Apple's Biggest Fear

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In the land of consumer technology, it's hard to stay as the king of the hill. Two decades ago, Sony ( SNE ) ruled the roost, with its hot-selling Walkmans and Trinitron TVs. About a decade ago, Nokia ( NOK ) looked poised to dominate the global cell phone market, and more recently, Motorola's ( MOT ) RAZR set that company up for a long-term run as a consumer favorite. All those companies can now be seen in Apple's (Nasdaq: AAPL) rear-view mirror.

With each passing year, Apple's brand only seems to get stronger. Forget about this month's iPhone antenna glitch, which has pushed shares down from their peak. Those kinds of issues are just noise, and will soon be forgotten. But on a much broader level, there's real reason for concern. Just as Apple is celebrating a successful rollout of the iPad and the latest version of the iPhone, a key competitor is set to steal Apple's thunder.

The competitor in question: well, it's a $155 billion (in market value) company that made a name for itself in the field of Internet search. Yes, just six miles up the road from Apple's Cupertino, Calif., headquarters lies the campus of Google (Nasdaq: GOOG) -- the tech behemoth that has spent the last two years laying the groundwork to beat Apple at its own game. And during the next few quarters, get ready for a torrent of new products in all shapes and sizes that run on Google's Android software. A host of new rivals for the iPhone? Check. A host of new rivals for the iPad? Check. Panasonic and others are now talking about adding Android software to flat panel TVs. Google is even hinting that a range of appliances found in your kitchen will soon have an Android browser.

Right about now, you can start to question whether Google can develop software and services that are even more compelling than those offered by Apple. They don't have to be. Good enough is good enough. The key distinction is that Google's Android will be ubiquitous. You'll find it on Dell's (Nasdaq: DELL) upcoming Streak tablet computer. You'll find it on Motorola's next line of smart phones. And you can expect giants such as Cisco Systems (Nasdaq: CSCO) and IBM ( IBM ) to start to embrace Android. In essence, Apple has created a closed universe, and Google has created an open one. And in the world of high-tech, open standards always win out.

How much market share Google can take is just one question you need to ask. The other involves the impact on Apple's business model presented by this rival that often gives its products away at low or no cost. Apple's products typically garner a premium price, which is why operating margins have expanded for six straight years and now approach 30%.

Inevitably, Apple will have to price its products closer to the peer group, which will likely eat into those robust profit margins. And that's all you need to know about profit growth. If sales keep rising but margins start to shrink, profit growth is likely to cool.

Apple has boosted earnings per share by at least +33% every year for each of the last six years. And it's on track to grow a heady +50% this year, according to consensus forecasts. And then the Google vortex is scheduled to rumble through town. Apple's new fiscal year starts October 1, which is right around the time that a whole new set of Google-powered tablet computers, smart phones and perhaps TVs are set to hit the market. Which is why analysts think EPS growth will cool to around +20% in fiscal (September) 2011.  Apple tends to handily exceed analysts' forecasts, so even as headwinds build, Apple could still post a solid set of results in 2011.

But savvy investors always look ahead. And as they look beyond 2011, they'll start to see that it's a Google world -- and we just live in it.

Action to Take --> The technical issues regarding the iPhone are only temporary, and once Apple announces a fix, shares could quickly move back toward the $280 all-time high. But as the Google onslaught starts to build, Apple's never-ending winning streak will likely come into question. Shares are not likely to plunge precipitously, but 2010 may turn out to be the year of the peak. It happened to Sony, it happened to Nokia, and soon enough, it may happen to Apple.


-- David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and has made numerous media appearances over the years, primarily on CNBC and Bloomberg TV. David has a master's degree in management from Georgia Tech. Read More...

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas


David Sterman

David Sterman

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