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Here's Why Apple Will Keep Crushing It (And Why The Stock Still Looks Great)

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Tim Cook (Image credit: Getty Images via @daylife)

After Apple's lousy quarter yesterday, the knives are coming out. Is this it? Is Apple doomed to slide?

In a series of posts, my former boss Henry Blodget points out a number of Apple chickens that have come home to roost:

  • Apple's profit margins are shockingly high, which means they've got nowhere to go but down. (Which should hammer the stock.)
  • In particular, Apple's product mix is shifting to the low end, which means less revenue and less profits all else equal. While early adopters bought state of the art iPads and iPhones, now the mass market is buying the entry models.
  • Apple screwed up by sticking to a yearly iPhone release cycle and shifting the iPhone to a Fall release cycle, prompting consumers to stop buying early as they expect a new iPhone, and allowing Samsung to come out with really good phones that are making the iPhone look old.

Be all that as it may...

The biggest misunderstanding that people have about Apple is that it's a hardware company. Steve Jobs liked to use the quote "People who are serious about software make their own hardware," and it's impossible to understand Apple without understanding that the value in its products comes from the software, and not the hardware.

It's Apple's software that sets it apart, not the hardware (Image credit: Getty Images via @daylife)

At the end of the day, it's software that determines why people buy a product. People want to buy the phone/tablet/computer with the best apps and services, and if it comes in a sexy package then all the better. It's because Apple controls the whole experience, including hardware, that it's able to offer great software, but the hardware is a consequence of this software focus, it's not the core thing.

What does this mean?

It means that what will determine Apple's success over the long run is whether it's got the best and most attractive suite of software and services, not whether it has the sexiest gizmo at any given moment.

Which means that it's the software that watchers and investors need to focus on.

At BI Intelligence, I spent a lot of time understanding and explaining the network effect that Apple enjoys with its mobile operating system, iOS. A network effect is what happens when your product becomes more useful the more people use it, which software platforms have. The more people use a platform, the more software gets developed for it, which means more people buy it, and so on in a virtuous cycle.

A lot of people have been saying that this network effect plays to Apple's disadvantage, because Google and its allies have been flooding the market with cheaper Android devices and enjoying huge market share gains. The point I've consistently made in response, is that when you're talking about a software platform, what matters isn't the end user market share, what matters is the developer market share. A software platform has a network effect if and only if developers make more and better software for it. (Developers may or may not follow the users, but it's important to understand that what ultimately matters is the developers, not the users.)

(Image credit: AFP via @daylife)

And on that score, Apple is undoubtedly way ahead of the competition. Developers make more money on Apple's platform: cross-platform apps make only 24% of iOS revenue on Android. This means they make more apps for iOS. This means that iOS has the best apps. This means that Apple still has the best software platform.

And this, ultimately, is what will determine Apple's success. And on this score, nothing that happened with the previous quarter changes anything. Apple still has the best software platform and so they are poised, over the long run, to keep crushing it.

(And why does the stock still look great? It's got a price-to-earnings ratio of 13.5 as I write this, or about the same as the overall S&P 500. This means that the market is saying that a company that's experienced high double-digit growth, 30% profit margins, $100+ billion in cash and no debt, etc. etc. will only grow as fast as the average of Corporate America. That just don't make no sense.)