After all the buildup over the past couple months to last Friday's launch of the iPhone, the clearest winners are Apple's shareholders, who have seen a 35 percent jump in the stock since April. In fact, Cowen and Company estimates that the price jump has added $24 billion to Apple's enterprise value in that time period (when the stock went from $90 to $122, as of the close on Friday), meaning that the market thinks the iPhone alone is worth two-thirds the enterprise value of Motorola and one-third that of Nokia. (Enterprise value is slightly different than straight market value because it takes into account debt and other liabilities). To put that into perspective, Apple hopes to sell 10 million iPhones in 2008. Nokia and Motorola together are expected to sell a combined total of 650 million cell phones. In a note technology Cowen sent out on Friday, it cautions:
We smell a lot of retail participation in this process.
That is code for the average investor, suckers like you and me who have been watching too many iPhone ads on TV as opposed to the Wall Street pros who supposedly look at the market dispassionately through the cold logic of their spreadsheets.
The analysts at Cowen also made another observation. Over the past two years, Apple's stock (AAPL) and Google's stock (GOOG) have tracked each other very closely) see chart at right). But there's been an extreme divergence since April (see chart above). Since Wall Street always assumes that stocks revert to the mean, Cowen suggetsts this is a great signal to dump the overhyped Apple shares and pick up more Google shares, which deserve at least the same mobile Internet premium as Apple. As the note puts it:
The PE ratios on Google and Apple are now identical – a sharp departure from past experience. Should Apple and Google trade at the same valuations? We think the correct answer to this question is “absolutely not”. Growth, risk and return are the holy trinity of corporate financial performance. Google trumps Apple in all 3 categories
After all the search on the iPhone's Safari Web browser is powered by Google, as are some of its other applications. And Google Mobile works on any phone. To the extent Google can serve up mobile search ads, its margins will be much better than Apple's.
What Cowen does not explain, though, is why the stock price of Apple (a digital hardware manufacturer) historically has been so closely in sync with that of Google's (a search advertising company), or why it should revert to that pattern in the future. While it is a fascinating correlation, I'm not exactly sure what conclusions to draw from it. Is it a coincidence? Is it just that institutional and retail investors looking for hot tech stocks gravitate towards Apple and Google? Or does the market somehow know that Google is going to end up buying Apple, so it's been treating them the same, but now it's not so sure anymore?
Even if you buy the theory that the correlation between the two stocks will reassert itself, it does not necessarily follow that Google's stock returns will rise to meet Apple's. It could work out the other way around, and Apple's stock could fall until it gets back in sync with Google's. Either way, Google is a safer bet than Apple right now.
Update: Predictably, this post has generated an outpouring of emotions, as all things Apple and Google tend to do (see comments below). I won't attempt to answer each one, but there are some general points that I will try to address. First and foremost is that Apple is not as invincible as many would hope to believe (for instance, its iTunes store faces the possibility of losing the right to sell songs from Universal Music Group). But to clarify some questions raised in the comments:
—This post is based on a research note from Cowen and Company, a Wall Street investment bank. I think it is an interesting and noteworthy analysis, but I am not sure I buy it completely (see the last two paragraphs above).
—The correlation between Apple and Google shares goes back two years (see the small chart above), and diverges about two months ago (see the big chart above).
—The $24 billion enterprise value ascribed to the iPhone is just what's been added in the past two months. This is the figure that was compared to Nokia and Motorola, so it is an attempt to make an apples-to-apples comparison. While the 10 million iPhones Apple is projecting it will sell in 2008 are much more expensive and higher-margin than the estimated 650 million cell phones they are expected to sell next year, the math still does not add up. Even if you assume the average price of a Nokia or Motorola phone is $55 (it's probably higher), and the average price of an iPhone is $550, those ten million iPhones would translate to the equivalent of 100 million Nokia and Motorola phones, not 650 million.
Cowen actually does an analysis that goes out five years as well, estimating that Nokia alone will ship 2 billion phones over that time. With an enterprise value of $76 billion, the market today is paying $38 for each of those phones. Based on the $24 billion enterprise value and 90 million iPhones shipped over the next five years, the market is paying $267 for each iPhone, calculates Cowen. You can double or triple the estimate of iPhones Apple might sell over the next five years, but the numbers are still out of whack (even after you figure in the higher value each iPhone rightly deserves).
—The P/E ratios cited by commenter Luke (45 for Google and 38 for Apple) are based on trailing twelve-month earnings. If you look at projected earnings, as most Wall Street analysts do, the P/E s are about the same (28 for Google, and 29 for Apple).
—People might buy Apple because of the software, but it makes its money selling hardware. While it does have higher net profit margins (15 percent) than, say, Dell (7 percent), its net profit margins don't come close to Google's (27 percent).