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Buy Google or Apple? The answer is simple

October 23, 2012: 9:22 AM ET

Putting to rest the Google vs Apple debate by letting the numbers tell the story.

By Andy M. Zaky, contributor

FORTUNE -- The Google versus Apple debate has never been more vibrant. Ever since both companies rose to dominance in 2007, we've seen countless investors, journalists and analysts take opposing sides on virtually every aspect of this war between the tech titans.

But is there really a debate when it comes to investing? The short answer: Not based on the numbers there isn't. The financials, fundamentals, and valuation continue to fall squarely in Apple's corner. Any level-headed investor would buy Apple over Google today, especially in light of Google's recent unjustified parabolic rally to $770 a share just before it reported an epic miss on earnings.

The reason Apple has outperformed and will continue to outperform Google both on the earnings front and in terms of the stock performance comes down to the simple fact that Apple operates in a substantially larger market than Google. The smartphone industry is a much larger beast than the online ad market, and Apple is becoming an increasingly dominant player within that space. Google, which continues to derive a large majority of its revenues from online ads, operates in a low billion-dollar market while Apple operates in a trillion-dollar market. Google's maximum upside potential is only a mere fraction of Apple's maximum upside potential.

Just to get a sense of how much larger Apple's core operating market is consider that before the inaugural launch of the iPhone in 2007, Google reported $4.2 billion in net income, more than the $3.5 billion Apple (AAPL) reported that year. However, as the iPhone exploded in popularity, Apple not only surpassed Google (GOOG) in both revenue and net income, it actually surpassed every single company on the entire NASDAQ-100.

MORE: Among many hits, Apple's lonely flop

In 2009, Apple earned more than Google in net income for the first time in its history. Three years later, Apple reported three times as much in net income as Google. In 2013, Apple is expected to quadruple Google's net income and report twice Google's growth rate. That gives you a sense of the size of the smartphone market relative to the ad market. Can this even be remotely characterized as a close contest? This chart below tells a very powerful visual story of how much Apple has outperformed Google over the past three years.

If you think that looks dramatic, take a look at the revenue comparison of these two companies. Before the advent of the iPhone, Apple had maintained a small lead on Google when it came to sales. It was never really anything very significant. Today, it's mind-boggling how much Apple has pulled away from Google in terms of sales. When the books are closed on the year, Apple will likely have reported nearly four times Google's revenue.

In 2007, by contrast, Apple only reported 50% more in revenue than Google. Thus, the gap in sales between Google and Apple has widened by a factor of eight between 2007 and 2012. And everything points to that gap widening even further in 2013, 2014 and 2015 as Apple gets closer to selling 200 million iPhones a quarter. Apple is expected to sell roughly 40 to 50 million iPhones per quarter next year. Google still hasn't been able to surpass what Apple made in revenue when it sold only 8 million iPhones a quarter back in 2009.


What this all demonstrates is that anyone who has argued that Google was a better buying opportunity than Apple in any year since 2007 has been dead wrong. They have been dead wrong not only from a stock performance perspective given that Apple's stock has outperformed Google by a factor of 3-1 over the past several years now, but they have been wrong from a pure earnings growth and valuation perspective as well. The chart below compares Apple's revenue growth to Google's. Notice how even though Apple reports four times Google's revenue, and even though Apple reports three times as much in net income as Google, Apple still grows at twice the pace of Google on both the top and bottom-line on a percentage basis — and it is widely expected it will do so in 2013 as well:


Despite the fact that Apple has been able to far outpace Google's top and bottom-line growth, Apple still trades at a far lower valuation than Google. So Apple not only makes more money than Google, grows its earnings faster than Google, operates in a larger market than Google, has much greater upside earnings potential than Google, but it also trades at a substantially lower valuation. Apple's price-to-sales ratio, price-earnings ratio and price-to-cash ratio are currently much lower than Google's.

Even after Google missed on earnings last week, causing a precipitous 70-point drop in the stock price, Google still trades at a higher P/E ratio (21.4) than Apple (14.3). And get this. Once Apple reports earnings on Friday, if the stock doesn't move substantially higher, it's P/E ratio will drop to 13.1 based on Friday's close. As it stands right now, investors are already paying an extra 40% premium just to have the right to buy Google over Apple even though Apple has grown its income at more than twice the pace of Google, not just in 2012 but over the past 5-years on average.

