Apple and Samsung shouldn't expect the earnings bandwidth for smartphones to keep growing much longer. The number of advanced handsets sold last year grew an incredible 43 per cent to 700 million. They now account for more than two-fifths of the otherwise stagnant cellphone market, according to Strategy Analytics.
Simple mathematics suggests growth will slow – at this rate, their slice would be bigger than the whole handset pie within two years. Tech history also suggests prices will continue to fall. That's a toxic combination for margins.
Just look back in history at what happened to PC makers at a similar point in their development. Half of homes in the United States had a computer by the end of 1998, after almost doubling in three years. The rate of growth then slowed and eventually reached a crawl. Unfortunately, prices continued their march downward, falling more than 90 per cent since 1998, according to government statistics, as the price of chips and other parts became commodities. That encouraged PC firms to turn from finding new customers to using price wars to lure them from rivals.
This hurt PC makers. Dell's net margin reached 8 per cent in 1998 and 1999 before steadily shrinking. Its margin has averaged around 4 per cent over the past five years, while its shares have lost about three-quarters of their value since 1998.
There are already signs that smartphone makers are in a similar bind. Last week Apple reported flat earnings in the most recent quarter, with lower margins on its newest iPhone shouldering part of the blame. And Samsung warned last week that it expected intensified competition in the handset market as smartphone growth slows this year.
But that doesn't mean that all of history will repeat itself. Dell's stock traded at more than 70 times earnings in 1998. Investors weren't prepared for falling margins so stockholders fled once they arrived. The multiple then shrank – the stock now trades at less than eight times estimated 2013 earnings. Apple currently trades at about nine times estimated earnings. Considering its overall performance and its $120-billion (U.S.) cash pile, that looks too low. But at least investors are far more prepared for falling margins this time round.