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Can Apple Outperform Microsoft?

Wednesday - 2/6/2013, 11:27pm  ET

LONDON -- If you're interested in building a profitable, diversified portfolio, then you will often need to compare similar companies when choosing which share to buy next. These comparisons aren't always as easy as they sound, so in this series, I'm going to compare some of the best-known names from the FTSE 100, FTSE 250 and the U.S. stock market.

I'm going to use three key criteria -- value, income and growth -- to compare companies to their sector peers. I've included some U.S. shares, as these provide U.K. investors with access to some of the world's largest and most successful companies. Although there are some tax implications to holding U.S. shares in a UK. .dealing account, they are pretty straightforward and I feel are outweighed by the investing potential of the American market.

Today, I'm going to take a look at two of the brands that have defined the tech industry, Apple  and Microsoft .

1. Value
The easiest way to lose money on shares is to pay too much for them -- so which share looks better value, Apple or Microsoft?

ValueAppleMicrosoft
Current price-to-earnings ratio (P/E) 10.0 15.1
Forecast P/E 9.7 9.0
Price-to-book ratio (P/B) 3.3 3.2
Price-to-sales ratio (P/S) 2.5 3.2

Apple edges ahead in terms of value, with a much lower P/E ratio and a lower price-to-sales ratio, showing that you get more revenue for your money when you buy Apple stock. A meaningful comparison of P/S ratios requires you to compare profit margins, too -- revenue is no use if it isn't profitable -- but in this case Apple's advantage is confirmed, thanks to its pre-tax profit margin of 34%, which is higher than Microsoft's 28% pre-tax margin.

It's also interesting to note that if both companies' net cash balances are removed from their market capitalisations, they look even cheaper. Apple has $137 billion of net cash, which equates to a P/E ratio of 7, net of cash. Microsoft has net cash of $64 billion, which equates to a P/E of 10.9 -- both of these are in value territory, and are well below the NASDAQ market average of 16.6.

2. Income
With low interest rates set to continue for the foreseeable future, dividends have become one of the most popular ways of generating an investment income. How do Apple and Microsoft compare in terms of income?

ValueAppleMicrosoft
Historic dividend yield 0.6% 2.7%
5-year average historical yield n/a 2.2%
5-year dividend average growth rate n/a 14.9%
2013 forecast yield 2.4% 3.4%

Microsoft takes the lead in the income stakes, thanks to its much longer record of rising dividend payments. The maker of Windows has increased its dividend ten times over since 2003, raising its payout every single year. Apple, by contrast, only reintroduced dividend payments in 2012, after a 17-year break.

However, both companies could afford to pay much more generous dividends from their free cash flow alone -- without touching their cash piles. A decision by either company to do this would also be likely to trigger strong share price gains, as both already offer yields well above the S&P 500 average of 2.2%.

3. Growth
Even if your main interest is value or income investing, you do need to consider growth. At the very least, a company needs to deliver growth in line with inflation -- and realistically, most successful companies need to grow ahead of inflation, if they are to protect their market share and profit margins.

How do Apple and Microsoft shape up in terms of growth?

ValueAppleMicrosoft
5-year earnings-per-share growth rate 62.2% 7%
5-year revenue growth rate 44.8% 7.6%
5-year share price return 242% -9.7%

There's no competition: Apple may be priced like a mature stock, but it has displayed the characteristics of a growth stock over the last five years, delivering a price return of 242% as earnings rose by an average of 62% per year. Microsoft's performance looks pretty dismal in comparison, but in reality, 7% earnings growth each year is very respectable, especially as the software giant has similar profit margins to Apple and owns products -- such as Windows and Office -- that millions of businesses around the globe rely on and pay to upgrade regularly.

Looking ahead, I suspect that Apple's growth will moderate and that Microsoft's may improve slightly, thanks to its near-monopoly position in business computing. Although Microsoft's new smartphone and tablet offerings have not yet been sufficiently successful to pose a threat to Apple, I think they form part of a bigger plan to enable the company to maintain its hold on the global business computing market. My experience of working in big companies suggests that a companywide, centrally managed IT solution will remain a key requirement for most businesses for the foreseeable future, and only Microsoft has the installed user base, software, and large scale required to provide this.

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