Rather frequently, we hear the argument that this or that other stock might be the “next Apple” (AAPL), or “the next Microsoft” (MSFT). These arguments are usually used to justify out-of-whack valuations, based on their supposedly incredible, but deeply uncertain, future.
It might be useful to try to understand how Apple or Microsoft actually traded, when they were really about to be the “next Apple” and “next Microsoft.”
I will do this by going back in time, to a point where Apple and Microsoft were growing strongly, and will use the 10-K’s year-end earnings to calculate a Price/Earnings 6 months before for each of those years. We will then see what we can conclude.
I’ll start with Apple. Apple launched the iPod in 20th November 2001, and most everybody retrospectively would expect that was about the moment where Apple started its current huge growth phase, with the iPhone’s launch back in 29th June 2007 being another significant landmark. I will thus use FY 2002, FY 2005 and FY 2008 earnings, plus the market caps at the start of CY Q2 (about 6 months before the Fiscal Year end) during 2002, 2005 and 2008, to calculate the P/E it traded at back then (Apple’s Fiscal Year ended on the 26th September, so FY 2008 ended on September 2008).
Regarding Microsoft (MSFT), they launched Windows 3.0 during 1990, Windows 95 during 1995, and Windows 2000 (server) during 2000 plus Windows XP during 2001. I’ll use FY 1994, FY 1996 and FY 2001 as the years to make this exercise (using years before FY 1994 would lead to needing lots of corrections on stock splits as Edgar Online only goes as far back as the 10-K for 1994). I’ll also check stock quotes 6 months earlier to calculate the P/E. (Microsoft’s Fiscal Year ended on the 30th June, so FY 1991 ended on June 1991, and I’ll use quotes from the start of the year to calculate the P/E)
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What can we conclude from the samples shown above? We can conclude that both Apple and Microsoft did not trade as if they were the “Next Apple” and the “Next Microsoft.” Isn’t that incredible? The real deal didn’t trade as if they were huge promises, in spite of having everything on their side.
Yet, time and time again investors and speculators award huge multiples to situations that are far less certain in the hope that those companies will turn out to be like the real deal, such as is now happening with Amazon.com (AMZN), (2011 PE of 177) or Salesforce.com (CRM), (2011 PE over 600 if you take into account compensation paid in stock, though the low earnings resulting from that could lead to high multiples).
What this means is that even in the best of times, the best of companies possess enough uncertainty that they never trade for a huge, order of magnitude, premium to all others. So, it makes no sense to award inferior, much more uncertain, much less profitable companies, the huge premium the originals never got.
This should be a warning to those investing in what can only be termed as bubbles, even if in retrospect, in a few years’ time, those companies actually achieve the greatness that Apple or Microsoft achieved. Indeed, there might have been one point where Microsoft traded as the huge promise that it was, reaching a P/E of around 69 during the 2000 tech bubble. What happened since then? Microsoft earnings more than doubled and the stock went down significantly. On an adjusted basis, Microsoft trades today at little more than half what it traded back in the end of 1999 ($45.89 during 1st December 1999 versus $26.25 today. Net income was $9.42 billion in FY 2000 rising to $23.15 billion in FY 2011).