There is no question that Apple has done some amazing things. It has become the largest company in the world, by market value, because it has redefined industries. It redefined the music business, it redefined smartphones and it redefined tablet computing. Apple did not invent these businesses. Most observers would argue that the likes of Handspring/Palm and RIM invented smartphones and stylus-oriented computing devices, including Apple's Newton and Microsoft's Tablet PC certainly pre-dated the iPad. But Apple massively and permanently redefined consumers’ expectations in these markets. While doing so, they built up an incredibly profitable hardware business.
Amazon is a different beast. It, too, has redefined a something -- e-commerce. Amazon makes everyone else look irrelevant, including giants like Walmart. Amazon also re-invented books with the Kindle, and you could argue they re-invented the Internet by introducing all sorts of cloud computing and cloud storage services.
While both companies have been incredibly successful at disrupting past industries, Apple is the one with a track record of doing this profitably. Amazon, on the other hand, doesn’t really make much money at all yet.
Let’s look at some actual numbers, shall we? Here’s how the last 12 months shakes out for both companies according to data from S&P Capital IQ. Amazon brought in $57 billion in sales with operating income of $531 million. That’s slightly less than a 1% operating profit margin. Apple brought in $157 billion in revenue, with an operating income of 55.2 billion. Apple’s operating profit margin is 35%. The difference is nothing short of night and day.
So why is it that Apple’s stock hasn’t actually outperformed Amazon by that much? Year to date, the two stocks are both up about 40%.
Despite the impressive difference in profitability between Apple and Amazon, the web shopping giant enjoys more confidence from Wall Street on future earnings potential. We can look at both companies’ enterprise value to sales ratio to see this.
Enterprise value (EV) is a company’s market value excluding cash and debt, so it represents the value of just the business. A higher ratio of EV to sales means the market values a dollar of sales higher than, say, a company trading at a lower ratio.
Apple’s EV/S multiple is 3.5x, whereas Amazon’s is 1.85x. Amazon should trade at a lower multiple considering its operating margin is just shy of 1% while Apple’s is 35%. But Amazon’s EV/S ratio trails Apple’s by half.
Let’s put this in perspective. If Apple holds its profitability ratio constant, Amazon would need to improve its profitability ratio by about 18x for Wall Street to be paying an equivalent value for a dollar of sales by either company.
I don’t actually think Amazon is overvalued here. That’s just my opinion, but I see a lot of value in what they are doing to build a long-term profitable platform on which to conduct e-commerce.
The market has more future confidence in Amazon because it seems easier to justify. Amazon’s profit margin is next to zero, and seemingly has way more upside (as they scale) compared to Apple. After all, Apple could face pressure from the onslaught of Android devices and from Amazon’s own Kindle Fire platform.
If you think about how Apple implemented the App Store, it changed the way we all think about what we are willing to pay for software. Apple makes money from hardware, so what they’ve done is in their own best interests. Apple makes incredibly good software, but it’s packaged with hardware and justifies the fat margins they make. But they have no interest in helping developers keep software prices high. It does them no good.
In much the same way, Amazon doesn’t care about making money on hardware. They’re in the e-commerce, e-book, streaming media and cloud computing business. They could care less about selling hardware for a profit. It is in their best interests to quietly destroy the profitability of mobile computing hardware, harming their competitors (such as Apple) while building up their profits where others have a hard time competing.
I’m always a fan of balanced analysis. Yes, I’m a huge Apple product fan and I own the stock. I think it’s got a lot of room to go higher. I think it’s crazy that Wall Street is acting as if Apple “needs” to invent a whole new multi-billion dollar market in able to continue growing. But I do see value in having the debate. After all, most of Apple’s profit is now tied to the iPhone and iPad. If Amazon or anyone else is successful in crushing profit margins on hardware, Apple will suffer.
If anything, I think this illustrates just how important it is to control a platform, not just sell hardware running some else’s operating system and apps.
So, iMore readers - what’s your take? Do you think Amazon can destroy pricing on hardware as Apple has on software? Or has Apple’s power become too significant for any low-cost maker to overcome at this point?
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