As consumers pick up smartphones at an exponential rate, it is no surprise that investment analysts are bullish on the growth and profitability of the industry’s key manufacturers.

Unlike traditional cellphones, which have only telephone and text-messaging capabilities, smartphones have distinct operating systems that run much like those on computers, allowing the user to surf the Internet, operate mobile office applications and access multimedia content. As a result of these advanced features, manufacturers can charge a premium on the handsets, creating substantially higher profit margins. For example, without a carrier subsidy, a smartphone can retail for $200-$300 on the low end, while high-end touch-screen devices can cost between $400 and $600. In contrast, traditional cellphones cost between $100 and $200. (All figures are in U.S. dollars.)

Despite the higher price points, smartphones sold like hotcakes during the recession, indicating consumers are more than willing to pay a premium for the increased functionality. For instance, in the nine months ended Sept. 26, 2009, sales of Cupertino, Calif.-based Apple Inc.’ s iPhone skyrocketed to 16.4 million units, a hefty 76% increase from the 9.3 million units it sold during the same period a year prior. Waterloo, Ont.-based Research In Motion Ltd. also saw similar success, as shipments of its BlackBerry devices jumped to 26.2 million units during the nine months ended Nov. 28, 2009, up by 44% from 18.2 million devices in the same period a year earlier.

This double-digit growth is likely to continue for smartphone manufacturers well into this decade, suggests a report issued on Nov. 6, 2009, by Cambridge, Mass.-based Forrester Research Inc. The report predicts the adoption rate for smartphones will grow to four out of five handsets by 2014 from one in three today.

Besides increased functionality, another reason more consumers are shifting to smartphones is because of declining prices on data plans and hardware, says Kevin Restivo, an analyst with IDC Canada Ltd. in Toronto: “Devices can now be found at different price points and data plan prices are also trending downward.”

According to Forrester Research, the average data access fee for U.S. customers — on top of their regular cellphone costs — should fall to $16.64 a month by 2014 from the $17.34 it was in September 2009.

But although the smartphone market has massive growth opportunities in the years ahead, Tim Long, managing director and analyst with Toronto-based BMO Capital Markets Corp. in New York, cautions that stable, growing revenue is not in order — even for the biggest players.

Maintaining a growing revenue stream depends on the manufacturer’s ability to come out with a winning smartphone throughout each product cycle, which typically lasts six to nine months. Much like the fashion industry, says Long, it’s not unlikely that a large player could miss a phone trend one cycle and then bring out a hit the next.

And as more competitors enter the market, there is a risk that those product cycles may become even shorter. For instance, Mountain View, Calif.-based Google Inc. ’s Nexus One smartphone was launched this month.

Given the short-term nature of smartphone product cycles, investors may see the stocks of these companies as trading vehicles, as opposed to long-term investments, Long says: “The stock of a company behaves as the product cycle of the company behaves, so the [smartphone] market could be doing very well, but a company might not have a great product and could be losing share” — if it is not producing the smartphone consumers are looking for in that particular period.

The key for your clients who want to invest in a particular manufacturer, adds Long, is to remain committed in the face of huge deviations and not to react to the market in haste. Some investors, he notes, choose to match the holding time for a stock to the success of a company’s product line. For example, your client may hold the stock of a company that has a smartphone that’s selling well, then sell the stock when the product starts to get old.

When determining which companies are most likely to be trendsetters for most product cycles in the long run, you need to grade a manufacturer on three critical fronts, suggests Ken Dulaney, an analyst with Stamford, Conn.-based Gartner Inc. in San Jose, Calif.: hardware, software and access to an application store.

@page_break@Part of what keeps Apple ahead in the smartphone race is its ability to score an “A+” on all three of these fronts, says Dulaney. “What killed many manufacturers is they didn’t understand that if you are going to have a touch-screen device, you have to have at least 3.5 inches,” the iPhone’s screen size.

For the quarter ended Sept. 26, 2009, Apple’s seven million iPhones sold resulted in a 17.1% share of the total smartphones sold worldwide, up from 12.9% a year earlier, according to a Gartner report issued this past November.

Apple’s overall sales for the nine months ended Sept. 26, 2009, were $26.4 billion, up from $22.9 billion during the same period a year prior. Its net income was $4.1 billion, up from $3.2 billion. Of the $9.8 billion in sales Apple generated in the quarter ended Sept. 26, 2009, the iPhone and related products and services accounted for 23%, or $2.3 billion.

When it comes to a smartphone with a physical keyboard, RIM is a key player to watch, says Dulaney. According to the Gartner report, RIM’s BlackBerry smartphones make up 21% of the global marketplace, up from 16% the previous year.

RIM’s revenue for the nine months ended Nov. 28, 2009 totalled $10.9 billion, up from $7.6 billion in the same period a year prior. Its net income for the nine-month period was $1.7 billion, up from $1.4 billion.

Google, with its Nexus One, is another North American smartphone manufacturer worth keeping an eye on. Nexus One uses Google’s Android operating system, which is slowly gaining popularity. Android phones now make up 3.5% of the worldwide market in terms of units, according to the Gartner report. Previously, Google had been selling its smartphone operating system strictly to other vendors, such as Schaumburg, Ill.-based Motorola Inc.; however, Google’s partnership with Taiwan-based hardware manufacturer HTC Corp. gives Google more control over the handset itself.

Currently, Google earns most of its revenue from online advertising. Google’s revenue was $17 billion for the nine months ended Sept. 30, 2009, up from $16.1 billion it earned in the same period a year earlier. Net income was $4.6 billion, up from $3.8 billion. As a smartphone vendor, Google is planning to sell Nexus One directly to consumers in an unlocked format, so consumers can choose their own wireless carrier. The Nexus One retails for $529 without a service plan.

Aside from increasing the sales of handsets, top-line growth for manufacturers will also come from advertising, says Dulaney: “I think the advertising market for mobile phones is going to take off.”

To gain a handle on digital mobile advertising, Google recently purchased San Mateo, Calif.-based AdMob Inc., and Apple bought Waltham, Mass.-based Quattro Wireless Inc. As for RIM, it “has already showed innovation in this arena,” says Dulaney, noting that the BlackBerry’s advertising service helps developers integrate advertising into their applications. IE