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How Cheap is the World's Largest Tech Company?

Saturday - 4/6/2013, 8:29pm  ET

How cheap is Apple ? Is it going to rise? And if so, when? These are all good questions, but perhaps the best is, “how does it compare to other tech giants,” more specifically, Microsoft ?

By now, everyone knows that Apple has lost 35% of its value in six months and that it trades remarkably cheap compared to fundamentals. I say, “remarkably cheap” because although investors disagree on their outlook, I have heard very few say that it is expensive. To better explain, and to put this into perspective, I am comparing Apple to another tech giant, Microsoft, using some of the more common metrics of valuation so that you may see just why it is so cheap.

It’s not really fair to compare cash flow such as accounts receivable, inventories, expenditures, or cash positions and some of the more telling fundamental metrics for two companies that are so different in size. Instead, it is wise to look at what I call the “homepage metrics,” those that are psychologically most important to the market, and are most widely watched by all investors to get an idea of how a company might stack up against another.

  

Apple

Microsoft

1.

Trailing P/E

9.59

11.04*

2.

Forward P/E

8.53

9.17

3.

PEG Ratio

0.51

1.11

4.

Price/Sales

2.44

3.28

5.

Operating Margin

33.46%

35.43%

6.

Return on Equity

38.41%

22.62%

7.

Revenue Growth

17.70%

2.70%

8.

Expected 2013 Growth

15%-20%

2%-4%

*minus $6.3 billion in unusual operating expenses

1. The “P/E Ratio” is perhaps the most discussed metric among retail investors, a metric that often attracts investors to a stock. Obviously, Apple wins by a large margin, however Microsoft did have a number of unusual expenses over the last 12 months.

2. The forward P/E ratio is more important than the P/E ratio because it takes into account the stock’s current price versus the next year’s expected earnings. This is important because a stock’s price is based on expectations. In comparison, Microsoft and Apple are close, but Microsoft is 8% more expensive than Apple.

3. The PEG ratio takes into account earnings growth and valuation, with a “1.00” considered “fair value.” In a sense, Microsoft is 120% more expensive compared to Apple in terms of growth/valuation.

4. Microsoft is 35% more expensive than Apple in its price/sales. This premium implies that Microsoft has the better growth, as faster growing companies trade at higher multiples to fundamentals.

5. Everyone worries about Apple’s margins being too high, but they are comparable with others in the industry. Even Google has operating margins over 25%, meaning the downside in margins may not be so great.

6. Return on Equity shows management’s efficiency at making investments. Apple wins this battle by a great margin.

7. With Microsoft’s large premium on virtually all key metrics, you’d expect better growth. However, Apple grew 650% more than Microsoft last quarter!

8. Like I said, a stock reflects current fundamentals and future expectations. Apple is expected to grow at minimum five times greater than Microsoft in sales. Yet Microsoft is more expensive in all fundamental/valuation metrics. It simply doesn’t make sense!

I belong to several investment groups, both professionally and for the retail community. I speak on a daily basis to those who have just a few thousand to invest and also those with a couple hundred million dollars to invest in the market. Yet despite this wide range of connections, the only real response I hear from bears on Apple is that “it is going to fall lower.”

Unfortunately, I have yet to hear one educated reason for why it is a sell at these levels. Sure, some will feed you information about the company’s margins, its product cycle, or its concerns regarding innovation. However, last time I checked, Apple is highly profitable, is continuing to grow, and has the greatest ecosystem the world has ever seen (its growth, sales, and dominance as proof). Therefore, the only way to properly explain such large loss, while others that are more expensive (i.e., Microsoft) have near zero growth, is to accept that Apple’s downfall and current valuation is much related to psychological factors, and less related to fundamentals.

Conclusion

When I decided to write my most recent book, Taking Charge With Value Investing (McGraw-Hill, 2013), my goal was to first deeply explore the psychological side of investing but also to explain value in a very simple manner. Far too often we make investing more difficult than it has to be, overanalyzing in place of common sense. Looking at Apple, and comparing it to one of its closest competitors, the presence of value truly is common sense. I can’t assure that it will trade higher this month, or that it has reached a bottom, but what I do know is that it’s cheap, and that producing large gains are much easier when you purchase stocks that are cheap. 

This article was originally published as How Cheap is the World's Largest Tech Company?on Fool.com

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