Microsoft or Apple Shares? ... Which is the Better Value Now?

Earlier today we commented on Apple's share price and its meteoric rise the past several years, as well as its recent decline.

But what about Microsoft, whose stock has been in a rut for the past decade or so?

My take is that while both are great companies with great long term futures, Microsoft's stock is perhaps the better 'value' at this time. Let's take a look at why that's the case.

Why Microsoft Beats Apple has the comparison, both historically and currently:

"Today, those old rivals Microsoft and Apple  both look like inexpensive stocks.

Microsoft could be the better value. Not only is it cheaper than Apple relative to its earnings per share, but Microsoft's business also has greater strengths, and better prospects, than the market appreciates.

Granted, when these two have gone head-to-head in the past, Microsoft has come off worse—in tablet computers, music players and smartphone software. Apple desktops and laptops also have gained market share in the past decade, albeit from a small base.

Microsoft for the past decade also has paled in comparison as an investment. Someone who invested $10,000 in Microsoft stock 10 years ago and reinvested the dividends would have about $13,000 today, according to FactSet. The equivalent figure for Apple would be $700,000.

But today, Microsoft's prospects look better than its market valuation reflects. And while Apple stock also seems reasonably valued, its business is more vulnerable than many realize.

"Apple is a super company currently making supernormal profits from very high market shares in markets it created with truly super products," says Steve Russell, chief investment officer of London-based investment firm Ruffer & Co., which has $20 billion under management. But that "marvelous situation" won't continue forever, he says.

Microsoft is the opposite, Mr. Russell says, "a so-so company making OK profits with nothing expected to change. But they are currently launching a key set of new products that might just change all this."

Microsoft's strengths include a broad range of "sticky" products—ones users are reluctant to change. Windows operating systems provide about a quarter of revenue, and business software such as Office about a third. Another quarter of sales come from servers; the rest, from Xbox computer games and other sources.

Now Microsoft is introducing its Office suite of products—Word, Excel, PowerPoint and the rest—to a new market of touch-screen tablet users.

Microsoft recently unveiled tablet software, called Windows RT, that received good reviews. More important, Microsoft's new Windows 8 operating system has been completely redesigned for a new generation of touch-screen tablet computers being rolled out by the likes of Samsung, Toshiba and others.

Windows 8 allows these lightweight computers to run Office and Outlook, as well as other advanced software, such as business programs, designed for Windows desktops. That makes the tablets credible replacements for laptops for businesses, allowing users to work on robust spreadsheets and data presentations—a powerful competitive edge against existing tablets, such as the iPad, which run on more limited operating systems.

The new operating system means these tablets can target an enormous existing base of users and applications: everyone who uses a Windows computer at work or home. About 90% of computers world-wide already use Windows.

Apple still is riding high. The iPad remains the dominant tablet computer, and the new iPhone 5 has been a success since September's launch. The company's brand continues to boast high quality and a peerless brand.

Yet it is overwhelmingly dependent on two products: the iPhone and iPad, which together accounted for 69% of revenue last quarter. Financial-research company Trefis estimates they will account for about 80% of gross profits this year. It ascribes 50% of the stock's valuation to expectations of future profits from the iPhone.

Sure, Apple enjoys wide profit margins: Trefis estimates that gross margins on iPhones currently are about 45%.

Yet neither the iPhone nor the iPad is as revolutionary as they once were. Touch-screen smartphones are now common, and tablet computers are flooding the market. Goldman Sachs Group forecasts a total of 117 million tablets will be sold world-wide this year, rising 44% next year.

In such circumstances, companies typically end up competing on price. Apple's margins can't remain completely immune.

Such worries have helped batter the stock. Apple shares have plunged in recent weeks from a record $705 to $515, due to fears of growing competition, an economic slowdown and a possible increase on capital-gains tax at year-end.

Today, Apple has a market value of $485 billion, the most of any company in the world. That looks sky-high. But it also holds about $90 billion net in cash, investments and liquid assets such as inventories, leaving an underlying value of about $395 billion. That is only about nine times the $43 billion in net income that Stifel Nicolaus & Co. forecasts over the next four quarters.

According to FactSet, the equivalent figure for the overall market is about 15 times.

Microsoft is even cheaper. At $26 a share, it has a market value of $220 billion, or about $180 billion net of liquid assets and debt. That is less than eight times its forecast $24.4 billion net income for the next four quarters. The stock also has a 3.3% dividend yield, or dividend payments divided by the stock price. The Standard & Poor's 500-stock index has a 2.4% yield, and Apple 2%.

Bottom line: You might want more than just Apples in your basket, and slow-and-steady Microsoft might not be a bad bet." 

SUMMING UP

Relative to other sectors, technology is inexpensive these days, as are industrials, financial stocks and even energy. 

For those with a long term investing horizon, the trick is to buy the really good companies in a sector that's currently out of favor. Technology is such a sector today.

Apple is a great company, as is Microsoft. Other examples of tech stocks offering good value and the prospects for solid future dividend growth are blue chips like Intel, IBM and Cisco.

Oh, and one more thing. While Microsoft hasn't performed well as a stock in the past decade, it has been a super star over the years. In fact, it sold for less than 10% of its current share price 20 years ago.

As a result, when looking at share prices, it's always good to have in clear view the projected long term value of a company based on its current and future competitive position, earnings, cash flow and dividends. 

As has been the case with the pair of Coke and Pepsi over many years, the pair of Microsoft and Apple is a long term winning combination as well. 

Thus, there's no need to pick one company over the other, but if you're only picking one stock for the next decade, my bet is on Microsoft. 

It's cheaper than Apple relative to its share price compared to earnings, has a higher dividend yield and has a track record of regularly increasing its dividends. Besides, most investors continue to ignore it for now.

What's not to like?

Thanks. Bob.