In This Big Battle, One Is The Better Value

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

There is no doubt about it, Google (NASDAQ: GOOG) is coming after Apple (NASDAQ: AAPL) in a big way. In a recent announcement, Google is offering customers a service similar to iTunes Match, but for free. The company will allow its users of Google Music to store up to 20,000 songs in the cloud through their sync and match service. By comparison, Apple's iTunes Match allows users to store up to 25,000 songs, but costs $24.99 per year. While $25 a year isn't exactly going to break the bank for most customers, getting something for nothing is almost always better. This isn't the first time Google has stepped on Apple's toes either. The two companies compete in multiple segments, and while there are proponents of each company, one is the better value. 

To be clear, I'm a big Apple fan, you can call me a fanboy if you want, but their products generally work well, have attractive designs, and with iCloud they work together without much thought. That being said, Google gets a lot of my attention also. I use Gmail every day, Google Reader helps me keep up with news, YouTube is a favorite of mine, and Google Search is the only search engine I use. I only say this to point out that I'm not bashing either company, but there are some clear advantages and disadvantages between these two behemoths. 

The Smartphone War: 

Unless you have been living under a rock, you know that Android and iOS are the two dominant mobile operating systems. Recent reports show Android owning over 70% of the smartphone market. Normally any company that dominates a field is the company to buy. Look at Microsoft (NASDAQ: MSFT) and their dominance of the PC industry in the 90s and how their stock performed for proof. If you look at how Google has performed since dominating the search segment, you'll see a similar correlation. However, there is a big difference between Google's relationship to Android and their dominance in search. To be blunt, Google doesn't make much at all from when an Android powered smartphone is sold. Instead, the company makes money from advertising when its built in products are used and from search advertising. This is a situation where believe it or not, Apple and Microsoft actually stand to benefit more when a phone with their operating system is sold. 

Apple might only have about 14% of the smartphone market, but this is enough to make the company billions in profits. The difference here is, Apple's iPhone is designed in house and when an iPhone is sold, the company makes money from the actual sale. Any additional revenue generated when customers use other Apple offerings like iTunes Match or the iTunes store just adds to their profitability.

Microsoft is positioning itself to try and take third place in the smartphone industry. What is really ironic is, the company is rumored to make more money from Android than Google does. If you think about this, it is theoretically possible for Microsoft to benefit greatly even if they stay far behind Google and Apple because of this licensing revenue. If Microsoft can take over third place, mobile could be a big growth driver in the future. In addition, with the introduction of the Microsoft Surface tablet, the company has shown they aren't afraid to get into the hardware game. For months, the rumor has been that a Surface phone might be in the works as well. Long story short, Apple and Microsoft actually stand to make more money even if Google's Android system continues to win the market share battle. This is the benefit of owning what you sell, rather than giving it away for free. 

The State of The Slate: 

Probably the second most talked about business in technology is the evolution of the tablet. Until recently the iPad's dominance was unquestioned. With competitive offerings from the Samsung Galaxy lineup, the previously mentioned Microsoft Surface, and competition from Amazon and others, the field is getting crowded. This industry shares some similarities to the smartphone business. Google makes money after the fact, Apple makes money when the iPad is sold. If the Surface is a hit for Microsoft, the company could steal some business from both of the dominant operating systems. What I've noticed is tablets are becoming more powerful, and apps are becoming more PC like. This is a very good thing for customers, as tablets may be looked at for content creation instead of mainly content consumption.  

In a strange way, Apple needs to seriously consider taking a page from Microsoft's playbook. Microsoft is the first company offering software that works the same across smartphones, tablets, and computers. Apple has been moving iOS and Mac OSX toward each other with features like iMessage, Notifications, the Launchpad and more. It is time to make the iPad a full fledged computing device. While in theory the iPad would cannibalize Mac sales if this occurred, Mac sales are a small part of Apple's revenue, and the jump in iPad sales could be significant. Google's Android already works in similar fashion across smartphones and tablets, but making the jump to the desktop and laptop world would be a difficult move because of the lack of apps really designed for larger screens. 

Which Is The Better Value? 

Google is currently selling for about 15.5 times next year's earnings, and analysts expect EPS growth of about 13.6%. The company generates significant free cash flow with over $3 billion average free cash flow in the last four quarters. This equates to about $0.22 of free cash flow per $1 of sales. Since the company doesn't pay a dividend, this cash increases Google's cash and investment balances, which currently sit at almost $44 billion.  

Apple on the other hand, sells for a cheaper ratio of just 10.7 times next year's earnings, yet analysts expect EPS growth of better than 20%. In an astounding comparison, Apple generates more than twice the free cash flow at over $10 billion on average in the last four quarters. In the current quarter, Apple's free cash flow equaled about $0.16 per $1 of sales, but this was in a capital expenditure heavy quarter. In the prior quarter, Apple generated $0.23 of free cash flow per $1 of sales. Apple does pay a dividend, which yields about 2%, and it is well covered with a payout ratio of just 23.41%. Even more impressive is Apple has almost three times the cash and investments compared to Google with over $120 billion on the balance sheet.

Though some might argue the point, Apple seems the better value. The company pays a yield that Google does not. Apple produces significantly more free cash flow, and has both a lower P/E ratio and a higher expected growth rate. In theory Apple could disappoint on earnings, and have a lower projected growth rate, and still be a better relative value. Both stocks should be good long-term plays, but right now Apple is the better investment. 


MHenage owns shares of Apple. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, and Microsoft. 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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