Smartphone Stocks May Be at End of Long Run

Apple seems the more expensive of the two. For $167 billion, the company is yours in its entirety. But for $3 billion less you can buy both Hewlett-Packard (HPQ), which shipped more than three times as many personal computers as Apple in its most recent quarter, and RIMM, whose BlackBerry phones are expected to outsell Apple's iPhone 2-to-1 this year. Of course, your H-P/RIMM combo would come with low-margin printers instead of high-margin iPods, but all told you'd still have more than four times Apple's trailing sales and more than double its profits.

I know: With Apple, you're paying for the growth potential. But the numbers suggest you're paying a touch too much right now. Consider that Apple trades at 39 times forecast earnings for last year, in between H-P's 17 (based on its fiscal 2007, ended Oct. 31) and 51 for RIMM (based on its fiscal 2008, which ends March 3). Apple's earnings are projected to grow 29% this year, putting it again in between H-P's 15% and RIMM's 51%. To see which company offers the most near-term growth for the money, divide the price/earnings ratio for each by the next-year growth rate. You get a 1.0 for RIMM, a 1.1 for H-P and a 1.3 for Apple (and a 1.1 for the S&P 500 index). Based on perceived growth prospects, RIMM and H-P are priced on par with the broad stock market, while Apple is some 18% more expensive.

As for RIMM, while its price might seem justified by the near-term growth, it's unclear how long the company can sustain that growth. While its service and software revenue growth tends to be fairly stable from one quarter to the next, its hardware sales growth tends to soar and swoon, depending on whether a new generation of phones has recently been introduced. Tavis McCourt, who covers RIMM shares for Morgan Keegan, an investment bank, wonders if we're at the peak of the upgrade cycle for the company's 8000 series of phones. McCourt notes that shares of RIMM rocketed 350% higher during the 18 months ended February 2004, the company's last upgrade cycle, but that it was flat during the 18 months ended August 2007, the last ebb in the cycle. He reckons that the current upgrade cycle began with the launch of the popular Pearl model a year ago, and will slow by the end of summer 2008. Hardware currently contributes about 80% of RIMM's sales, the highest percentage in the company's history, so it's particularly exposed right now to the upgrade cycle. The stock also seems riskier than that of Apple, given that RIMM is reliant on a single product category for its fortunes, unlike Apple, which can disappoint on iPhones but make up for it with Mac computers.

None of this detracts from the impressiveness of both companies' product lines and financial successes. Both turned up recently along with four other companies in a search for recent improvement in profit margins. (Run the search for yourself anytime using SmartMoney's stock screener, along with the full list of screen criteria.) Considering their price momentum, both stocks are well capable of mocking my caution by marching higher in the months to come. Such is often the fate of those of us who favor data over faith.