A Professional Viewpoint on Apple Versus Google

By Alexander Cho – May 23, 2013 | Tickers: AAPL, GOOG, YHOO | 0 Comments

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Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Why is Google (NASDAQ: GOOG) catching up in valuation to Apple (NASDAQ: AAPL) even though Apple trades at a fairly attractive earnings multiple? The issue investors have with Apple is that Apple’s business sustainability is called into question. Technology is known for having fads. Whereas Google has a fairly predictable advertising business model that it can fall back on, even if it fails to stimulate any substantial growth from its Google Play Store, Google+, Google Fiber, and Motorola Mobility. Apple investors are making an all-in bet on Apple’s ability to sustain growth from consumer electronics and computers. The debate of whether Apple can or cannot stay a competitive player in the space continues, but it seems that the data overwhelmingly supports both a strong investment thesis in Apple and Google.

Google valuation

Source: Ycharts

Investors have been aggressively chasing after Google over Apple. Google’s market capitalization increased by 26.10% since the beginning of the year whereas Apple’s declined by 21% over the same period.

Google’s ad-word and ad-sense business are likely to generate consistent growth. Google’s advertisement services are the best in the world for small and medium sized businesses looking to accomplish non-sales-selling. Many of the software and services in the world are sold relying upon Google advertising because it isn’t sleazy; it’s effective and cheap. Having a company show up in a banner advertisement through Google’s ad-network, or showing up in search results as a relevant search topic is a subliminal way to get into the target-markets mind. When you land on a website you’re not bombarded by annoying sales-reps, rather the company presents a product/solution that may appeal to the consumer, and perhaps the consumer will purchase the product.

Some software companies have been able to avoid the need to hire a sales force due to the effectiveness of using Google advertising. The less over-head the more money a company can make. Many micro-entrepreneurs make a living creating and selling apps on the Google play store. No matter what, Google seems like an enabler to product innovation and exploiting inefficiencies in traditional business. The company in essence has a proven product strategy that is unlikely to change anytime soon.

Where will Google’s growth come from?

Source: Data from International Telecommunication Union with the data from 2012-2020 forecasted by Alex Cho

While it is true that Google’s search services have been kicked out of China, I believe that the world market for the internet hasn’t been fully saturated. I created a conservative estimate using the average rate of percentage growth to determine the internet penetration rate on an international scale. I assume that, by 2020, the number of internet users will at least exceed 4 billion users.

Analysts predict that because the number of internet users will consistently increase it is, therefore, likely that Google will be able to sustain its growth. What contributes to the optimism is that Google has been aggressively investing into growth opportunities like Android, Google Fiber, and Google Glass. Wearable computing may take-off unexpectedly, if not Google can roll-out fiber-optic internet across North and South America in order to sustain higher rate of growth. Ultimately it is highly likely that the company will be able to sustain higher rates of growth which is why investors are willing to price the earnings at a 27.1 multiple.

Yahoo! (NASDAQ: YHOO) has been able to hold onto its market presence with Google in search and banner advertisements. Unfortunately, the demand for banner ads has declined. Facebook has been stealing markets share from every web-based advertising company in the space.

Yahoo! reported a 6% decline in display based ads year-over-year in its latest quarterly earnings release. As a result, Yahoo! is in search of alternative business models to pursue. Yahoo! is potentially considering a buyout of Hulu, which may increase its display advertising revenue and could grow into an extremely lucrative enterprise, similar to what happened to Alibaba.

Is Apple’s valuation justified?

Apple’s growth in Smart Phone sales wasn’t enough to keep analysts on board the company. The competition in the space heated up as Google was able to unify phone manufacturers under a robust Software platform. This helped to keep companies like Samsung, HTC, Sony, and LG market competitive with Apple.

Source: Apple

Apple in its latest quarterly earnings release reported a 3% gain in year-over-year revenue from its Apple iPhone. The potential market saturation of the Apple iPhone is what keeps investors from investing into Apple. However, the good news is that unit growth was at 7%, which implies that Apple’s gross margins for the quarter declined rather than the demand for smart phones. To be fair, Apple spent an additional $2 billion in marketing related expenses. Apple is spending additional capital into advertising in order to sustain its competitive advantage. The effects of its advertising can be reflected in its 2.7% market share gain, which ComScore quantifies.

Apple is investing capital into advertising while gaining market share in an environment of increasing smart phone adoption. This can be further supported, by IDC estimates that the smart phone market will double between 2012 and 2016 to an incredible 1.4 billion units annually, and Gartner estimates that the tablet market is growing at an even faster rate from 125 million units in 2012 to a projected 375 million by 2016.

Conclusion

While I don’t disagree with the fact that Google’s growth is predictable, which is why it merits a higher earnings multiple. I also believe that Apple’s advances in market share along with the un-tapped growth opportunity still left in smart phones should keep investors optimistic of Apple’s future. It also helps that Apple is investing aggressively into marketing its products while having plans to deploy a lower cost alternative to its traditional iPhone in the Chinese market later this year.

Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google.