Thursday, November 8, 2012

iCraze or Amazon Craze, Which One to Buy?


The iCraze has been the mainstream of the stock market for the last several years, beginning with the launch of an iPod, iPhone, then iPad. People love the products so much that it has reflected quite positively in Apple’s (NASDAQ: AAPL) stock price. For 5 years, investors have realized a gain of 226.3%. Besides Apple, there is another stock, which receives similar market sentiment. This stock has made investors wealthier by 164.4% during the past 5 years. That is Amazon (NASDAQ: AMZN).
We may ask ourselves what we should buy, Apple or Amazon? Or, we should buy both? Or, we should avoid both for now?
Both Amazon and Apple are manufacturing tablets, Apple with the iPad and Amazon with the Kindle Fire, but with different strategies with totally different price points. iPad is one of the mainstream products of Apple, so if iPad doesn’t become a market leader in the tablet industry, Apple’s share will definitely shrink. Luckily, the iCraze has made Apple the tablet market leader. For Amazon, Kindle Fire is just a tool for its main businesses, selling books, magazines, games, and movies online via its digital storefront. Following IHS iSuppli, in Q2 2012, Apple’s tablet accounted for nearly 70% of the total market, whereas Amazon accounted for only 4.2%.
The different strategies create different price points for Apple’s and Amazon’s tablets. The smaller iPad, the iPad mini, is released to compete directly with Kindle Fire HD, with a much lower price than the normal iPad. These two tablets are quite similar in nearly every hardware related aspect. However, the iPad mini is still more expensive than the Kindle Fire HD. iPad mini is selling for $329, whereas Kindle Fire HD is selling for just $199.  Jeff Bezos, Amazon’s CEO, admitted that Amazon’s tablet is sold at a cost to customers as the company doesn’t try to make money on the hardware. He commented on Amazon’s philosophy: “We do not like the razor and razor blade model, where you lose money up front and then somehow make it up on the backend. We also do not like the other model, where you make a lot of money on the device, because it doesn’t follow our approach…In my view, you set up the business in a way that is aligned with the customer, or you can set it up in odds with the customer. When you have the option, you should figure out a way to be in alignment. Sometimes that requires you to be more patient, so it’s part and parcel with long-term thinking.”
When Apple missed earnings estimates, its shares plunged. It has dropped from $700 to $604 within a little over a month. At $604, Apple is valued at 14.2 trailing P/E and 0.4x PEG, even with a 35% operating margin and a 44% return on invested capital, the dividend yield is 1.75%. Amazon has a much higher valuation, with 294x trailing P/E and 2.9x PEG ratio. Its operating margin and return on invested capital is much lower, of 1.2% and 4.94% respectively.
Foolish Bottom Line
I like Jeff Bezos’ business approach, with a long-term focus to deliver customers’ long-term value and satisfaction. However, the market is valuing Amazon too high with triple-digit earnings valuation and a 2.9x PEG ratio. It seems that Amazon’s extraordinary growth has been over-factored in its share price. In contrast, Apple can be an attractive investment to investors. It is quite rare to see such a growth powerhouse is being valued quite cheaply at only 14.2x P/E and a 0.4x PEG ratio, and it is paying 1.75% yield. 

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