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I write for Seeking Alpha to transfer the investment ideas and concepts cluttered in my head onto paper. Follow me on Twitter @JosephHarry87 Follow on StockTwits: http://stocktwits.com/jharry1 Add me on LinkedIn: www.linkedin.com/pub/joe-harry/44/435/906/ My performance can be viewed at... More
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  • Apple & Microsoft: Assessing The Return On Equity And Valuation Gaps

    Apple (NASDAQ:AAPL) has been beating Microsoft (NASDAQ:MSFT) year to date appreciation-wise, as well as the overall market. Not only that, the difference in its superior return on equity in comparison to Microsoft's is widening:

    AAPL Return on Equity (<a href=

    AAPL Return on Equity (NYSE:TTM) data by YCharts

    I'd like to know why. I'd also like to expand on the comparisons between the companies further, largely because I see them as the top two contenders for investors wishing to add an allocation to the tech sector with a conservative, dividend-paying blue-chip.

    Breaking down return on equity

    To gain more insight into the opposing ROE trends of both companies, I've pulled numbers from their annual reports to construct a five stage Dupont analysis.

    Note: I'm using annual figures to make the comparisons easier, but these numbers are a little outdated. Apple's fiscal 2014 ended in September 2014, Microsoft's ended in June 2014. This is why I used ttm to examine more current ROE trends on a rolling basis in the beginning of the article. These numbers are still useful for examining the overall trends in ROE for both companies, however. Microsoft won't report FY2015 until the end of July if history is any indication.

    (click to enlarge)

    We can see over the last 3 years that Apple has managed to generate better ROE mostly because of its ability to utilize its assets better than Microsoft, despite the latter's better operating margins. Its superior ROE, along with its intention to keep more of its earnings than it pays out in dividends, also gives Apple a superior sustainable growth rate, nearly twice the rate as Microsoft's.

    Microsoft's margins are impressive, but declined year-over-year. It should also be noted that it's more dividend-oriented, with shares yielding about 2.8%, as opposed to Apple's dividend yield of only 1.6%. This makes sense, however, because lower growth usually means higher dividends.

    Valuations and fundamentals

    Apple is expected to grow over 26%, Microsoft is only expected to grow 7-8% for the year. Growth is expected to dip for both firms in 2016, more so for Microsoft than for Apple, however. While this makes Apple look more attractive, valuations are important as well.

    Here's where Apple shines even more, trading at only about 14 times this years earnings and 13 times forward earnings. Microsoft is trading at over 18 times this years earnings and 16 times forward earnings.

    Turning to the balance sheet, both companies have fat cash piles, with much of it held overseas. This has led to increased debt issuance to cover certain things domestically instead of repatriating the cash to do it, including buybacks. This may help to explain why both companies have seen their financial leverage ratios (assets/equity) trend higher over the last few years.

    Microsoft carried a current ratio of 2.5 for FY2014, a drop from 2013's ratio of 2.7, but solid nonetheless. Apple's dropped to 1.08 from a current ratio of 1.68 in 2013. This was largely due to an increase in accounts payable and the addition of a significant amount of commercial paper. Both companies appear to have solid liquidity with adequate working capital.

    I'd now like to turn to the cash conversion cycle to see how efficient the companies are managing cash flow.

    AAPL Days Sales Outstanding (Annual) Chart

    AAPL Days Sales Outstanding (Annual) data by YCharts

    As can be seen, Microsoft puts more pressure on suppliers by taking longer to pay than Apple does, judging by its DPO. This surprised me, as I thought Apple would be the winner here. Apple's inventory management is incredible as well, and it also seems to convert receivables much more efficiently than Microsoft.

    This is why Apple has a negative CCC and Microsoft's stands at (an acceptable) 20.14 days. This likely has to do with different business models, however, as one company is more hardware-oriented and the other is more software-based. Turning to solvency ratios, both companies look solid as well:

    AAPL Debt to Equity Ratio (Annual) Chart

    AAPL Debt to Equity Ratio (Annual) data by YCharts

    We can see that despite the recent trend of both companies issuing more debt, it hasn't battered the overall financial health of either firm by adding too much of it to their existing capital structures.

    Conclusion

    Apple appears to be a more attractive investment than Microsoft when looking at ROE, growth prospects, efficiency, and even balance sheets, so why the discount?

