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Why Apple Is a Better Buy than Other Smartphone Players

May 27, 2014 | About:
Vinay Singh

Vinay Singh

5 followers

The iPhone versus Android war rages on, and one area where Apple (AAPL) has the upper hand is security. Apple tightly controls the apps that are let into its store, and consumers receive iPhone updates quickly. Android devices are very slow to update, exposing consumers to many dangers.

Security Matters

Consumers are slowly waking up to the fact that smartphone security matters. The Google (GOOG) Play store shows that the Bank of America App has an install base between 10 million and 50 million. These are 10 million to 50 million consumers with sensitive financial data, who need to take security seriously. Sensitive banking apps are not limited to Android, as Apple's App store has similar offerings.

Openness Has Its Downsides

It was recently discovered that a flaw in the verification of Android's apps has opened up hundreds of millions of devices to vulnerabilities. The flaw has been present since Android 1.6, released in 2009. It allows seemingly safe apps to be turned into Trojans.

At the same time, Apple is upgrading its closed ecosystem. Its new iOS 7 will include an improved activation lock system. If an individual loses his or her iPhone and locks it down, no longer can a potential thief get a free iPhone by restoring it to factory settings. This is a great feature that protects data and will decrease the number of stolen iPhones.

Microsoft has the advantage that its install base is so small that it is not very profitable for hackers to break into Windows Phone devices. Optimistic analysts project that Windows Phone may have just 12.7% of all smartphone shipments by 2017.

BlackBerry is one of the most secure devices available. For high-security environments within governments, BlackBerry is very cost effective.

BlackBerry's downside is it that it has lost the heart of the broad market. Recently, market share fell to 4.8%. Many corporations are letting their users bring their own devices. The average consumer wants Android or Apple, and this leaves BlackBerry stuck in second place. It remains to be seen if the company can be profitable as a niche player.

Apple's Financial Security

Beyond Apple's huge cash reserves, its current valuation helps investors sleep safely. While its days of extreme growth are gone, the company is still profitable as a slow-moving behemoth. Its free cash flow per share is steady around $46.5, its profit margin has fallen to a more reasonable 23.5%, and it is likely that its return on investment (ROI) of 29.3% will follow.

By taking Apple's current free cash flow of $46.52 per share, a three-year growth rate of 1% with a cost of equity of 7.55%, then a permanent growth rate of 3% with a cost of equity of 8.55%, Apple has an intrinsic value of $838.26 per share. This is around double its current stock price. The cost of equity numbers are based off of the current ten-year Treasury plus 2%. The second period's cost of equity is higher than the first, because the end of quantitative easing will boost interest rates.

The Competition

Android is less secure than iPhone, but consumers are willing to sacrifice security for lower prices. Google is still priced as a growth stock, with a P/E ratio around 26.5. Its ROI has already come down to a reasonable 14.3%, while its profit margin of 20.9% is around the industry average. Google comes at a price premium, but it may be worth it for investors looking for growth.

Microsoft is stable and profitable, with a ROI of 18.5%, a profit margin of 21.6% and a yield of around 2.7%. The company isn't winning the smartphone wars, but its Windows operating system keeps its bank account full.

BlackBerry is trying to turn itself around, and it has boosted its profit margin to -1.87%. Its ROI of -2.3% needs to increase, but its balance sheet is relatively clean with a total debt to equity ratio of 0 and a quick ratio of 1.6. If the company can become profitable by focusing on government and corporate contracts, then it will be worth a second look.

Conclusion

For risk-adverse value investors, Apple has a very convincing argument. If it just grows its free cash flow along with inflation, it is an attractive buy at current prices. For growth investors looking to ride the next wave of technological developments like fiber optic Internet connections, Google may be a better fit. Those looking for a stable piece of the tech world should look at Microsoft. Until BlackBerry can make consistent profits, it is better to wait on the sidelines.


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