Has Apple’s Dedication To Hardware Run Its Course?

In the wake of the roller coaster ride that Apple (NASDAQ:AAPL) has experienced in recent months, and the meteoric rise that the company has flown on in years past, investors, analysts and industry observers have taken a closer look. On the verge of the quarterly earnings release, which analysts are expecting might be the first year-over-year decline in ten years, the Wall Street Journal has published a piece exploring how the company is valued — and why it might be wrong.

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Traditionally, investors have viewed Apple as a hardware maker, and valued it as such. The classification is certainly accurate, as Apple’s hardware — from its iconic iPod Classic, to the Macbook line, which has become one of the most recognizable pieces of tech in the industry — has backed up its software offerings with equally distinct and attractive exteriors that were — and still are — a fashion statement in and of themselves.

However, as the Journal points out, the classification may be too restricting. Being viewed and valued as a hardware maker has its drawbacks, such as commoditization, and shifts in consumer tastes — BlackBerry (NASDAQ:BBRY) can vouch for that from first hand experience. Instead, would it make more sense to value Apple as a hardware and software hybrid?

If Wall Street sentiment towards the company were to move in that direction, the company would instead be valued more as an Internet company or software firm that has a different model of recurring revenue streams, and from a market standpoint, often trade at higher price-to-earnings ratios than hardware companies, the Journal notes.

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“The market views Apple as a consumer hardware company tied to product cycles that drive volatile revenue and earnings streams,” says Morgan Stanley analyst Katy Huberty. But that view isn’t complete, she says, since “Apple customers buy into a brand that offers ease of use similar to companies like Amazon.com (NASDAQ:AMZN) or enterprise companies like NetApp (NASDAQ:NTAP).”

When stacked up against other hardware makers, Apple’s market valuation is 8.6 times the expected earnings per share for the next year. HewlettPackard (NYSE:HPQ), which made a fraction of the profits that Apple did during the quarter ended in December, is valued at 5.6 times.

However, unlike HP or Dell (NASDAQ:DELL), Apple already has a strong software arm that has set it apart from other manufacturers…

Its iTunes program and OSX operating system are omnipresent in several cultures, and Apple’s app store has 500 million credit cards tethered to it. This, in theory, would put Apple in the valuation gap between hardware and software manufacturers — but Wall Street has been slow to respond, despite CEO Tim Cook’s efforts to convince it otherwise.

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The Journal attributed Wall Street’s reluctance to the pattern of hardware companies that failed to make the switch to software, and ironically fell out of public favor at the hands of Apple. Sony’s (NYSE:SNE) Walkman failed to compete with the iPod; and BlackBerry’s email service, once heralded by professionals and business executives, fell from grace when Apple showed it could do the same thing — with a simpler interface.

Regardless of where Wall Street fancies its valuations, Apple will consistently face the challenge of outdoing its former products with one better. If the company falls behind in software — and its recurring revenue streams beloved by investors everywhere — it will need to maintain huge degrees of innovation, which becomes harder and harder as products become better and more efficient.

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