Apple has a greater market capitalization than Microsoft. Market capitalization is basically a function of investors’ collective estimate of future profits. The market is seeing a greater future for Apple than Microsoft. Rational, or reality distortion field?
In 2009, Microsoft made US$14.6 billion in profit on $58.4 billion in revenue. Apple made $8.2 billion on $42.9 in sales. That’s 78% more sales than Apple and a profit margin of 25% as opposed to Apple’s 19%.
To reach Microsoft’s profit level at its current margin, Apple would have required sales of $76.4 billion (an increase of 78%). For Microsoft to have made Apple’s profit, their revenue would have had to been “just” $32.8 billion.
Yet the price-to-earnings ratio shows that investors are willing to pay a lot more for a piece of Apple’s pie. As I write this, AAPL’s P:E is over 22 while MSFT’s is hovering under 14. In other words, to own a dollar of Apple’s yearly revenues will cost you $22. Microsoft’s P:E puts it in the same ballpark as IBM, Coca Cola and Walmart, while investors are betting that Apple’s revenues will increase dramatically. The price-to-earnings ratio, more than share price or even market capitalization, speaks to the different perceptions of the company by investors.
If not revenue increase, the other way to justify a higher P:E is to anticipate better profit margins, but it’s surely harder for Apple, whose revenue comes with manufacturing costs, to dramatically increase margins than for a software company such as Microsoft. (Google, which enjoys a similar P:E to Apple, has an even higher profit margin than Microsoft.) At these volumes, even significant revenue windfalls (such as the bump Microsoft will get this year from Windows 7 and Office 2010, and that Apple will get from the iPad’s launch frenzy) don’t justify such gaps.
All of which is to say that the market is betting that the game is going to change. Microsoft changed the world of general computing several times, but the last time they did so was in the game of office software. While Microsoft’s Internet and cloud initiatives have shown an admirable ability to “turn the ship,” its leadership in those fields, much less its dominance, is not a given. Apple, on the other hand: iPod, iPhone, iPad. Pretty good decade.
But to use the finance industry’s favorite weasel words: “Past performance is no guarantee of future results.” Just ask Microsoft. Or IBM. Or General Motors. The “Great Man” theory of history would explain Apple’s ascendancy to the return of Steve Jobs and, increasingly, Microsoft’s stagnancy to the retirement of Bill Gates and the leadership of Steve Ballmer.
Recently, Jobs made it clear that a prototype of a touch-screen tablet preceded the creation of the iPhone. Apparently, when Jobs saw the finger-flick scrolling, he realized, “We can build a phone on this.” In retrospect, the decision to let iPhone and Touch pave the way for the iPad was a multibillion-dollar correct call. A $500 single-tasking netbook without a keyboard? Not a good bet five years ago.
Microsoft has only recently “transitioned” away J Allard and Robbie Bach from Microsoft’s Entertainment and Devices Division, the division most likely to spearhead the move beyond the desktop. The Xbox was until recent years a huge money pit, including an Xbox 360 recall estimated to have cost around a billion dollars. The 360 backed the wrong horse in the Blu-ray/HD-DVD race, and the Wii is generally considered the device that changed the console game (people like to move around and be with others while having fun? Who could have anticipated that?). The less said about Windows Mobile the better.