Ten years ago, Alphabet Inc. (GOOG, Financial) (GOOGL, Financial), then Google, was more than twice the size of Apple (AAPL, Financial). Since then, Apple has rallied to become the world’s most valuable company with a market value of about $539 billion. This compares to Alphabet’s $510 billion market valuation.
Last year, Apple temporarily rallied to reach a market value of more than $700 billion but has since dropped to the current value of just under $540 billion. On the other hand, Alphabet has rallied from a market cap of just over $350 billion as of June last year to the current level of about $510 billion.
Alphabet’s rally was triggered by a single-day 14% increase in stock price, which saw it add more than $50 billion in market value on July 15 last year. The following month, the company’s CEO Larry Page, revealed plans to rename it Alphabet, Inc. under which several businesses would operate as stand-alone entities.
Investors appear to have bought optimistically into this idea thereby maintaining the company’s bullish valuation by boosting the stock price. Now, investors appear to be convinced that Alphabet could yet overtake Apple to become the world’s most valuable company at some point this year, if not sooner.
As per the chart above, Apple was valued at more than $700 billion at the end of June 2015, while Alphabet was valued at just over $350 billion. In other words, Apple was worth more than double the value of Alphabet. That gap is now down to just $29 billion.
So where did it all go wrong for Apple?
From a price-performance perspective, it is pretty easy to tell why Alphabet has been able to close on Apple in market valuation over the last few months. For instance, on July 9, Alphabet traded at $520 per share while Apple was going for about $120 per share.
At this point, the talk of the market was about when Apple was going to hit $150, but after temporarily rallying to trade in the region of $135 per share, the shares of the iPhone maker have since declined nearly 30% while counterpart Alphabet has gained more than 40%. The combination of the loss in Apple’s value plus Alphabet’s gain brings a change of about 70% in market value between the two stocks.
However, the real reason why Alphabet is gaining ground on Apple is mostly based on the company’s business moat rather than any fundamentals related to current business operations. Investors appear to have positively bought into the name change at Alphabet, which now houses Google, Nest, Calico, Fiber and Verily, among other businesses, as a holding company.
Investors now believe that the name change, along with the restructuring that came with it, gives Alphabet the best opportunity to grow. These will not only help the company improve in terms of performance per business entity, but they will also help to sell the new brand name “Alphabet” to investors. On the other hand, Apple continues to operate as a single company, albeit with several business units.
Google, which is Alphabet’s largest business entity, enjoys a massive business moat compared to Apple. Apple’s largest income comes from the sale of iPhones. This business unit has been experiencing a slowdown in sales volume due to the company’s premium pricing of its products coupled with market saturation. In addition, Apple is not currently the world’s largest smartphone seller by volume. That title goes to Korean-based electronics giant Samsung Electronics (SSNNF, Financial). But from a revenue perspective, Apple edges its rivals.
On the other hand, Google’s search business is the largest in the world, in terms of user base and revenues, with Facebook (FB, Financial) offering the biggest challenge globally excluding China. Chinese search giant Baidu (BIDU, Financial) leads the ranks locally. Actually, Google’s biggest threat in its search business appears to come from alternative ways of advertising as companies continue to increase the marketing budgets allocated to social media advertising, but the search engine giant still collects a majority of the checks.
Now, when we assess the two companies fundamentally, Apple appears to have a better growth potential than Alphabet (in terms of earnings for the short-term horizon). Apple has price/earnings to growth PEG ratio (five-year expected) of 0.93x compared to Alphabet’s 1.48x.
In addition, Apple boasts an operating margin of about 30% which compares to Alphabet’s 26%. The company also posts revenues of about $235 billion per year, as compared to Alphabet’s $72 billion. As such, Apple appears extremely cheap when compared to Alphabet as it trades at a P/S multiple of 2.22x versus 7x for Alphabet. Apple also enjoys an impressive P/E multiple of just 10.36x compared to Alphabet’s P/E ratio of about 31.32x while the industry average is pegged at 17.05x.
However, it is good to note that, while Apple reports more revenue and earnings as compared to Alphabet despite their close market valuations, most of Alphabet’s investments are yet to begin generating meaningful income. On the other hand, Apple’s main product, the iPhone, appears to have peaked already, and sales are now slowing in a similar trend to that of the company’s other major product, the Mac.
Furthermore, Alphabet’s main business entity Google operates in what is referred to as a light industry because of low-zero inventory requirements as compared to Apple’s iPhone, iPad and Mac business units. Light industries often enjoy high gross margins, and this is well demonstrated by Alphabet’s gross margin of 63% compared to Apple’s margin of 40%. The low operating margin for Alphabet can be justified by the fact that the company is making several investments into new business entities that are yet to begin generating income.
Conclusion
The bottom line is that Apple appears to have reached a point where it will either have to redefine itself by investing in new product lines or become a dividend stock. For whatever it is worth, Apple may yet consider taking the route taken by Alphabet to break up its business units and operate under one holding company. The company has shown interest in revamping its service business as growth slows in the product business, but investors do not look very convinced by this move.
However, Apple has always been known to be one of the most secretive companies, which means you never know when a major announcement is coming. It could be during the next Apple event in March, or in September this year.
On the other hand, Alphabet appears to have sold its growth plan well to investors, but has the stock rallied too much too soon? We will have to wait and see. The battle is just beginning.
