Samsung's Earnings: Could This Be a Bigger Risk Than Galaxy Sales?

By Jamal

Source: Samsung.

Although Samsung does have a publicly traded equity security in the United States, the unsponsored American depositary share [ADR] has significant drawbacks. For starters, the stock is thinly traded with a three-month average daily volume of 111 shares, presenting investors with low liquidity from a bid-ask basis.

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However, that doesn't mean technology-related investors should not pay attention to the South Korean conglomerate. For one thing, the company's semiconductor business is critical in a host of device manufacturers -- including competitor Apple , which partially depends upon Samsung for fabrication of its beastly A9 chip used in Apple's signature iPhone (spoiler alert).

But perhaps a bigger reason Apple investors should pay attention to Samsung is from a market research standpoint. When it comes to high-end smartphones, it's nearly a zero-sum sales construct -- either Samsung's winning with its Galaxy line or Apple's iPhone is adding to Cupertino's top-line growth.

Samsung had a strong report, but only partially due to smartphonesBreaking its seven-quarter slump, Samsung finally reported its first year-on-year operating profit increase last month, reporting 7.4 trillion Korean won ($6.5 billion) in the heavily watched line item.

On a year-on-year basis, this is up a strong 82% from last year's corresponding quarter, in which Samsung reported 4.0 trillion won ($3.5 billion). As for the top line, the company also reported a year-on-year gain, going from 47.5 trillion ($41.8 billion) won to 51.7 trillion ($45 billion).

However, the majority of this outperformance was not due to Samsung's smartphone sales. Since the company's Galaxy S4 success, the two follow-up units have failed to continue its growth path. This trend appears to continue, with the company's smartphone-dependent IT and mobile communications division reporting a narrower year-on-year gain of 37%.

Instead, Samsung's operating profit was driven by its semiconductor businessAs for the star performer of operating-profit growth, it was Samsung's Device Solutions division. Unlike the mobile and IT business, the company separates operating profit into semiconductors and display products. This is an important division, as it relates to operating profit, as Samsung's semiconductor business is nearly half of the company's total operating profit. And in this rather large contributor, Samsung grew segment operating profit in its semiconductor business 62% on a year-on-year basis. However, for Apple investors, there's a bullish note hidden in Samsung's result.

In Samsung's results and outlook section, Samsung noted it began to supply 14-nanometer foundry products as a reason for the improved results. One of the higher-profile recipients of Samsung's 14-nanometer product is Apple's iPhone.

Samsung's A9 slot may be more important to the company's bottom line than its Galaxy smartphones. Source: Apple.

During a teardown for the newest-gen iPhone 6s and iPhone 6s Plus earlier this year, it was found Apple continued to dual-source its chip, with Taiwan Semiconductor Manufacturing creating a 16-nanometer version and Samsung making a smaller, generally more efficient 14-nanometer chip.

Could Samsung's chip be a bigger risk than its phones?Notice I said generally, as in there are exceptions to the rule, and Samsung's newest 14-nanometer chip appears to be that exception. According to Engadget, Samsung's chip is less efficient and has lower-quality battery performance. Later reports under less-strenuous CPU-intensive conditions found the differences to be more favorable to Apple.

That said, a smaller chip is supposed to be more efficient and faster. If it's not, then there's really no reason for its existence. Apple could quickly put this debate to bed by shifting all its production to TSMC. And, if so, that could really hurt Samsung, as it expects earnings to improve by its 14-nanometer foundry supply growth. Even worse, if Apple does shift production, it could portend bad news for future business.

In the end, though, Samsung's outlook for its 14-nanometer foundry is a good sign for Apple's iPhone going forward. If Samsung's 14-nanometer business continues to grow, it will be in large part -- at least initially -- due to Apple.

The article Samsung's Earnings: Could This Be a Bigger Risk Than Galaxy Sales? originally appeared on

Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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