We all know the story right? A couple of talented visionaries drop out of college to start a software company that becomes the darling of the tech world and can do no wrong. The company goes public, and one founder cashes out millions in stock and walks away as the other continues on and becomes the face of the business. New innovative products wow the public as the company becomes the dominant player - controlling market share while the stock price skyrockets. Eventually the remaining founder hands over the reins to a trusted and capable successor and the future of the company seems secure. Then, just when it seems everyone wants to own at least a few shares of the stock and every tech analyst worth his salt is predicting higher highs every week, the share price stumbles... then recovers a bit... then tumbles even further.
Apple (AAPL) you say? No, actually I'm referring to Microsoft (MSFT). The chart above shows the rise (and fall) of MSFT stock for a ten-year period from the early 1990's into the early 2000's. However, you could be forgiven if, for a split second you thought I might be talking about Apple. The similarities are startling. In fact, if a growth chart of MSFT stock from 1990 to present were overlaid with the most recent 10-year growth chart for AAPL, it would look like this:
So if, as an investor watching AAPL, it seems you have seen this all somewhere before, well - you have. The correlation on the left side of the chart for these two companies is so close that one could be excused for mistaking one company for the other. However, it's the right side of the chart that catches my eye. This is where one can clearly see what has happened to MSFT since - In short, not much.
If you invested in one share of MSFT stock on February 19, 2003 (right after the last stock split) it would have cost you $24.50. Today, ten years later, that share is worth all of $28. Dividends would have added another $7.54 in your pocket so your total return would be just over $11 or, on average, about 4.4% per year. During that same time, the NASDAQ 100 index averaged 13.7% per year, and a single share of AAPL has grown from about $15 to $460 (after an oh so brief stop above $700). Total average annual return for AAPL during the past 10 years is 45.3%.
The fear for investors, of course, is that Apple will be the next Microsoft. With Android-based smartphones dominating the iPhone in market share, and new competitively priced tablets forcing Apple to play defense with the lower priced iPad Mini, the concern is that Apple has transitioned from an innovative market leader into a reactionary business with a lackluster growth outlook. Put another way; Is Tim Cook destined to be the next Steve Ballmer - doomed to lead Apple into a Microsoft-like purgatory for the next decade?
To my way of thinking, the answer to that question comes down to (1) Company Leadership, (2) Continued Strong Financials and (3) Product Innovation.
If Steve Jobs proved anything, he proved that a true leader can make all the difference in the success or failure of a company. Jobs, by pure force of personality, resuscitated the company which was on life support, and turned it into the global force it is today. That's an incredibly tough act to follow and much has been written and said comparing and contrasting Tim Cook and Steve Jobs. But what about Tim Cook and Steve Ballmer? - how do they compare?
Like the left hand side of the chart above, the similarities between these two CEO's is startling. Ballmer took the reins of the company right at the top of Microsoft's dominance in the marketplace and the near all-time highs for its stock price. Ditto Tim Cook and Apple.
Ballmer is not a techie, but was brought in to oversee the business side of the company. Likewise, Tim Cook is seen as a guru in logistics - not technology or product development.
Neither CEO is considered to be overly shareholder-friendly and at times both seem to be dismissive of shareholder concerns. Ballmer, in a recent Forbes interview, refused to acknowledge the lack of value being returned to shareholders when a question was posed about the "lost decade" for MSFT investors and was quoted as saying "If we deliver exciting products and we make more money, eventually that will translate into rewards for our shareholders" Eventually? Is ten years not long enough?
For his part, Cook, who has repeatedly pooh-poohed increasingly strident shareholder concerns about Apple's massive $140 billion cash hoard, recently said the company does not have a "depression era mentality" and referred to shareholder lawsuits on the matter as "a silly sideshow." However to his credit, soon after assuming the permanent role of CEO, he did institute a common stock dividend which currently yields about 2.3%.
In short, I'd say that Tim Cook is more like Steve Ballmer than Steve Jobs… and if history is any indication, that's not going to be a good thing for Apple.
Continued Strong Financials
Apple proponents will be quick to point out the most recent quarterly financials show - a healthy 18% YoY Revenue growth and 7% annual increase in Earnings Per Share. Certainly these are metrics any growth company would be proud to own. But in February of 2003, Microsoft was also motoring along with 15% revenue growth and - you guessed it - 7% EPS growth.
The fact is that margins, as is the case in any maturing business when competition starts eating into market share, are starting to narrow at Apple. Growth is starting to slow and, in the case of the PC market, actually contracting somewhat. Apple aficionados' may not like to hear this, but it is the cold hard truth of the matter. How Apple deals with this inevitability will, in a large part, determine where they will be 10 years from now.
One big difference in the metrics however is the P/E ratio. Ten years ago, MSFT was trading at 33 times earnings - appropriate for a growth company. Today, even while revenues have increased, albeit at a slower clip, the company is trading at a 15x multiple to earnings. Again, in my view, more or less appropriate. AAPL on the other hand, is currently trading at just over 10x earnings - right behind Dell in P/E rankings on the NASDAQ 100! It would seem, based upon this metric, that a decade of ultra slow growth has already been priced into the stock.
Product innovation is, of course, THE big question. Everyone is waiting to see what the "Next Big Thing" is that will transform the "user experience" and catapult AAPL stock price into the stratosphere. Such is easier said than done though.
In his Forbes interview, Steve Ballmer claimed that over the past 10 years, Microsoft had continued to innovate and introduce new products, citing:
"I think we've been pretty successful, but it's hard. It is hard. I think we've done a pretty good job of it. We not only did Windows, we did Office. We not only did Windows and Office, we actually were the company that really drove PC chips into the data center. That was us! Seventy-five percent of all the computers that get installed in data centers these days are actually Windows Servers. It's quite phenomenal, if I don't mind saying so myself."
Now I'm not saying they haven't grown and expanded but that's not innovation - that's marketing and sales. The fact is that even the Windows 8 is just the newest version of the same old program they introduced with Windows 95 back in, ah... 1995.
The fact is that it's now been over three years since the last truly "new" Apple product, the iPad, was first introduced. Fears that the company's "culture of innovation" might be fading seem to have been reinforced by the "launching" of a smaller version of the iPad and newer version of the iPhone while upgrading the speed and memory of pretty much their entire product line during last year's December quarter.
I'm sorry but upgrading, while it is appreciated, is not innovating - it's just... upgrading. The public didn't buy it and market didn't buy it and the stock price got hammered.
Of course, rumors have circulated for some time now about an Apple TV device that will revolutionize our viewing experience and more recently there was talk of some kind of "iWatch" being developed. No doubt there are teams in Cupertino working on these and other ideas, some of which most of us haven't even thought of yet. However, so far it's been all rumor and no action.
I started this article a couple of weeks ago intending on showing the disparate differences between Apple and Microsoft and debunking the notion of any similarity between the two. However, the more I researched, the more I came to realize that the two are more alike than I had at first realized. Like Microsoft, Apple is at risk of being a victim of its own success. To some degree, that cannot be helped. The company and its investors need to recognize that competition will erode market share, cause pricing pressure, and squeeze margins. There will be good years and bad but 30-40% YoY growth is not sustainable. That doesn't mean you stop innovating, it just means that you can't expect record revenues and outsized margins year after year.
As an investor in AAPL, lacking any innovative new product or catalyst for continued high growth, I expect value to be returned to me in the form of increased dividends and stock buybacks. Otherwise I know what the future holds because I've already seen it and it's not pretty.