Apple Needs To Start Innovating Again, Or Become Irrelevant

Apple’s price/earnings ratio dropped to 10 while I was on the phone with financial advisor Mark Miller of Wells Fargo Advisors on Friday. Microsoft’s P/E ratio was at 15 at the same time. So why should you care?

Unless you’re an Apple investor, the company’s P/E ratio in and of itself doesn’t matter that much. But what does matter is that a low P/E ratio from a company with strong earnings is a symptom of a company in trouble down the road. And there’s no question that given its current situation, Apple is heading for trouble. In the long run, that trouble can affect you as a customer.

Investors doubt Apple’s potential

On the surface, Apple’s low P/E ratio is a sign that investors don’t think the company has a lot of potential for growth. As Wells Fargo’s Miller explained it to me, this is primarily psychological. Big investors want to own parts of a company that they see as staged for strong growth. Because of a number of missteps by Apple, it’s losing its edge.

Part of that perception of loss comes from adverse reports from analysts such as CNBC’s Jim Cramer, who accuses Apple of arrogance in its unwillingness to explain its financial performance. Cramer said that Apple’s $137 billion cash hoard needs to find a use in product development, dividends, buybacks or acquisitions. Right now, there appear to be no plan to use it for anything.

Others point out that Apple’s poor stock performance is due to a number of reasons. Many people, it seems sold off their Apple stock in the fall of 2012, both to profit from the then-high price, and to turn it into cash before tax rules changed at the beginning of 2013. In addition, big institutional investors have rules that govern the percentage of any stock they can own, and when Apple stock shot up in value, they were forced to unload it.

But the real drag on Apple’s stock and its P/E ratio is lack of confidence in Apple as a company. While nobody expects the company to stop being profitable nor is anyone suggesting that Apple’s in immediate financial trouble, that doesn’t translate into Apple being a great investment. What’s the point, for example, in buying Apple stock if it’s not going up in value consistently, and the company isn’t paying dividends despite its huge profit margins?

Adding to the lack of confidence is the belief that Apple has lost the ability to innovate. The iPhone 5 is a good example of that. At best, the iPhone 5 was an upgrade to the iPhone 4S, with the primary difference being support for LTE and a slightly larger screen. Macintosh computers went for years without an upgrade and when the upgrade was delivered the primary difference was a better display.

In other words, Apple is acting like any other publicly traded company in that it’s selling slightly better products as the technology becomes available, but it’s not driving the technology the way it once did a few years ago and it’s not innovating, it’s simply upgrading.

Microsoft is quietly innovating

Contrast this with Microsoft, which has quietly managed to become innovative again. Regardless of whether you like Windows 8, or Windows Phone 8, both of these are some of the first real differences we’ve seen in user interfaces in years. In fact, Microsoft’s move into real innovation is significant enough that financial analysts are suggesting that the company could become the dominant player in mobile platforms. Analyst Charles Lewis Sizemore, writing in the Sizemore Investment Letter, in fact predicts that Microsoft will eventually muscle out Apple and “crush” Google in the smartphone and tablet world.

Sizemore explained in an interview on CNBC that Google’s business model simply doesn’t make sense. He also suggested that handset manufacturers really don’t want to be stuck in a solitary relationship with Google, and predicted that Samsung and others would be introducing Windows phones in the very near future.

What this means to Apple is that its future is even more clouded. Apple’s latest quarterly earnings report shows that iPhone 5 sales are softer than the company would like. Meanwhile, it appears that Microsoft, which could be a formidable competitor, is gaining steam and in the minds of some analysts, is about to reach critical mass.

In case you’re interested, that critical mass will happen when at least one major handset maker, besides Nokia, really gets behind Windows Phone 8. Samsung, for instance, makes the Samsung Galaxy Ativ S, but clearly bases its strategy on Android. If that changes, Microsoft’s mobile market share will rise dramatically.

So what can Apple do to keep from losing ground to arch-rival Microsoft? First, Apple needs to reclaim the title of being the top innovator in the tech arena and it can’t do it just by buying up small companies. Then it needs products that actually work like they’re supposed to, in contrast to the poor quality of Apple’s Maps and Siri applications. Then it needs to actually invent something, anything, that shows that the company hasn’t lost its innovative edge, and folks, Apple TV isn’t that something.

Finally, Apple executives need to demonstrate that they’re running a public company responsibly. Besides defending their cash hoard, Apple needs to take a break from the legal and verbal battles that make the company look like it’s more interested in greed than service. Those stupid fights with Microsoft over SkyDrive or Office for the iPad are just two examples.

Apple already has more money than it can spend. Maybe it’s time to look after current and future customers by giving them what they want and need, and inventing the next big thing.

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Originally published on eWeek.