Apple (AAPL) currently spends more on Research and Development (R&D) in one year than it did in total over the 7 years prior to the launch of the first iPhone in 2007. Its rapidly accelerating spending on technology is creating a durable competitive technology advantage or “technology moat” to competition which has not yet been fully appreciated by the investment marketplace. Apple’s technology spending includes several important components that together create this effective “technology moat” strategy which I will define in more detail in the article below.
The term “moat” in investment terms was first popularized by Warren Buffett when trying to measure a company’s ability to maintain a durable competitive advantage over it’s competitors within a specific market. Apple is using it’s huge cash-flow and financial resources to create a growing technology competitive advantage within it’s chosen markets
From 2000 – 2007, Apple spent a total of $3.85 billion on R&D prior to the launch of the first iPhone. For fiscal year 2013, Apple’s R&D spent $4.47 billion in that year alone. In fact its R&D spending has been growing over 35% annually since the death of Steve Job’s in 2011.
As R&D spending has increased, so has the number of technology patents awarded annually to Apple. In 2013, Apple was granted a total of 1,775 patents in the United States compared to 676 in 2011; a growth rate of 62% annually.
The key to Apple’s growing technology competitiveness is its willingness to aggressively fight patent infringement globally against all competitors. Apple spends hundreds of millions of dollars annually on legal costs defending it’s inventions and that effort is critical to creating its durable competitive technology position or “technology moat”. Because of Apple’s aggressive defense of patents, few companies can afford the risk of being accused of violating their patents and facing prolonged and expensive legal battles worldwide.
To advance its technology competitive position further, Apple is also spending heavily on acquisitions to acquire both technology and technical talent as well. On the March 2014 earnings conference call, CEO Tim Cook confirmed that Apple has acquired 24 companies over the last 18 months and is “on the prowl” for more. Media website “Appleinsider” recently estimated that Apple has been spending more than Google (GOOG) on acquisitions and over the previous 5 quarters ending December 2013, it “officially reported total acquisition investments of $11.2 billion dollars”.
Apple’s strong technology position is evident to it’s competitors even though the investment community as a whole does not yet understand or appreciate it’s significance. In May 2012 Google (GOOG) acquired Motorola Mobility for $12.5 billion. After only 22 months, Google ended up selling its cell phone handset business to China’s Lenova group for only $2.9 billion, but kept a valuable trove of patents. Over the past 5 years, many companies have lost premium market positions to Apple in the consumer smart phone market, most notably Nokia, Blackberry, and Motorola. It is also significant to note Nike’s recent decision to not compete in the “fuelband” hardware market. This may be based on some awareness that Apple plans to enter this “consumer smart band or watch” market soon and that Nike cannot compete with Apple from a technology view-point.
Apple’s current share price significantly undervalues Apple’s growing superior technology power position, thus making it an exceptional long-term investment opportunity for investors. Currently Apple trades at about 14 price/earnings (p/e) ratio compared to an overall market p/e ratio of about 18 using the S&P 500 as a benchmark. Over time, as Apple’s technology position continues to advance, it will become clearer to the investment marketplace that Apple has a durable competitive advantage and this will ultimately be reflected in an above average market valuation. If one includes in this scenario, that 1) Apple’s dividend will continue to grow annually 2) it’s buyback of shares will continue to contribute to earnings per share growth, and 3) it’s technology spending will support the introduction of many new consumer electronic products in the future, then it is not difficult to conclude that Apple makes one of the best long-term investments in history.