Sunday, January 27, 2008

Microsoft's Fourth Quarter

With Apple (AAPL) stock down Friday to $130 per share, off 36% from its recent peak of $202.96, folks might want to revisit the adage "slow and steady wins the race." Apple is a good profit generator and reported good Q4 2007 earnings recently, but its stock had been in its own private bubble. Its high PE ratio could only be maintained by the fiction of eternal rapid revenue and earnings growth. With iPod sales up only 5% from year-earlier (which I warned about: See Apple iPod Sales Decelerate?), Apple will probably continue to grow. But not at the rate it has seen since the iPod lifted it off its moribund pre-iPod base.

Even after Friday was over Apple's P/E ratio was 28.51. Microsoft had a very upbeat Q4 earnings report on Thursday, but its PE ratio at close of day Friday was a quite conservative 18 (I am using today's Nasdaq figures: be warned all PE calculations are not alike!).

See my Summary of Microsoft's January 24, 2008 Analyst Conference for details on Q4 2007 (their fiscal Q2 2008). Here I'll just highlight some issues.

Microsoft revenue was $16.37 billion, up 30% from year earlier. Basically everything sold well, from Xbox 360 consoles and games to Vista to business software like SQL Server and Office. This figure was turbocharged because in the December 2006 quarter some revenues were deferred for purchases of Windows XP that allowed a free upgrade to Vista.

Earnings per share (EPS) were $0.50, almost doubling the $0.26 of the year-earlier quarter.

Like Apple, Microsoft's business is somewhat seasonal. It is strongest in the back-to-school and Christmas periods. So for the March quarter Microsoft guidance on EPS is $0.42 to $0.45. Still, the earnings run rate is moving towards $2 per share per year.

Apple's earnings were also growing quickly, up 54% from year earlier.

A economist who believes in rational investors and pricing being automatically set by free markets would have trouble with these numbers. If what investors want is earnings, and Microsoft's earnings are growing faster than Apples, then Microsoft should have a higher PE ratio than Apple, not a lower one.

Well, in case you had not noticed, investors are not entirely rational, and auction pricing of stocks drives prices away from equilibrium in the short run.

There are many details that can be picked apart in the Microsoft and Apple stories to justify bullish and bearish attitudes towards the stocks. But overall, Apple is a pet stock just as its technologies are driven by fashion over function. Microsoft is boring. The only reason to own Microsoft stock is to make money.

The death of Microsoft has been much heralded. Many companies that were going to kill Microsoft are themselves dead. The Internet did not kill Microsoft, and neither did Google. Oh, sure, it still might happen. Microsoft has a very, very, broad set of offerings; failure in one area can be made up in other areas.

Because of the current liquidity scare both companies stock prices now look undervalued to me, and that is true of many technology companies.

The most important thing is not whether you have a lot of Apple stock of Microsoft stock, but how smart you are in diversification. Diversification hedges your bets, but you still want to be careful in the selection of each and every stock in your portfolio.

I own Microsoft stock and have worked freelance for Microsoft. I don't own Apple stock, but have friends and family that own Apple stock and/or work(ed) for Apple.

More data:

My Microsoft main page
My Apple main page

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