My, how the world has changed in a little over a decade.
Julian Robertson is an investing legend. He founded his hedge fund Tiger Management in the early 1980s with $8 million in capital and by 1996 Tiger was managing $22 billion. Over that period Robertson and Tiger compounded money at prodigious rates by employing a value investing philosophy across a variety of asset classes.
By 2000 Robertson and Tiger were basically forced out of business because of their refusal to participate in investing in the technology stock bubble. The underperformance of Robertson’s value investments in comparison with the rapidly increasing tech stocks led to a flood of redemptions and Tiger shutting down.
Now, a little over a decade later Robertson thinks that the very stocks that helped run him out of business are fabulous
opportunities. In the linked interview Robertson specifically names Apple (NASDAQ:AAPL
) and Google (NASDAQ:GOOG
) as being especially attractive.
With respect to Apple specifically Robertson thinks that the current valuation for a company of the caliber of Apple is ridiculous. Robertson suggests that if this were the 1980s that Apple stock would be three or four times the current price.
I have previously
looked at Apple as an investment but decided to pass. My concern with Apple is just how large the current enterprise value is. In relation to Apple’s current cash flow generating ability and recent growth rates I agree that the valuation looks attractive.
I referred to the following summary of Apple’s valuation:
At acquisition, Apple traded at about $335 per share. With 936 million shares outstanding, this equates to a market capitalization of $315 billion. Based on our earnings estimate for the fiscal year ending September 30, 2011 of approximately $24 billion, Apple is trading at a price-earnings ratio of 13x. While we consider 13x to be fairly inexpensive for a company of Apple’s stature, it’s actually even cheaper than that when one takes a closer look at he structure of the balance sheet. Assets include $66 billion of cash and short-term and long-term investments, which is up from just $15 billion less than four years ago as cash generation has massively exceeded spending. Stripping out the cash and investments, which can theoretically be liquidated and used to buy back stock, the enterprise value decreases to under $250 billion and the P/E is closer to 10x. As we said, baffling.
The questions I’m not comfortable with are why isn’t it possible that the folks at Apple run out of ideas? If the next version of a product isn’t much better than the prior, won’t a lot of customers simply not upgrade? And why can’t someone else do something that steals some of Apple’s business? When you are generating $24 billion of cash flow from products that rely on having the coolest technology you are under a lot of pressure to sell a lot of product.
I’m not saying I’m right. I actually think that I’m wrong. But it makes me a little uncomfortable so I’ll take a pass on Apple.
Robertson also mentions Google as being very attractive. And surprisingly he isn’t the only long in the tooth value investor who thinks so. The venerable value investment manager Sequoia Fund also has taken a stake in Google.
Which leads me to ask, aren’t value investors supposed to avoid technology companies?
The Sequoia Fund held an investor day earlier this year and went into considerable detail
(PDF) about why it finds Google attractive:
Google is unusual for us. It first got our attention on a valuation basis because it seemed like an anomaly; the speed at which it was growing relative to the valuation seemed out of whack. But as you know we look for sustainable competitive advantages.
So the first thing I concentrated on when I looked at Google was how sustainable its advantage in search was. What we found is that the days of someone coming up with a clever algorithm and competing against Google in search are essentially over.
A lot of people may not understand that when you search the internet, first you have to crawl the internet, download the internet, and parse the internet. That takes a tremendous amount of investment and infrastructure.
Google owns more servers than anyone else. It owns a tremendous amount of fiber optic cable. It places its computer servers next to very cheap energy. Google has its systems built literally next to hydroelectric dams. So you’re talking about a business with a tremendous amount of investment
There’s really only one competitor out there that is trying to compete directly with Google in search and that’s Microsoft. If you look at the numbers — because the media don’t always frame this with the numbers in place; there’s a lot of hype —Google’s revenue last year was a little over $29 billion. Its operating income was a little over $10 billion. Microsoft, in its online services, had revenue of $2.1 billion and it had losses of $2.4 billion. For every dollar it took in as revenue, it lost more than a dollar.
Facebook is the big threat Google these days in a lot of people’s minds. In display that’s true, but Facebook is not directly competing with Google in search; so there’s room for them both to do very, very well. Facebook will do well in display and Google will do well in display as well. But in search it’s very hard to see a competitor coming up now — it’s tech so I could always be wrong — but I think it will take a long time before anyone threatens Google in this area.
When I compare Google and Apple it seems to me that Google has a much more impenetrable moat than Apple does. Apple needs to continually innovate and satisfy customer tastes. Google has one serious competitor in Microsoft (NASDAQ:MSFT
), which should likely be throwing in the towel.
I don’t own either though. But I do own Dell (DEL, which as a 25% free cash flow yield. Even I can get comfortable with that kind of valuation.
Disclosure: I am long DELL.