Friday, February 13, 2015

Apple: Market Share vs Profit Share

Those who think it's such a wonderful idea to aggressively pursue market share might want to consider Apple's (AAPL) share of the worldwide smartphone market.

As things currently stand, Apple's share was 15% last year and nearly 20% in the fourth quarter.

More than solid, of course, but that measure doesn't do much to reveal the true economic picture.

According to Canaccord Genuity, roughly 93% of fourth quarter smartphone profits went to Apple while Samsung (005930.KS) captured 9% of the profits. The fact that the profits of Apple and Samsung are greater than 100% means the remaining competitors combined are actually losing money. The rest collectively aren't just eating crumbs, many competitors are essentially at or near the business equivalent of starvation.

Basically, Apple feasts while, other than maybe Samsung, the rest don't even have enough leftovers to share.

Apple had something like 87% of smartphone profits roughly a year ago. So, while the new iPhones certainly contributed a bunch to the fourth quarter performance, Apple was getting more than their fair share of profits well before the new products were launched.

Now, as I've said on prior occasions, I'm generally no fan of technology stocks unless the margin of safety becomes very large.

Yet it's still hard to not admire what Apple has been doing. Describing Apple as exceptional is not only stating the obvious, it's actually a huge understatement.

Here's the tough part: Is that level of profitability is sustainable over the longer haul? For me, that still seems not an easy thing to gauge at all.

The fact that so much of Apple's profit comes from the iPhone is another important consideration.

In other words, a company's accomplishments can be extremely impressive -- as it certainly is with Apple -- but that doesn't necessarily mean estimating per share intrinsic value is easy. Figuring out Apple's value within a narrow enough range is, to me, challenging at best and warrants a significant margin of safety.*
(When I've purchased the stock in the past, my judgment was that the market price at the time offered a great deal of protection against permanent capital loss. Still, it's no favorite -- and likely never will be -- for the longer haul.)

Apple is currently a valuable business but, as far as I'm concerned, the range of outcomes is still rather too wide.

Others naturally might feel more comfortable with judging Apple's future prospects. It won't surprise me if Apple's continues to do very well. It's just that my favorite businesses have more understandable long-term prospects -- and usually that means less dependence on creating/updating brilliant products on a regular basis -- within a comparably narrow range.

How well would one of Apple's products from seven years ago compete against current alternatives?

How well would some trusted brand of soda from seven years ago compete against current alternatives?

Businesses that need to produce one hit after another run the risk of eventually hitting a wall. It's not that the business necessarily fails altogether; it's that remaining competitive long-term necessitates material changes to core business economics (i.e. increased investment and operating costs, reduced pricing power) with serious consequences for owners.

The net result being a range of outcomes -- after a number of product cycles and maybe a technological shift or two -- that's often too wide with the worst case scenario being unacceptable.

Apple, it seems more than fair to say, has earned and deserves huge respect. It's an extraordinary enterprise with, at least at the present time, astonishing economics. What they've created over the years has had an enormous favorable impact on the world. It's just important to remember this guarantees absolutely nothing about future results for a long-term shareholder.

Societal impact and rewards to investors need not necessarily be positively correlated. Over the past decade or so the correlation has clearly been, to say the least, rather very positive for Apple.

This may continue to be the case going forward but is far from a given.

It's understandable that some will pursue the transformational businesses with the potential for spectacular returns. Yet the chance for costly mistakes is usually high. Compounding at attractive (even if less than spectacular) rates of return for a very long time is, for investors, not easy but all-important.

Well, it's tough to be confident the time frame will be a very long time with any business that depends extensively on ingenious innovations being delivered on a regular basis.**

The power of long-term compounding effects can inadvertently become lost in the chase for the next big thing.

The market eventually weighs business success or failure reasonably well even if sometimes the recognition is delayed.

That delayed recognition can, at times, be a very good thing for the long-term owner.


Long position in AAPL established at much lower than recent market prices

Related posts:
Mr. Market
Buffett on Autos, Airplanes, and Airlines
Warren Buffett on "The Key to Investing"
Technology Stocks

* As always, I have no opinion about how Apple's stock (or any stock) might perform in the near-term or even intermediate-term. In fact, I never have a view on such things. Those who attempt to profit from price action are engaged in an entirely different game (whether or not fundamentals are used in their decision-making). My emphasis is on how price compares to value (based upon the excess cash a business is expected to produce over time), the likelihood that the value will increase at least at a satisfactory clip, and long-term effects. Business prospects are sometimes mispriced -- even for an extended period -- but eventually should be confirmed by, and reflected in, market prices.
** Some quality businesses can maintain substantial competitive advantages over the longer haul without lots of innovation. Still, even the best businesses will face real challenges from time to time.
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