Money in Mobile

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It is no secret that the smart-phone market is growing world-wide. Gartner estimates that approximately 169 million smartphones were shipped in the third calendar quarter of 2012 representing a 47% year-over-year growth. What may be a bit more ambiguous is the way to invest in the smartphone market. One way to play the growth in smartphones is with Apple (NASDAQ: AAPL) and their revolutionary iPhone. Another way to invest in the growth in smart-phones is to buy Google (NASDAQ: GOOG), with their market leading Android OS. However, I feel Qualcomm (NASDAQ: QCOM) is the best way to play the overall growth in the smart-phone market.

The case for Qualcomm

Qualcomm derives its revenue by selling chips, like the snapdragon processor, to cellphone manufacturers. Currently Qualcomm dominates the smartphone chip market with revenue of over $19 billion in 2012. The snapdragon processor runs many Android and Windows OS smart-phones, including the Google Nexus 4, Galaxy S III, Nokia Lumia, and Motorola Razr M. Qualcomm has been able to maintain gross margins of 37% between its first quarter of 2013 and the first quarter of 2012. Qualcomm currently trades at just under 13.5 times next year's earnings and has a projected five year growth rate of 14.7%.

The case against Apple and Google

Apple strives to make "the best products in the world," and many people would agree that they do. Unlike the United States, much of the rest of the world’s telecommunications companies do not subsidize the purchase of phones like AT&T and Verizon do. That means that the iPhone 5 starts at $649, not $199, which causes many consumers to either choose cheaper Android phones or earlier iterations of the iPhone that will hurt margins. Apple is also seeing significant competition from companies like Samsung with the Galaxy S III (Also running the Android OS) in the high-end smart-phone market. Pressure from both the high and low end of the smartphone market has already begun to hurt Apple's margins. In the first quarter of 2013, Apple reported a gross margin of 38.6%. In first quarter of 2012 they reported gross margin of 44.7%. Despite these headwinds, the current five year growth rate for Apple is just under 19%. This growth rate estimate should fall substantially as these problems become more apparent. However, Apple only trades at 8.8 times forward earnings.

Google gives its Android OS away to smart-phone manufacturers in the hopes of increasing ad revenue. Currently, mobile ads receive a lower cost-per-click than desktop ads that hurts margins. In 2012 Google had gross margins of 34.8%. In 2011 Google had gross margins of 41%. Google trades at 14.8 times forward earnings. Google has a five year projected growth rate of 13.7%.

The takeaway

The point I am trying to make is not that Apple or Google are bad investments, but that Qualcomm is the best pure play on smart-phone growth. Unlike Apple and Google however, Qualcomm is not suffering from margin compression. Qualcomm also has a higher five year projected growth rate and lower forward price to earnings ratio than Google. Qualcomm should see higher growth than Apple going forward despite Apple's current five year growth rate expectations. Also, if the Windows operating system does begin to take market-share from Apple and Google, Qualcomm's earnings growth should not be affected.

If you do not currently have a position in Qualcomm, I would start your position here by buying 25% of the position you are looking to create. I recommend waiting for a pullback from here to buy more shares considering how strong of a performance we have seen so far this year.

Justinboucher has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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