    In my opinion, it obviously has something to do with the diversification of revenues bases. While Apple has lots of "irons in the fire", it's still heavily reliant on iPhone sales. I think this concern is overblown personally, but I can see the logic of it: one bad iPhone flop and revenues could drop off pretty significantly pretty quickly. Even with this in mind, however, I still think Apple is cheaper than it should be, especially as it seems to be firing on all cylinders.

    Here's where Microsoft deserves some credit as a long-term investment, however. As long as consumers, and more importantly, businesses, continue to rely on its products like Office, Azure, and Windows, I think the company has a tremendous moat around its business that will remain for many years to come. Especially as it transitions many of these services to be more cloud-oriented, converting them to lucrative subscription-based business models. This cuts down on piracy, and the recurring nature of them makes them even stickier to business in my opinion. Will this degrade margins though? Possibly, which is something to watch out for.

    I think Apple is a better value here, especially in the near term. Microsoft is still a great longer-term investment, and Apple will likely be as well, depending on what the future of the iPhone and the future diversification of its business mix looks like. Me personally? I'm going to keep collecting dividends from Microsoft, but I'm also seriously considering adding Apple to my portfolio, too. It just looks too cheap not to.

    Jul 01 4:55 PM | Link | Comment!
  • Don't Want To Sit In Cash? How To Start A Portfolio With New Money Today

    With the market looking quite expensive after an extended bull run, it's hard to argue with the risk averse who suggest holding cash. But what about younger investors who are looking to put some money to work and begin their journey investing? I've run into this problem after I was instructed to invest some funds for my younger siblings now, and after some digging around, I've identified some companies that are still trading at reasonable valuations that can be used to develop a starter portfolio today.

    The Portfolio

    The goal here is to invest primarily in high quality blue-chips. The overall portfolio also needs to be cheaper than the overall market and provide a higher yield, without "reaching" for yield. Here's what I came up with as a solution.

    (click to enlarge)

    Trailing earnings are from Yahoo! Finance and Macro data is from Multpl.com.

    Tech/Telecomms

    Apple (NASDAQ:AAPL) was an obvious choice as a pick for this sector, due to its cash loaded balance sheet and strong growth prospects. It's also only trading at roughly 13.5 times forward earnings. Qualcomm (NASDAQ:QCOM) seemed like a logical choice to pair alongside Apple, because it's also cheap and cash-loaded. These two tech companies have fortress-like balance sheets, generate impressive free cash flow, and should have many days of dividend growth ahead of them.

    AT&T (NYSE:T) is included in this sector primarily to prop up the overall portfolio's yield, but also makes a nice value play, trading at only about 13.5 times forward earnings. The company also has some outlets available for future growth, such as expansion into Mexico and the Internet of Everything.

    Oil/Energy

    This sector is beaten down, but also provides fair valuations and high yield. ExxonMobil (NYSE:XOM) is one of the few companies in the sector that I would commit some long-term funds to now, due to its reasonable valuations, strong management, and industry-leading balance sheet. It's one of only three companies in the world left with AAA credit, which means it should have ample liquidity and access to cheap financing if oil remains low and things get turbulent.

    BP (NYSE:BP) is here due to its cheap valuations, international exposure, and high dividend yield. This company is definitely risky, but some added risk and yield in the context of an otherwise conservative portfolio is worth it in my opinion.

    Healthcare

    Pfizer (NYSE:PFE) and Johnson&Johnson (NYSE:JNJ) are both fairly priced, and offer dividend yields of around 3%. These are solid, established blue chips that can serve as a foundation for exposure to this sector in the portfolio.

    Gilead (NASDAQ:GILD) is the newcomer, with a low starting yield but very high growth prospects. Shares are cheap as long as it dominates the hep c market, and even if it loses some of its grip on hep c, it's still got its lucrative HIV business that's growing by double-digits. This is a great stock to own for younger investors with a longer time frame.

    Consumer staples

    I have decided to go international here, and include the world's largest packaged foods company, Nestle (OTCPK:NSRGY) alongside London-based alcohol beverage producer, Diageo (NYSE:DEO). Both companies are trading around fair value and offer decent dividends. Nestle sells everything from bottled water to pet food to Butterfingers. Diageo owns a large portion of the liquor market with brands such as Johhny Walker, Kettel One, Smirnoff, Tanquerey, Don Julio, and Guiness, just to name a few. It's hard to see these companies not being solid long term investments.

    Rounding out the staples section we have Hershey's (NYSE:HSY), which is slightly overvalued, but also near its 52 week lows. This is one of the growthier staples, and this is likely why it always seems to trade at a premium. Sometimes you have to pay up for quality, however.

