You Have to Focus on Valuation Metrics in the Stock Market!

As an Apple, Inc. lover (and someone who spends tens of thousands of dollars a year on hardware and software from Apple for headquarters), I am incredibly excited about what Steve and his team have accomplished.  The results for Apple investors have been remarkable.  Here is the actual quote from a news story today:

When Steve Jobs assumed the CEO position at Apple on July 9, 1997 Apple shares cost $3.42 and the company had a market cap of around $3 billion. This week Apple shares hit $266 with a market cap of $241 billion — 80 times larger than it was 13 years ago.  Microsoft shares, in contrast, went from $17.67 to $31 in the same time frame — not even a doubling despite more than $80 billion in share buy-backs by the company.

What is my problem?  Once again, here is an example of how clueless most financial journalists are … they didn’t even consider the billions upon billions of dollars that were returned to Microsoft shareholders in the form of cash dividends. The cult of stock price is one of the reasons it is so incredibly easy to make money in the market.

Even more egregiously, they ignore valuation metrics.  If they had paid attention to them, they would have realized that 13 years ago, Microsoft had gotten to $60.00 per share, which represented a price-to-earnings ratio of 85.71, or an earnings yield of 1.1%.  In other words, you could have put your money in the bank and earned 6.00% on certificates of deposit at the time with no risk, or taken a hell of a lot of risk an bought Microsoft for an earnings yield of 1.1%. Today, Microsoft has a p/e ratio of 17.01 and an earnings yield of 5.88%.

Put another way: For every $1 in profit the company earned in 1999, the market rewarded Microsoft with $85.71 in stock price.  Today, the market is valuing the firm more rationally and giving only $17.01 in stock value for every $1 in earnings. If earnings had remained consistent, the stock would have fallen by 80%, wiping out investor’s wealth.  Instead, Microsoft continued to generate unfathomable quantities of cash from operating systems, software, server licensing fees, consulting, and video games.  They returned almost all of this profit to stockholders in the form of cash dividends and share buybacks.

Thus, the fact that the stock has doubled, plus shareholders have received several dollars in dividends per share, over the past 13 years is a remarkable accomplishment given the completely unjustifiable and irrational valuation applied to the stock in the past.

I may be an Apple fan boy, but saying that Apple “beat” Microsoft is like saying the child who is a recovering heroin addict “beat” the child who is a successful Harvard-educated brain surgeon because the trajectory of the drug-addicts life, now that they are clean, was improving faster than the trajectory of the doctor’s life.  You cannot really compare the two businesses on stock price – you can only judge management on underlying operating performance.  Microsoft was priced to perfection 13 years ago.

I should point out, though, that the source article itself was an excellent analysis of the challenges faced by Microsoft.  It is definitely worth reading.

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