Amazon’s Smart-Home Products Can Boost Amazon Stock

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Amazon (NASDAQ: AMZN) and Apple (NASDAQ: AAPL) are following completely opposite strategies for accelerating their growth. Amazon’s strategy looks poised to be much more beneficial for Amazon stock than Apple’s strategy will be for Apple stock.

Amazon (AMZN) Stock Should Be Boosted by Its Smart-Home Products

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By selling more smart speakers and other smart-home devices, Amazon is seeking to greatly improve its consumer-electronics business, thereby boosting Amazon stock. AMZN recently purchased Eero, which should improve its ability to build more smart-home devices. Last year, Amazon purchased Ring for close to $1 billion. And a recent report by CIRP shows that Amazon is clearly a market leader in the smart- speaker segment.

Apple is utilizing a completely different strategy. Apple wants to increase its Services revenue at all costs, even if doing so negatively impacts its product sales. For instance, it recently began offering its Apple Music service on Amazon’s Echo products. Apple has been able to increase its Services revenue at a decent rate,  but a large part of its Services top line is still dependent on the number of devices it sells and on the success of its App Store. Investors who are looking to choose between Amazon stock and Apple stock should assess and compare the companies’ strategies.

Amazon’s Change in Direction

In the past, Amazon focused on expanding its retail platform and increasing the revenue of its cloud business, known as Amazon Web Services. However, in recent quarters its overall revenue growth has slowed. In the current quarter, it expects its top line to increase 10%-18% year-over-year, meaningfully lower growth than in the past. The main reason for this slowdown is the decelerating revenue growth of its core retail platform.

Fig: The revenue growth of Amazon’s online stores and third-party seller services is slowing. Source: Amazon filings

Amazon’s Q4 revenue was $72.3 billion. Its online store and third-party-seller services had combined revenue of $53.2 billion, or 74% of the total. In the last few quarters, both these segments’ revenue growth has slowed. They also have very low margins. Nevertheless, the deceleration of their revenue growth has made investors less bullish about Amazon stock and has weighed on Amazon stock price.

For the past few years., Amazon has tried to introduce new products in an effort to boost its profits and lift Amazon stock price.  Some of its initiatives, like Fire Phone, were unsuccessful. However, Amazon’s smart-speaker products have been successful,  and it is well-positioned to develop additional smart-home devices.

Fig: The growth of the overall smart-speaker installed base and Amazon’s share of the market. Source: CIRP

Amazon’s Advantage

In a recent report, CIRP has noted that the number of installed smart speakers in December 2018 had increased to 66 million, from 36 million in December 2017. As Amazon has introduced new smart speakers, it has been able to retain its leadership of the segment.

Consumers usually stay loyal to the smart-speaker brand that they choose initially, mainly because all newer devices are seamlessly integrated with older ones. Consequently, Amazon should be able to increase its market share over the next few years.

On the other hand, Apple has been focusing less on its products. The company is looking to double the sales of its Services segment between 2016 and 2020. It is currently on track to do so, and in Q4 its Services revenue surged 19% YoY, compared to a 15% decline of its iPhone revenue.

In addition to streaming Apple Music on Amazon’s Echo devices, Apple has made a deal to stream video on Samsung TVs. That’s another sign that the company wants to move away from products and is not looking to build an integrated product and streaming ecosystem.

Which Strategy Is Better?

That is a trillion-dollar question. Amazon and Apple chose their respective strategies based on the nature of their businesses. Due to the saturation of the smartphone segment, Apple probably won’t be able to increase iPhone unit sales. Similarly, Amazon’s online-retail platform has dominated the industry, but after years of strong sales growth, the industry is showing some signs of saturation.

As a result, Apple is relying on services to provide additional revenue growth in the future, while Amazon is looking to grow its smart-home segment in order to deemphasize its low-margin retail unit. Apple still needs the iPhone, while Amazon needs its retail platform. However, future increases of Amazon stock and Apple stock will depend on the ability of these companies to add new revenue streams.

