41% share. Samsung comes in second at 27% in the US as Apple is working a deal to sell their smartphones through the largest cellular companies in China. Again, Apple’s products command a higher margin.

The reason Apple bests all competitors is they integrate every feature with every product they bring to market. They develop part of the solution, license another portion and then, through smaller acquisitions, acquire the last little pieces they can’t design and build themselves or cross-license.

My daughter is well aware of the “cool factor” with the latest hip function in Android, but neither she nor her friends will relinquish their iPhones in favor of something from Samsung. In my case, corporate security requirements force me to maintain strong passwords on my smartphone. Bottom line: Apple has the only corporate-approved fingerprint security solution amongst all smartphones. This means I won’t switch from an iPhone anytime soon. Truthfully, I know the product well enough that I doubt I would ever switch; who needs to learn about a new phone operating system when I don’t have to?

Apple also has some new acquisitions that will be released into their ecosystem in the future. Furthermore, it appears they will venture into new payment systems and compete with PayPal and others. What are the odds these new products from Apple will be totally integrated and far superior than anything else in the marketplace? What are the odds that Apple will take share away from competitors the way they did with iPods and cell phones? We think the odds are very good, and that is why we rated Apple as our top pick for the likely increasingly turbulent 2014 and 2015.

Verizon, like Apple, is a cash machine. They sell ring tones, smartphones, tablets, TV access and Internet access – all without owning or developing any of the content. The costs for Verizon are small. The larger costs have always been in the size of their leverage. They will be buying out Vodaphone’s share of the company this year.

Verizon does face renewed competition from AT&T; however, the coming price competition has been slow to materialize and the price cuts from the competition have also been incremental rather than cutting prices in half or something on a more dramatic scale.

Verizon built their innogration model around innovating their telecommunications infrastructure by adapting it to licensed products they resell. They then doubled down on the reliability and speed which the competition does not have cash to build or replicate. The strategy was unique 10 years ago and is paying good dividends today, both as a real dividend to shareholders as well as a strategy which runs circles around the cellular competition.

It was for this reason STI ranked Verizon as the second best buy for 2014. If Verizon can break out of the low $50 trough they have been in for a while, shareholders may not only be pocketing 4+% dividends but stock price growth a year ahead of schedule.

Apple is currently rated a ‘hold’, and Verizon is now being added to our Investments Portfolio up to $54.