Apple (AAPL) crushed Wall Street estimates when it reported earnings on July 21. Earnings per share for the company’s fiscal third quarter grew 13% from the third quarter of 2008. Revenue grew by 12% in a quarter when almost no company is reporting any sales growth.
Nokia (NOK), on the other hand, stunk up the joint with its second quarter results announced on July 16. Earnings per share did meet expectations but that was the last piece of good news that the cell phone maker delivered. Revenue missed projections by 3.8% and plunged 24.6% from the second quarter of 2008. Unit volume fell 15% from the second quarter of 2008. And the company took back its forecast that it would pick up market share in 2009. Now Nokia is saying its share will stay flat this year.
So which of these two stocks is a better buy? It’s not as easy a decision as it looks.
Apple, the company, is on a tear, driven by the huge popularity of its iPhones. The company sold 5.2 million iPhones in the quarter. That’s more than 7 times the volume that Apple sold in the second quarter of 2008. Operating margins were up—at 20% they easily outpaced last year’s 18.5%. And rather than playing fast and loose with its accounting in an effort to grease growth, the company very conservatively books iPhone revenue on a subscription basis so that it spreads out revenue over the 24 months of an iPhone contract. Yes, computer sales aren’t growing nearly as fast, but they are growing with the company selling 4% more computers in the quarter.
That makes Apple the stock a classic growth momentum play. It trades at a price to earnings ratio of 27.2 times trailing 12-month earnings. That’s not high by Apple’s own historical standards—the stock’s five-year average price-to-earnings ratio is 35.9—but it is way more expensive than the market as a whole where the price-to-earnings ratio of the Standard & Poor’s 500 is just 15.4. Apple’s shares sell at 4.1 times sales per share—and that’s above Apple’s five year average of 3.8 and the S&P’s price-to-sales ratio of 1.
Nokia, on the other hand, is a company without traction. Everyone knows what the problem is—two years after Apple introduced the iPhone, the Finnish company doesn’t have a competitive smart phone on the market. It’s not like Nokia isn’t trying. It has—finally—introduced a raft of new models such as the N85. (Catchy name, right?) It bought full ownership of the Symbian operating system. It started up its own Apps store, OVI, to compete with the iPhone store. It acquired mapping company Navteq so it would own a data base for building localization features.
But nothing much has worked. The company is still the global leader in market share with a 37% share, but break down that figure and you can see trouble. Nokia has a 50% market share for entry level phones, those selling for 50 Euros of less. In the higher-priced smart phone segment, however, its share dropped to 38% at the end of 2008 from 50% in 2007. You can see the effect of that in the falling average selling price: with its sales dominated by cheaper phones and its share of the smart phone market falling, the average selling price of a Nokia phone has tumbled to 62 Euros in the second quarter of 2009 from 74 Euros in the second quarter of 2008. That’s a 16% decline.
Nokia, the stock, is the exact opposite of a momentum play. I’d call it a value stock. Shares trade at a price-to-earnings ratio of 17.1 and a price-to-sales ratio of just 1.3. That’s quite a contrast to Apple’s price-to-sales ratio of 4.1. An investor in Nokia is buying about three times as much current revenue for a dollar of investment as someone who buys Apple.
Let me tell you a secret: That kind of comparison is pretty much useless when you’re comparing a growth momentum and a value stock. Instead of trying to measure the two stocks on one common scale, you’re better off asking how good a growth momentum stock Apple is, and how good a value stock Nokia is.
You have to ask totally different questions about the two stocks.
So in the case of Apple what you really want to know is how long the growth momentum will last. In the case of Apple I think the answer is “A long while.” Apple has a huge lead in the number of applications available for the iPhone (35,000 to 50,000) against competitors such as Palm (PALM) (less than 100 in late June), Blackberry (RIMM) (more than 1,000 in June), and Nokia (less than 1,000).
For all intents and purposes the iPhone application store has now gone viral, reaching that wonderful state of Internet marketing where the more people use it, the more applications developers will write, the more customers are draw to the store and the more developers write. The evidence is that it takes a lot to divert a current like this once it’s flowing. Does Apple need to keep coming up with cool products? Yep. Can the company expect to see iPhone sales grow seven times from current levels next year? Nope.
But what’s intriguing to me as an investor looking for a growth stock that might be undervalued—despite its high ratios—is that Wall Street looks like it’s underestimating how long Apple’s run will last. Projections right now call for earnings growth of just 14.5% in 2010 and then of 18.9% for the five years beginning in 2009. It’s unlikely that Apple can match the 85% average earnings growth over the last five years, but hey, Wall Street isn’t expecting the company to. The target to beat is short of 20%. Not easy but not impossible either.
The question an investor wants to ask about Nokia is how long it will take to turn around the company. On one end of the scale, there’s forever: Nokia will never get it right. On the other end, there’s tomorrow: Nokia’s got the magic bullet already loaded into its gun.
I think the answer is something like a couple of years. Not to vanquish Apple but to demonstrate that Nokia has got its smart phone act together, is a competent competitor in that market again, and is picking up a few points of market share. It won’t be easy. The Symbian operating system is long in the tooth and may, finally, not be able to meet today’s demands for a smart phone interface. The company has got to figure out a way to crack the U.S. market and to recruit significant numbers of developers to write for the OVI store.
But Nokia isn’t some conglomerate that’s taken its eye off the knitting. The company remains most efficient manufacturer of phones in the world. And its recent strategic steps indicate that the company knows it’s got a problem that could put the company at risk if not addressed. Nokia doesn’t have a solution yet, but admitting that a problem exists is often the hardest step of all.
So between the two stocks?
Apple for now. If you’re looking for a growth story in an economy without very many real growth stories, this is your stock. For the next year to 18 months.
Nokia for later. If you’re patient, and aren’t the kind to get scared out of a stock by the next quarter of bad news (and Nokia has got a few more of those ahead), then this is a stock that you’d should buy whenever it’s relatively cheap. I’d call anything up to $13 a share cheap.