We need to take a close look at their respective strategies. Over the last few quarters, Apple’s Services segment has grown decently. But a large part of this growth has been due to the increases of its revenue from its App Store. The App Store is facing new headwinds as major apps like Netflix (NASDAQ: NFLX) start processing payments on their own, eliminating Apple’s commission. Netflix was able to move from testing its payment-processing system to rolling it out within less than 4 months. Other big streaming players may follow in Netflix’s footsteps.

Services like Apple Music have very low margins. Due to heavy competition, video-streaming services are likely to have similarly low margins. 

The Smart-Home Segment Can Boost Amazon Stock

There is a good chance that the margins of Amazon’s smart-home business will increase. According to CIRP data, Amazon sold 20 million smart speakers in 2018 in the U.S. At an average selling price of $60, its total revenue would have been around $1.2 billion from the domestic market alone. As households buy multiple smart speakers, the segment’s size will rise further, boosting Amazon’s profits and lifting Amazon stock.

Amazon should be able to launch new smart-home devices by leveraging its current market leadership.  As Amazon releases more expensive smart-home products, its margins and total revenue should increase, further raising Amazon stock price. Amazon’s smart speakers have been launched in all major international markets, further increasing the long-term growth potential of these devices and raising the chances of them boosting Amazon stock price.

According to CIRP’s report, the annual growth rate of the smart-speaker segment is close to 100%. The addition of new devices, stronger growth in international markets and higher average selling prices should boost Amazon’s annual revenue from this segment to around $10 billion by the end of 2020.  Acquisitions by Amazon in this space should expand its product portfolio.

The company has not reported its margins for this segment, but they should meaningfully improve as the overall ecosystem of smart home devices strengthens. Although Google Home has begun to compete more effectively with Amazon’s Echo, it will be difficult for Google to replicate the seamless integration between Amazon’s retail business and its smart-home devices. Better pricing power and an expanding market should increase Amazon’s income from this segment, providing a positive catalyst for Amazon stock.

The Valuation of Amazon Stock and Apple Stock 

The market caps of both Amazon stock and Apple stock are close to $800 billion. While Amazon stock might look more expensive due to its higher earnings multiple, other metrics portray AMZN stock in a more bullish light.

Amazon’s price to free-cash-flow ratio is 46 compared to only 13.5 for Apple. But Amazon’s ratio has dropped substantially in the last few quarters as its margin increases have raised its FCF. Analysts’ forward estimates for earnings per share and revenue are also very promising for Amazon stock.

In the last year, analysts’ consensus EPS estimate for two fiscal years ahead has increased from $16 to $56. Continuous growth in advertising and the company’s cloud business should help improve its earnings thereby reducing the valuation multiples of Amazon stock.

Eventually, Wall Street gives better multiples to the stocks of companies that develop new revenue streams and increase their margins. As I noted above, Amazon’s smart-home devices should generate large amounts of revenue in the near future, while they can also carry good margins and improve the company’s overall ecosystem. As a result, the proliferation of these devices can boost Amazon stock. 

Apple faces a more difficult task. It needs to prevent apps from processing payments outside of the App Store. At the same time, it has to use its streaming business, which competes with companies that utilize the App Store., to boost its Services revenue.  

Although Amazon stock is more expensive than Apple stock, I believe that Amazon stock has a better chance of outperforming the stock market than Apple stock.

The Bottom Line on Amazon Stock and Apple Stock

Amazon and Apple are drastically changing their strategies. Amazon is moving away from its dependence on retail growth and trying to expand its product portfolio. Apple is trying to deemphasize products and use its ecosystem to accelerate the growth of its Services business at all cost.

As the average selling prices of Amazon’s new products increase and they account for an ever-larger proportion of its overall revenue,  Amazon’s margins should rise. Apple will probably have trouble increasing its already-high margins as it enters the streaming segment which generally has very low margins. Considering the changing business models of these two Goliaths, Amazon stock seems to be a better bet than Apple stock.

As of this writing, Rohit Chhatwal did not hold a position in any of the aforementioned securities.

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