The main argument Google pundits make is that Apple's extraordinary past performance notwithstanding, it is the future — and not the past — that determines value. The market is forward looking and thus places more value on future potential than it does on past results. Google bulls have argued this for years, and every year Apple's performance has proven the them wrong.

Year after year Apple is the proven winner, while Google pundits continue to cling onto delusions that Google is somehow a better value "next year." And yet this time next year, Apple's earnings growth and stock performance will absolutely decimate Google's earnings and stock performance, and we will still hear the same arguments about how "the market is forward looking" and how Google will win "next time."

The reality is that Apple is not only destroying Google in this race, it is destroying all large cap technology companies. Not a solitary top-10 tech company has been able to even remotely keep up pace with Apple. If you go back to 2005, Apple was the second smallest of the top-10 in tech reporting only 1/6th the net income of Microsoft — the then leader.

Today Apple far exceeds every other tech company and reports more than three times the net income than most of them. What's more, despite Apple's size, its growth rate continues to far exceed the other top-10 tech companies. Yet, somehow Apple maintains a much lower P/E ratio than most of these top-10 companies. So how is Google supposed to compete with Apple when Apple is in its own league without a competitor? The chart below speaks volumes:

Let's take a look at the future prospects of the these two companies, comparing the revenue and earnings outlook for 2013 to see whether a case can be made to own Google over Apple.

Without taking into account the highly anticipated introduction of the iPad Mini on Tuesday, top analysts covering Apple expect the company to report roughly $63 billion in net income on $230 billion in revenues for the 2013 fiscal year. That would represent roughly 47.3% earnings growth and 43.75% revenue growth when compared to Apple's fiscal 2012. So just to get this straight, the largest market cap company is about to grow its earnings by 43.75% this year.

Google, by contrast, is expected to grow its net income by roughly 18.7% according to a consensus of Wall Street analysts. The analysts are looking for Google to report roughly $16.8 billion in adjusted net income on $53.6 billion in revenue. Unlike Apple, Google very rarely surprises analyst expectations by any large degree. Over the past four quarters, for example, Google missed by 9.5%, beat by 4.50%, beat by 0.80% and missed by 15.20%.

Apple, on the other hand, tends to decimate expectations in most quarters. In fact, there has yet to be a year where analysts haven't had to scramble to adjusted their estimates higher as Apple comes in and destroys expectations. So that $63 billion in net income on $230 billion in revenue estimate is likely to move up as the year progresses and as Apple introduces new innovative products and services.

Apple has not only objectively won the debate from 2009 to 2012, it is largely expected to win next year. But somehow and based on some measure Google is supposed to be a better investment than Apple? Here is what the Google v. Apple story looks like going ahead to 2013:

Here is another way to think about all of this. If an investor had $1 trillion in her bank account and had the ability to buy Apple or Google outright in cash at their current market capitalizations, only someone who didn't care about money would buy Google for $223.5 billion over Apple at $571.7 billion. The reason? Given that Apple not only already has $130 billion of that market cap in cash (as of this Friday's report), Apple's return on equity is much larger than Google's.

Next year Apple will return 14.5% of its entire net market capitalization while Google will return 9.4%. That means if both companies stopped growing, it would only take Apple about six and a half years to completely pay off its entire net market capitalization while it would take Google more than 11-years to accomplish the same feat.

Apple still has at least 3-years of explosive growth ahead of it based on where it stands in the global handset market, and another 3-5 after that of moderate growth.

That's what all of these people who think Apple is going to hit some major peak and then collapse like its 1999 don't quite understand. If Apple merely just remained at this current price-level, it would have its entire market cap in cash over the next four years. If it collapsed as some believe that it will, the company would simply be able to take itself private. That's why Apple continues to push higher, why it will continue to push higher and why it is clearly a much better investment opportunity than Google going into the next three years.

Andy M. Zaky is a fund manager at Bullish Cross Asset Management, which owns a significant position in Apple as a core holding across several different portfolios. The opinions expressed here are his own.

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