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Google's "Android Future" & The Case For Microsoft

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

The smartphone market has seen tremendous innovation, but I think one issue that has not been addressed enough is that innovation breeds competition. There are virtually no barriers to entry in this kind of high-growth tech innovation: today's winners become yesterday's fads, and the market barely takes time to notice. Accordingly, multiples can stay hot for an irrational time as cutting-edge substitutes start to make inroads. Apple shareholders have started to take note, but it has not done enough to lift Google's stock price. Can we expect the market to correct this anomaly? And will Microsoft repeat Google's success?

Why You Should Buy Google (NASDAQ: GOOG)

As the days go by, I continue to be amazed that more investors are not jumping on the Google bandwagon. Though shares look expensive at 22.4x past earnings, this multiple is warranted due to the company's superior growth curve. It has a current ratio of 3.9x and a little less than one-fifth of the market capitalization represented by its $45.7 billion cash holding. Analysts forecasted 15.7% annual EPS growth over the next 5 years, which is still a rate 880 bps less than what was achieved in the past 5 years. I find that the company is likely to see a positive surprise to the current forecast, as the company moves towards a unified model that monetizes its leading assets: Gmail, Search, YouTube, Chrome, and, specifically, Android.

It has been interesting to watch Apple's (NASDAQ: AAPL) growth story unfold due to the success of Android. Here are the November 2012 numbers: Apple has 53.3% of the domestic market while Google's has fallen 1,090 bps to a 41.9% share. But, in Europe, Android still has 51% of the market versus 25.3% for iPhone. Android also has 60% and 72.2% of the "Urban China" and Brazil markets, respectively. Overall, Android has a majority of smartphone sales, and this dominancy is only likely to increase with a growth of 1,750 bps y-o-y in the third quarter. There are several other catalysts that are likely to further steepen the growth curve: X Phone and Nexus sales.

It has been reported that Google is developing a high-end phone, the "X Phone", with Motorola Mobility, which is called the "X Phone". Many have complained that Android is a charity, even though it has been the source of the company's accelerated growth rate through a very weak 2008 economy. Although more Android devices are being purchased, Apple's iOS devices are still seeing more commercial use. iOS's share of the tracked ad impression market is 63% despite having only 15% of the smartphone market. But the X Phone should create even more obvious monetization opportunities that will cause Google's stock price to take off. Further, the company is already expected to have around 42.7% of the tablet market, and I see the introduction of a $99 Nexus furthering penetration. I strongly encourage investing before that becomes too obvious.

Don't Give Up On Microsoft (NASDAQ: MSFT)

Amidst all of the smartphone and tablet innovation, there has been one clear loser: Microsoft. Google's apps manager Clay Bavor said it best when he explained that "We invest and will go where the users are, but they are not on Windows Phone or Windows 8". However, I believe the downside has been more than factored into the stock price, since the company trades at only 10.3x free cash flow versus 11.8x for Apple and18.6x for Google.

While I think it is reasonable to argue that the company has become desperate with its abrupt decision to immediately roll out Surface beyond non-Microsoft stores, but there are numerous positive catalyst that are being overshadowed. China Mobile is aiming to sell two Windows Phone 8 models, and this is reinforced by the Windows Phone partnership with China Unicom. Microsoft had only 3% of the Chinese smartphone market in 3Q12, so there is definitely strong room for penetration. Consumers will still use PCs, and this creates significant synergistic value if the company can somehow get the market to accept a shift towards its mobile OS. To help create demand, Microsoft has taken the right approach in building 14 Indian innovation centers and planning launch 100 more in the emerging market between 2013 and 2015.

Analysts forecast 9.6% annual EPS growth over the next 5 years. Assuming the company meets expectations, 2016 EPS will come out to $4.22, which, at a multiple of 14x, translates to a future stock value of $59.15. When you factor in dividends, this comes out to 26.4% average annual returns. This provides a significant margin of safety at today's prices, and I encourage buying now.

TakeoverAnalyst has no positions in the stocks mentioned above. 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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