    Consumer discretionary

    Speaking of paying up for quality, the companies in this sector are a little pricier than I would like to pay, but add much needed growth prospects to the overall portfolio, without bringing up its overall valuation too much. Starbuck's (NASDAQ:SBUX), Disney (NYSE:DIS), and Visa (NYSE:V) are all slightly expensive, but not insultingly expensive. This is a trio of great companies at a good price, companies that can easily grow into their current valuations going forward.

    Finance

    The finance sector might be hated, and even feared, by some, but it doesn't make sense to exclude the sector completely.

    JPM Price to Tangible Book Value Chart

    JPM Price to Tangible Book Value data by YCharts

    Wells Fargo (NYSE:WFC) isn't exactly cheap at over 2 times book, and neither is JP Morgan (NYSE:JPM) at around 1.5 times book, but these are premium firms. Metlife (NYSE:MET) is cheap, and once the uncertainty related to its SIFI designation currently hovering around its shares evaporates, this could change. I expects all three of the above companies to maintain solid dividend growth going forward as the economy and the sector continue to recover.

    Transportation/Autos

    Union Pacific (NYSE:UNP) has taken quite the beating lately, leaving it priced at fair value. The company's growth prospects are still attractive, however, and I don't think it's crazy to start accumulating at roughly 14.5 times forward earnings for the long term. The company has a very wide moat, operating in an ogopolistic industry with extremely high barriers to entry. The company is also arguably best in class amongst its other publicly-traded peers, with an industry leading balance sheet and return on equity, coupled with an impressive operating ratio.

    Ford (NYSE:F) is a solid value play, and its dividend provides a nice bump in the overall portfolio's yield. With low oil and an improving economy, shares offer value at only 8 times forward earnings.

    Retail

    I've never been much of a fan of retail, but have always been a fan of Wal-Mart (NYSE:WMT) as an investment. Despite decelerating dividend growth and some short-term struggles, the company's massive size gives it a moat that's almost impossible to duplicate. It's also the nation's largest grocer, which should help it absorb economic shocks more so than companies in more business cycle-sensitive industries. It's also aggressively pushing into ecommerce, a business that it's growing by double digits. At roughly 15 times forward earnings, shares look fairly valued in an expensive market.

    Conclusion

    The above portfolio was more of a "thought exercise" than a detailed analysis, but I think it demonstrates that just because the overall market is pricey, this doesn't mean that you can't build a portfolio for a decent value now. Especially for younger investors. Maybe it's good to get the ball rolling instead of hesitating or waiting for a correction. I believe the above equally-weighted portfolio can offer a solid starting point to accomplish this. What do you think? Please let me know in the comment section below.

    May 30 9:37 PM | Link | 2 Comments
  • Hewlett-Packard: Double The Value?

    Hewlett-Packard (NASDAQ: HPQ) before Meg Whitman was a dying company with a messy balance sheet. Since her appointment as CEO, Whitman has made terrific strides in her attempt to turn around HP. It now has some exciting opportunities ahead, and shares are cheap.

    Whitman's clean-up and shareholder returns
    HP now sits on $5.9 billion of net operating cash, a significant improvement since its CEO took over, who inherited roughly $12 billion in net operating debt. For fiscal year 2014, the company also generated healthy free cash flow of $9.3 billion.

    The company is also becoming increasingly shareholder friendly, returning almost $4 billion to shareholders through a cocktail of dividends and share repurchases.

    HPQ Dividend Chart

    HPQ Dividend data by YCharts

    HP's annualized dividend growth over the last 3 years has been an impressive 21%, with the last double-digit increase coming in at roughly 10%. Despite its lowly 1.70% yield, the company's payout ratio sits at only around 24%, so there appears to be ample wiggle room for further increases.

    HPQ Average Diluted Shares Outstanding (Quarterly) Chart

    HPQ Average Diluted Shares Outstanding (Quarterly) data by YCharts

    While it didn't keep its promise of returning half of free-cash-flow to shareholders for this fiscal year, HP still did right by shareholders for 2014 in my opinion.

    Its CFO Cathie Lesjak also said during the recent conference call that HP intends to "make up the difference in fiscal 2015." The company projects an estimated $6.5 to $7 billion in FCF for the current year. Lesjak also indicated that shareholder returns for 2015 are likely to continue to be weighted more towards share buybacks than dividends.

