I recently opened a position in Apple. The main reason why I purchased Apple stock is that I don’t believe Apple is a technology company; instead, I want to show why I think Apple is instead a consumer discretionary company (goods and services that are considered non-essential by consumers, but desirable if their available income is sufficient to purchase them) through a brief analysis of its inputs, outputs, and customers. This is by no means an investment thesis.
Of the eleven S&P industries, Apple is commonly classified as a technology company. It is also commonly included in technology ETFs, often taking the top holding due to its enormous market capitalization. It’s not hard to see why Apple is classified as a technology company. In its recent line up of products, it announced its new A12 bionic chip, along with hosts of machine learning software to helps with things like improving its photo quality and speeding up FaceID. Its new Apple Watch has fall detection and workout detection, also powered by artificial intelligence. iCloud and Apple Music leverage the internet and cloud technologies as services for their users to get files and music anywhere.
But I believe investors that classify Apple as a technology company don’t fully understand its business model and strategy, which will ultimately be detrimental to their investment portfolio. I’d like to dive deeper into why I don’t think Apple is a technology company, but before I do that, let us first examine a different company that shares a lot of similarities but is easily classified as a consumer discretionary company.
Nike is a consumer discretionary company that we’re probably familiar with. They make various sporting goods, mostly shoes. In order to understand Nike, we need to examine its input, output, and customers.
Quite simply, Nike works with supplies to take a raw good such as fabrics and plastics to create a shoe. But it would be negligent to ignore the technological developments that went into creating their shoe. In Nike’s early years, Bill Bowerman was Nike’s chief inventor. One of Nike’s co-founders, Bill was Phil Knight’s track coach and a running shoe fanatic. Bowerman was a legend, not only for his ability to produce world class runners, but he would experiment with different materials and designs so that his runners could run faster. He was the creator of the Nike Cortez and his famous “waffle shoe”, both extremely successful shoes with both athletes and recreational joggers. Then in 1977, aerospace engineer Frank Rudy created the first shoe with an air-filled sole: the Nike Tailwind. The Nike Tailwind was another huge success, launching a new line of shoes with air-filled soles.
Another input to Nike’s products is its marketing, its output being the superior sensation of motivation and athleticism its customers feel. From Phil Knight’s introduction of the classic “Swoosh” logo as “the sound of someone passing you”, to today’s “Just do it” slogan. Nike’s brand is now associated with a deep psychological desires such as independence, action, and freedom. It also has lines of shoes based off of sports legends, further bolstering the feeling that people get from wearing Nike shoes. Its basketball line has brands such as the Jordan, Kobe, and LeBron. Most recently, the Nike’s Colin Kaepernick ad shows just how much mindshare Nike’s ad campaign can take.
Nike creates shoes and marketing messages that are directed at consumers, everyday people like you and me. I need good running shoes to jog to the gym. My roommate needs reliable shoes to play basketball. It’s important that we can have these shoes for our livelihood, have a good time, and achieve our athletic goals.
After examining Nike’s business from its input, output, and customers, let’s examine Apple along these dimensions. I’ll focus on the iPhone since it’s the good that most customers are familiar with.
Apple takes raw materials and leverages all sorts of inventive engineering to create the iPhone. Silicon to create chips, glass to create its screen, and electrical power to enable the phone to run. Industrial designers spend years debating the finest details about how much the phone should weigh (I have a friend who was an Apple product engineer on the Mac. One decision he was involved in was how much battery to fill the chassis of the Macbooks with because more battery space would mean longer battery life, but also a heavier laptop, not to mention unwanted weight distributions). Apple also leverages software and data in some simple but profound ways. Take Apple’s Airpods, that pair and unpair with iPhones seamlessly. It is Apple’s obsessiveness for hardware and software integration that allows it to give users a consistent and loved experience. Contrast this with the bloatware that can be found on some Android phones. Until the Pixel, Android phones did not have the luxury of software and hardware integration. Even Apple’s newest iPhone OS, iOS 12, didn’t come with a fanfare of new features, but its best improvement was the in its speed, which makes even old iPhones (I have an iPhone 6s) feel like new. At the end of the day, Apple creates a phone that consistently works well and feels great.
The other aspect of input and output is Apple’s marketing. Apple is able to take ideas of freedom, fun, and future into advertisements that can speak to a deep human need. That’s why their ads are able to gain an international audience. It’s no debate now that Apple’s marketing makes its customers feel some deeply human desires: the 1984 ad taps into our desire to be unique, the iPod ad taps into our desire to be free, and Apple’s latest ad for the Apple watch sells you on your ability to have your best self. When Apple released the iPhone X, people scoffed primarily at its high price point. Customers can get a similar Android phone for a lower price. Apple’s brand is so strong, however, that the high price point did not deter the iPhone X from becoming the best selling phone in the world.
Apple’s customers are people like you and me. Chances are you’re reading this on an iPhone, iPad, or your Macbook. It’s clear from the attention to detail they put in their work and the message they craft through their messaging that they want to convince you that Apple products are the best in the world while also being perfectly suited for you.
Apple is a consumer discretionary company
When examining Nike and Apple’s inputs, outputs, and customers, it is not hard to see that they are both consumer discretionary companies, not technology companies. Through inventiveness in their product development and marketing, Apple and Nike create products for consumers to enjoy.
One has to wonder why Nike isn’t classified as a technology company. It has competent engineers and designers to make state of the art shoes. It hires material scientists to find the best fabrics in terms of reliability, weight, and comfort. This is no different from Apple, yet because the product is a shoe and doesn’t need electricity, doesn’t have chips, and doesn’t run on the internet, it’s much easier in our minds to classify it as a consumer discretionary company. But when investors look at Apple, they primarily focus on the inputs of a company without encompassing the broader picture of its output and customer. This is a mistake.
Are there technology companies? Yes, but those companies produce technology for customers that are seeking technology. Amazon’s AWS is one of those examples, which provides infrastructure services for other companies.
We can do a simple analysis for other companies and see what results. I’ll include the FAANG stocks, as people regularly (and incorrectly) classify them as technology companies:
Note: I was surprised to find Alphabet, Netflix, and Facebook classified correctly as communication services companies under the S&P 500 industries.
One input that should stand out is that most of these companies leverage the internet, but the mistake that most people make is that because internet is one of the inputs, it makes it a technology company. The internet is ultimately a business-model-altering resource that makes distribution costs and transaction costs, once expensive, now negligible. Companies that don’t utilize the internet do it at their own peril, since they forgo an essentially limitlessly scalable and cost efficient way of reaching customers. Software is eating the world, as it goes, but that doesn’t mean that more companies should be classified as technology companies. Instead, it means that companies of all industries need to adopt the internet and software to maintain a competitive advantage.
Throughout my investing career, I worried that I over-indexed on “technology” stocks. Misclassification also plagues legendary investors like Warren Buffett, who didn’t want to touch “technology” companies because they were outside of his circle of competence. And for good reason too, since he avoided the mania of the late 90s and early 00s, when companies with business models centered on the internet weren’t making any money. But it’s been over 15 years since the tech crash and businesses have learned how to use the power of the internet to build profitable businesses. Warren Buffett has since changed his mind: it is now apparent that Apple, once classified as a technology company, is a consumer discretionary company in the eye of the world’s savviest investor. In fact, Apple is now Buffett’s largest holding. By understanding our investments more holistically in terms of their inputs, outputs, and customers, we can more strategically understand their strategies and structure our investment portfolios.