Apple vs. Microsoft

published 28 February 2007

Apple Inc.\'s TV advertising campaign cleverly portrays its products as hip alternatives to stodgy old Microsoft's. In a way, the portrayal fits the two companies' stocks as well. Apple shares (symbol AAPL) have risen more than 1,200% in the past four years to a recent $97, and they trade for 32 times expected calendar '07 earnings of $3.03 per share. By comparison, investors seem uninterested in Microsoft's shares, which have done little for five years. At $31, they can be had for just 19 times estimated calendar '07 earnings of $1.68 per share, way below their heyday price-earnings ratios. We think both stocks have promise, but for different reasons.

Apple's shares are "not ridiculously expensive," says Ryan Jacob, who counts the maker of two iconic products, the iPod and the Mac computer, among the top holdings of his Jacob Internet fund. "They have a lot of new products coming out next year, and that could increase their sales and earnings numbers considerably." In January, the Cupertino, Cal., company announced a potential blockbuster, a product that combines an iPod and a cell phone, as well as a device that lets you play computer-downloaded movies on your TV. Owning Apple is a bet that the company will continue to come up with hit products.

Microsoft's new-product schedule, which features updates of Office and the Windows operating system, has been known for some time. These products will be hits by virtue of Microsoft's huge base of users. Robert Millen, co-manager of Jensen fund, says the Redmond, Wash., company is entering the "most significant product cycle in its 30-year history." Curiously, Jensen fund's managers, who favor stocks with high returns on equity (a measure of profitability), had never bought Microsoft (MSFT) because it had always been too expensive and they were concerned about the company's antitrust problems. With the legal concerns now mostly resolved and the share price lagging, they began buying last September at about $27. Millen says he doesn't have a target price, but Jensen managers try to buy stocks when they are undervalued by 30% to 40%. That implies he thinks the shares could fetch $39 to $45 if fully valued.