Apple Inc. (NASDAQ:AAPL) shares have been trading at dirt-cheap P/E multiple of 13.34. Compare that with Google Inc (NASDAQ:GOOG)’s 33.58 and Facebook Inc (NASDAQ:FB)’s 109.97. Apple is a market leader, but in the hardware business. The other two companies are dominating the Internet businesses. Hardware technology companies are highly profitable, build world-class brands and grow quickly. But they have a big problem. Their growth slows, markets saturate, low-price competitors flood the market, and their profit margins come under pressure.

Apple Brand Loyalty

Apple showing most characteristics of a hardware tech company

Apple Inc. (NASDAQ:AAPL) is witnessing most of those characteristics. In contrast, big Internet companies don’t face those problems, says Jay Yao of The Motley Fool. Internet companies such as Google Inc (NASDAQ:GOOG) don’t suffer from margin pressure because new competitors enter the market at lower price points. It’s because their products are free for users. They get money from advertisers, who care only about the return on investment (ROI). A competitor can gain market share only if it comes up with a substantially better product. That’s quite difficult because Google and Facebook can use their muscle to overshadow the startups.

That means larger Internet companies are likely to remain profitable for a much longer period compared to the big hardware technology companies. Most investors believe that Apple Inc. (NASDAQ:AAPL) is a traditional hardware company, and its future margins would be like any other traditional hardware company. They have been right, to some extent. The iPhone maker’s quarterly gross margins have declined about 10% from their peak. But the company has maintained a steady margin of about 37%-38% over the past few quarters.

Apple

Investors need to realize Apple’s software potential

Though the Cupertino-based company’s brand has helped gross margins, its software has played an equally crucial role. The software keeps its existing users tied to Apple Inc. (NASDAQ:AAPL)’s ecosystem. If an iPhone user switches to Android, he will have to buy or transfer all the videos, documents and apps. That takes effort, time and money. So, a larger number of users simply buy another iDevice and stick to Apple.

Apple Inc. (NASDAQ:AAPL)’s valuation reflects that of a hardware company. Market participants don’t realize that its software keeps users tied to the ecosystem, boosts future cash flow, and ensures higher margins.

Apple Inc. (NASDAQ:AAPL) shares rose 1.26% to $537.59 at 11:52 AM EDT.