Why Microsoft Will Outperform Apple

| About: Microsoft Corporation (MSFT)

Apple's (NASDAQ:AAPL) stock has outperformed Microsoft (NASDAQ:MSFT) by almost 10,000% since 2003, some 300% over the last five years, and 80% since October 2011. So why on earth should its fortunes reverse now?

First, from a product development point of view, Microsoft is very aggressive. Microsoft right now is as bold as Apple was in 2003. While Apple is putting out new slightly improved versions of its product struggling to meet the incredible expectations it created, Microsoft has quietly been stepping up it's efforts on all fronts. Windows 8 for smartphones, tablets, and PCs will help Microsoft sell its products on all platforms and make sure Windows has the necessary exposure to the crucial tablet and phone markets. I admit Windows 8 is absolutely useless to mouse-and-keyboard PC users and will therefore not be picked up by enterprise customers, but most of the new notebooks shipping in 2013 will have a touchscreen. Why? Because hardware manufacturers gear their products toward the OS they use. And as far as PCs go, there still isn't any meaningful alternative to Windows. (The industry is aware of the need for ever more touchscreens, and Intel for one is doing its part to make sure there are enough touchscreens being produced.)

Among those raising concerns over Windows 8's impact on software developers is Valve's managing director, Gabe Newell. He is afraid that the 30% cut Microsoft's Windows store takes away from software developers might hurt the latter. On the other hand, that means additional revenue for Microsoft. This is obliviously a lesson Microsoft has learned from Apple's iTunes store. Another lesson from Apple has to do with design and building your own hardware. In both regards Microsoft made bold decisions. The surface tablet makes sure Windows 8's capabilities will not go unnoticed and a new logo and font symbolize Microsofts determination to not look back. And for people using the MS Office Suite, Windows 8 tablets will offer significant advantages over the iPad.

Then there is the concern about the number of apps available in Microsoft's store, a problem that management at Microsoft is fully aware of. The most innovative feature of Windows 8 is its cross-device nature, which will help a lot in supporting developers to create apps for Windows by offering a huge user base. The Windows Phone 8 store will launch with about 100,000 apps; Google's Play and Apple's App stores each have about 600,000 apps. Microsoft has still a long way to go, but the number of apps will certainly increase rapidly after the Windows 8 launch.

Second, Microsoft's stock seems to offers better valuation. To be clear, I don't think Apple is overpriced -- it's just that right now Microsoft offers more bang for the buck.

Forward P/E 9.05 12.58
Price/Sales 3.4 4.23
Price/Book 3.77 5.63

Apple's higher valuations can be explained with by its impressive revenue growth rate (22.6% year over year for the last quarter, and that is low for Apple). Microsoft's figure for the same period is a mere 4%, but Microsoft's revenue growth rate has been very volatile. I expect next year to be a good year for Microsoft with double digit revenue growth. If Apple keeps on growing as it is expected to, I would consider Apple undervalued at the moment. But what if Apple fails to met the high expectations? How often did this happen in the last 10 years? Only twice, and last time it happened it missed by about 1%. Two things I like about Microsoft's stock are the 9.5% insider ownership (compared to 0.05% at Apple) and the 3.1% dividend yield (compared to Apple's 1.6%). By the way, Nov. 13 is ex-dividend date for Microsoft. Add Microsoft's beta of 0.86 compared to the S&P 500 over the past three years (Apple's beta is 1.12) and about $62 billion in cash (Apple's is $27.6 billion) to the mix, and Microsoft seems like the perfect stock to buy and keep.

Third, is why I really think Microsoft will outperform Apple for the first time in a long time: It comes down to psychology. Apple had such a good run and people start feeling guilty for making so much money that they start taking money off the table. Microsoft's stock has a lot of catching up to do; it has underperformed all major indices in the last 12 months. People have called Microsoft a value trap for some years now, and in terms of stock price performance they are right (but don't forget the dividend). Why it is different this time? Management made some critical decisions that will soon make a meaningful difference in terms of brand perception and revenue growth. The media plays an important part as well -- it has been giving Apple practically free ad-time because people seem to care so much about their latest products.

But what we're seeing now: Reports on Apple's disappointing maps app show that media coverage can work both ways for Apple. At the same time, Microsoft will get a lot of media exposure this month as it launches Windows 8, Windows Phone 8 and its tablet, and before Christmas the first Windows 8 touchscreen notebooks will be in stores. And in some -- admittedly unlikely -- scenario, the virtuous circle around Apple might turn into a vicious one. This fear plus an increasing likelihood of an overall market correction, which would affect Apple more than Microsoft, will make some investors shift their money from Apple to Microsoft. Microsoft's earnings will come out on Oct. 18 and Apple's earnings will be released on Oct. 25, the same day Microsoft will launch Windows 8.

The question I was asking myself is whether to buy now or hope for disappointing earnings, but Microsoft's earnings history suggests it won't miss (I only found data going back to 2009). So I will buy before Oct. 25.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MSFT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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