Why You Shouldn’t Bite into Apple Inc. (AAPL): International Business Machines Corp. (IBM), Intel Corporation (INTC)

Apple Inc. (NASDAQ:AAPL) has been in free fall as of late.  From its $705 high in September 2012, Apple stock has dropped by more than 35% to under $450.  This seems sudden for a  technology bellwether like Apple, which was only recently regarded as being the “most valuable company in the world.”  The selloff has some Apple faithfuls thinking that now is a good time to gobble up some cheap Apple before it bounces back to $700.  As tempting as that sounds, I’d take a closer look at what you’re biting into.  We’ll start by taking a look back.

Apple Inc. (NASDAQ:AAPL)

Apple didn’t invent the smartphone, but it did set off a smartphone revolution when it introduced the iPhone in 2007.  Apple’s sales have gone bananas ever since.  Figure 1 shows how iPhone unit sales grew from 1.46 million in 2007 to more than 125 million in 2012.  That was a spectacular compound annual growth rate of more than 125%.  With growth like that, it’s understandable how Apple Inc. (NASDAQ:AAPL) shares more than tripled in price.

Figure 1

Then again, that growth rate was also the problem.  Think about it: 125 million is a very large number.  So large, that it would be impossible for Apple to maintain the same level of growth that propelled it to mega-cap status.  How impossible, you ask?  Well, if iPhone sales continued their spectacular historical growth rates, then in five years, Apple would be selling more iPhones than there are people in the world – it is
that impossible.

I realize that Apple has other products, but iPhones still dominate the income statement and constitute two-thirds of earnings.  That makes the iPhone Apple’s most important product.  At the same time, iPhone sales and earnings are not reoccurring.  In other words, Apple must sell 125 million new iPhones every year just to maintain current earnings.  The point is, investors were so enamored by Apple’s incredible growth, they may have lost sight of whether or not the growth was sustainable.  It clearly was not, in my opinion.  Moving forward, I think Apple faces other problems as well, problems similar to what it faced in the past.

After being the first company to successfully mass-market personal computers in the 1980’s, Apple lost its edge in the personal computing market within a decade.  One of the reasons Apple Inc. (NASDAQ:AAPL) stumbled was its insistence on vertical integration, and what seemed like a superiority complex.  Apple wanted full control over its products, and wanted to command both hardware and software.  That really limited Apple’s collaboration with others. For instance, Apple did not allow other manufacturers to use its operating system, perhaps thinking that would result in an inferior final product.  Whatever the case, the approach allowed Apple to have meticulous influence on the end user experience, but also left Apple vulnerable to more efficient models.

For example, the collaboration between International Business Machines Corp. (NYSE:IBM), Microsoft Corporation (NASDAQ:MSFT), and Intel Corporation (NASDAQ:INTC) that began in the 1980s allowed the companies to divide and conquer. They focused their resources to develop expertise in components, operating systems, and processors, respectively.  The result was the creation of the PC Compatible platform, and the rest is history.  Customers liked the more flexible and cost-efficient platform, Apple got marginalized, and the PC compatible platform is still the de facto worldwide standard for personal computing today. This is not to say that Apple products were ever inferior. But it was clearly very difficult for Apple to take on the coordinated efforts of its competitors.  Thinking that it could was naive at best, and arrogant at worst.