Before we answer the question of what tech stock is the best one to own in 2014, we must first address the bigger question of what we think 2014 holds in store for the financial markets in general, and technology stocks in particular.

By virtually any metric 2013 was a very good year for the U.S. stock market, and a great year for buzzwords.  Fears at the beginning of the year over the “fiscal cliff” quickly gave way to concerns over federal budget “sequestration,” which in turn led to anxiety over when the Federal Reserve’s “tapering” of its “quantitative easing” program might begin.  But despite that steady stream of sound-bite doom and gloom, most stock market indexes have surged 20 percent or more during the past 12 months.

Since the nadir of the “Great Recession” five years ago the U.S. stock market has more than doubled, a rising tide that has lifted almost every boat that remained afloat.  Tech stocks in particular have benefited more than most.

However, the Fed has made clear that the scaling back of its Quantitative Easing program, or “tapering,” should commence in 2014 as in its judgment the economy is now strong enough to grow with less stimulus. That may be true, but it is unlikely that the stock market will continue to enjoy an unencumbered glide path to further heights.

We believe 2014 will be the year that separates the sizzle from the steak, leaving in its wake an equal number of losers and winners. It will be a year that rewards companies that can deliver consistent financial results, while punishing those that have thus far been carried higher by the hot winds of lofty expectations

For that reason, we quickly narrowed our list to Verizon (NYSE: VZ) and Apple (NasdaqGS: AAPL). Both companies are the equivalent of ATM machines producing enormous sums of revenue and profit in adjacent segments of the tech sector.  And both reward their investors with generous dividends, with VZ yielding more than 4 percent and Apple at over 2 percent (and likely higher, if Carl Icahn has his way).

But when we looked at which one we would recommend as the tech sector stock for 2014 we decided it was not really a horse race. We see Apple as the best long term investment among stocks – not only within the tech sector but within any industry or sector for 2014!  That’s not to say that we believe it will necessarily be the best performing tech stock (there will always be the next “Johnny come lately” tech darling that will shoot up the charts before flaming out), but from a risk-reward perspective it is the surest bet to perform very well.

Why are we so bullish on Apple? Apple is the winner in several strategic categories of the tech sector (Endpoints and Cloud) which will extend its attainment in revenue and profit. Secondly, it has made investments to sustain differentiation, which ensures the market share it has captured will be sustained. Finally, the financial market environment will sustain the conditions necessary for the very best companies to grow despite the ongoing sluggish economy in 2014 and beyond.

The assertion that Apple is the “best-of-the-best” company in the world, not just the tech sector, is supported by its valuation. It is the highest valued company in the world today. But valuations can change, so let’s look at the metrics which explain Apple’s dominance.

When we refer to “categories” at Smart Tech Investor we are describing the direction the major core technologies are headed in the current development wave, and therefore is the expression of opportunity for growth as well. We asserted at the beginning of this article that Apple has already defined and differentiated itself in two critical categories – endpoints and consumer cloud – the combined effect of which should enhance its value even further.

Apple owns the Tablet market with its iPad product – having so totally eclipsed the market that Apple has more share than the rest of the field combined. A similar dynamic is occurring with Apple’s entries in the Smartphone market segment with its iPhone line.

The upshot of Apple dominating the emerging endpoints category and subcategories with its products has been, and continues to be, the cash machine – the “iATM”! The new endpoints are significant beyond the cash flow they are producing, in so much as these endpoints are a discontinuous change occurring within the tech industry.

The Personal Computer, even with as much market share as it possesses today, is being replaced by these new endpoints – Smartphones and tablets. The sales of PCs are now in decline and this shift will intensify as the new endpoints become more refined, such as keyboards, monitors and other interfacing hardware that will contribute towards total replacement of the legacy PC technologies.

The PC ecosystem has many well refined applications (called “Apps”) which provide a level of functionality that was thought to be irreplaceable just a few years ago, but no longer. The number of Apps for Smartphones is now much greater than those available for PCs. As the most critical Apps are ported to Smartphones – while the Smartphones functionality scales upward – the PC will be doomed to a niche position for endpoints in the 21^st century.

What this means for Apple is they not only possess the iATM for endpoints today, but for tomorrow as well. Therefore, the only significant worry which an investor needs to consider is not the usual suspect of market opportunity but rather, can they maintain differentiation for their products so that both strong demand for their products, and the healthy margins that ensue, remain at or near current levels?

