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Apple is in prime position to tap into the huge Chinese market and to cater to the worldwide demand for moderately priced smartphones. (Bobby Yip/REUTERS)
Apple is in prime position to tap into the huge Chinese market and to cater to the worldwide demand for moderately priced smartphones. (Bobby Yip/REUTERS)

STRATEGY LAB

New iPhones, new markets: Why I like Apple's cheap shares Add to ...

Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

In less than a month, the smartphone industry has been totally overhauled.

In early August, BlackBerry Ltd. announced it was reviewing its strategic alternatives, which could result in a sale of the company. Last week, Microsoft Corp. said it would buy Nokia Corp.’s handset business for $7.2-billion (U.S.). On Tuesday, Apple Inc. will completely refresh its lineup of iPhones.

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One trend is clear: Those who control the software aspects of a smartphone, such as the operating system and digital storefront, now want to also build the hardware, so they can gain full control over the mobile computing platform.

Apple and BlackBerry have followed this model from day one. Google Inc. and Microsoft, on the other hand, have focused on the software side of things while letting hardware specialists, such as Samsung Electronics Co. and Nokia, build the smartphones.

That software-only strategy is quickly becoming defunct. Google has been creeping slowly into hardware manufacturing ever since buying Motorola and is experimenting with both smartphones and Google Glass wearable computers. Microsoft is moving into the handset business because without Nokia there is no market for smartphones using the Microsoft Windows operating system.

Does the reshuffling of the smartphone industry change anything from an investor’s perspective?

I remain worried about BlackBerry’s future as a smartphone player, despite its hefty 5.9-per-cent gain on Monday on unconfirmed reports that Canadian investor Prem Watsa will buy the company.

Microsoft seems to have displaced the Canadian vendor from the No. 3 position in smartphones. Without a big improvement in the selection of big-name BlackBerry apps, an acceleration in growth will be a real challenge. A combined Microsoft-Nokia only increases the barriers ahead of BlackBerry.

I remain skeptical about Microsoft, too. I don’t like buying the No. 3 player in a market unless there is some reason to expect a big turnaround. To my eye, Microsoft’s acquisition of Nokia doesn’t alter the competitive equation. In the mobile market, it is still up against Apple and Google, two companies that are firmly entrenched and growing rapidly.

Despite its challenges, Microsoft isn’t particularly cheap. It trades for about 11 times next year’s forecast earnings, according to S&P Capital IQ estimates. So does Apple – yet Apple has much better growth opportunities over the coming year, especially if the new products it unveils Tuesday live up to expectations.

In the past, Apple has announced only a single iPhone model each year, then discounted earlier versions. But this time around, it’s expected to announce multiple models, including lower-priced versions aimed at the huge global population of first-time smartphone buyers.

In addition, it has invited Chinese media to a special event scheduled for Wednesday. That may signal an expansion of the iPhone rollout in China, something that could lead to several years of excellent growth.

Put it all together and Apple looks to my eye like a much better investment than Microsoft. It’s in prime position to tap into the huge Chinese market and to cater to the worldwide demand for moderately priced smartphones.

To be sure, I’ll be watching out for signs that I’m underestimating Microsoft.

It is possible that the combined Microsoft-Nokia could find a way to appeal to new smartphone customers, persuading them to try Windows Phone instead of a cheap Android device or a lower-cost (or older model) iPhone.

If this happens, Apple’s refreshed product lineup may not propel it back to the growth scenario I expect. But with massive free cash flow, a bullet-proof balance sheet and a price-to-earnings ratio of only 11, I think the risk in holding Apple stock is low. I can’t say the same for Microsoft.

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