    Beyond just the shareholders
    While some of HP's recent share price-related success has likely stemmed in part from cost-cutting (including billions in "labor savings"), the company is also investing in its future. Research and development spending increased 10% in 2014, and was increased across every segment -- including cloud and 3D printing. Margins also increased across every single business as well. During HP's latest conference call Meg Whitman said that:

    ...we announced exciting new products and services across our businesses and as we enter 2015, we have the strongest portfolio we've had in a decade.

    While the increase in R&D is encouraging and a step in the right direction, HP still seems to lag many of its competitors.

    HPQ R&D to Revenue (<a href=

    HPQ R&D to Revenue (NYSE:TTM) data by YCharts

    The company has evolved past just ink, PCs, and printers, however, and has some legitimate opportunities ahead of it, especially in cloud computing and 3D printing.

    Two for the price of one
    Currently on schedule to be completed by the end of fiscal 2015, HP plans to split into two separate companies. The transaction is expected to be tax-free to HP shareholders, giving them ownership over two more specialized, laser-focused companies. CEO Whitman explained that:

    This is a big and complicated separation. It is the biggest separation that's ever been done. And it's not a typical spin-off where you've got one big company spinning off a little part of the company. These are two Fortune 50 companies that as set of separation both have about $57 billion of revenue.

    Hewlett-Packard Enterprise appears to be the more attractive of the two newly proposed businesses at first glance, as it will continue to have Whitman as its CEO and will focus primarily on technology infrastructure, software, and services; as well as growth markets such as cloud, big data, security, and mobility in what HP calls the "New Style of IT."

    A future leader in 3D printing?
    The second business will be known as HP Inc, and will continue to focus on its lead in personal systems and printing markets. The company has a leading market share of around 40% in the traditional, 2D print market. This business may inevitably become a casualty to digitalization, but high margins and a dominate market share should keep it relevant for a little longer, as well as sustain the company until 3D printing technology becomes a little more "mainstream".

    Dion Weisler will be CEO, and will also have the opportunity to lead HP Inc into future growth with 3D printing. According to Gartner, the 3D printing market is expected to grow from $1.7 billion in 2011 to $6.5 billion by 2019-- and it's only natural HP should be a leader in this business. The market grew by over 100% just last year alone.

    HP is already diving into the 3D printer market, with offerings such as Sprout, a new computing platform or "blended reality" ecosystem capable of syncing a 3D scanner with Windows 8. HP also recently announced its Multi Jet Fusion technology, which is apparently ten times faster and also more affordable than products currently on the market, according to HP. Most of HP's offerings in 3D printing won't be available until 2016, however.

    While the more cloud computing-oriented company may appear more valuable at first glance, HP Inc appears to have some lucrative growth drivers up its sleeve as well.

    Valuations and fundamentals
    While HP's earnings aren't exploding with growth, remaining relatively flat, they are expected to grow this year. Shares trade at 14.51 times 2014 earnings and only about 9.2 times forward earnings. If the company meets its 2015 earnings expectations, shares look pretty cheap.

    A glaring weakness, however, is flat revenues that will need to grow for the company to sustainably gain traction in its turnaround efforts. Breaking up the current company into two may help achieve this much-needed growth in sales. The company recently missed expectations, but still reported a whopping $111.5 billion in revenues for 2014. One thing to consider as an investor, despite flat growth, is the fact that the market is currently valuing HP at only 0.64 times these sales-- so there isn't exactly a lot of optimism hiding in the share price, either.

    Shares of HP look cheap with growth or not. They will continue to be more valuable as well if Whitman's turnaround is successful and the balance sheet continues to be strengthened on top of increasing shareholder returns.

    The bottom line
    Hewlett-Packard is more than a standard turnaround play. It's also a fine example of a classic value play. The challenges going forward, in my opinion, will be growing revenues and earnings to keep pace with the significant increase in share price that was seen this year.

    Pre-split the company's shares look cheap, especially considering the drastic improvements to its business fundamentals and shareholder returns under CEO Meg Whitman. Post-split shareholders will own two world class businesses with opportunities to stay relevant going forward.

    If HP can continue to capitalize on enterprise under Whitman and establish itself as a leader in 3D printing under Weisler, shares might offer double the value at current levels. I am seriously considering layering into HP at this time, and will likely add shares on any dips.

    Tags: HPQ, long-ideas
    Dec 14 12:33 PM | Link | Comment!
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