This is where Apple’s management of “innogration” becomes core to Apple’s ability to sustain its market lead. We use the term “innogration” at STI to neatly describe a company’s management of technological innovation and the integration of existing external technologies in and around its products. As no company can neither own nor create all market-critical innovation, its management of innogration is decisive. A company’s strategy is, in effect, their plan for innogration whether they realize it or not.

Apple’s products clearly outperform its competitors today. Apple’s iPad trounces the competition not in features but rather in functionality. It is the functionality which is the most important factor for product differentiation.

Case in point: Apple’s iPad versus Microsoft’s (NasdaqGS: MSFT) Surface tablet. Microsoft’s Surface tablet was so slow and such a kluge (i.e., awkwardly configured) compared to the iPad tablets from Apple that no one is going back to sample Microsoft’s later Surface tablets despite the fact that Microsoft now offers a keyboard, a port for a USB memory stick and is lower priced. It is the quality and the stability of the functionality which is critical for product differentiation.

From Microsoft’s perspective, can a new CEO be named soon enough? Their release of Windows 8 is essentially a tablet user interface wrapped around Windows 7. Further, it is horrible for the PC users and at the same time not a good tablet OS. Also, Windows 8 forces users to link to Microsoft’s store. In contrast, Apple does not force users to log onto their tablets using their iTunes store ID and password, but instead integrates the functionality of iTunes with iPads and iPhones instead on an App level.

The difference is of course great innogration – new innovation and integration of existing technologies – versus simply chasing the leaders as Microsoft has chosen to do. Though Google (NasdaqGS: GOOG) gives away its Android operating system to give “try-and-build” a beachhead beneath Apple’s products based on price – it has thus far translated into zero revenue for Google. This in turn translates into no opportunity for Google to innograte while Apple continues to fire on all cylinders.

Consider the release of Apple’s 5S iPhone. Two months after its release you still can not walk up to a Verizon store and pick one up. Did Apple have a breakdown in their production of the new phone? No. The demand is incredible because Apple innograted beyond the market’s expectation for demand.

What Apple did was to buy up new technology and integrate it into the new 5S which eliminates having to remember and input all those unique passwords. Apple replaced all of that with the push of a button which checks your fingerprint against the fingerprint stored when the phone was setup.

This brings up the most important point about the new endpoints: They have not reached commodity status yet. Apple can manage that process through cost and product mix which they have done with lower priced handsets. Will Smartphones eventually become more of commodity? Yes, at some point, but the market has so much growth yet in front of it that Apple can continue to out innograte the field and continue to win handily.

Was Apple leading in cell phones before the iPhone? No – they had no cell phone at all. They had not chased the market and introduced a bad product, saying me-too! Instead, they rolled up cell phone service and MP3 music within a larger screen and made previous standalone products better.

While we’re on the subject of music, let’s look at iTunes. Did Apple decide, like Netflix and HBO, to create their own content and sell it in order to build the biggest money maker in consumer media cloud? No, they resell the best music in the marketplace. Their costs are in the storage of the digits, not in creation of the music.

When Apple innogrates, it only invests in the innovation and integration. You don’t have to worry that these outlays of cash will be used to make dud products, as so many of the big movie studios did. Everyone is now watching Apple’s entry into television and gaming. If it can do to those markets what it did to music and smartphones, it will add two big new revenue streams to its core business.

Given that Apple is flat out running over the entire marketplace, and paying a dividend while Carl Icahn pushes them to buy back stock and pay out even higher dividends, your concern might be that with the stock market at all-time highs this may not be the right time to invest in the best company in the world.

With economic growth still anemic and unemployment around 7 percent (and evidence to suggest that the actual unemployment rate is several points higher), the economic situation can hardly be described as robust or normal. The very real benefit of this market environment is through the skepticism which exists. In fact it was that skepticism which finally took the bloom off of Apple’s rose so to speak.

Apples valuation had gotten ahead of its performance earlier this year when the share price topped out over $700. We recommended against buying Apple at that price, but we do recommend it as a strong buy up to $595, with a stop loss price of $495 in the event of a major stock market correction.  Our two year price target on Apple is $760, a 35% increase from present levels not including dividends.

Other stocks mentioned in this article:

Verizon (VZ) is a ‘Hold’ at current prices.

Microsoft (MSFT) is a ‘Buy’ up to $42.

Google (GOOG) is a ‘Hold’ at current prices.