Apple Manages the Street, May Win Next Round

Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The last year has taught Apple (NASDAQ: AAPL) CEO Tim Cook some hard lessons, but based on the company's latest quarterly report he seems to have learned them, and is setting the company on a course for the next round of competition this Christmas.

Cook's people deftly managed expectations for the quarter down to a level they could beat, then beat it decisively. This masked the fact that the company only matched last year's $35 billion in sales and that earnings actually fell $2 billion, from $9 billion to $7 billion.

The key point about the release was the unexpected strength of the iPhone line. Sales for iPhone were up 20%, to 26 million, while sales for the iPad were down in big competition from Samsung Phablets and Amazon Kindles.

The next step

Since it became clear iOS will not dominate Android as was once hoped, Cook has turned Apple from a growth story into a value story. Investors are only willing to pay 11 times its trailing earnings, but an active stock buyback program and a $3.05 dividend give them a yield of 2.78% and limit their downside risk considerably.

As a result, the “beat” on earnings sent the stock soaring $20/share in early trading. Those who got in when the gloom was blackest are looking to be in good shape.

What investors really need to focus on is this fall's product announcements. A cheaper iPhone, with less memory and a plastic case, is expected. So is something to compete directly with the Phablet, whose 7-inch screen is big enough for watching TV while small enough to fit in a pocket and be used as a phone. These are key advantages in Asia, where consumers can't afford both a tablet and a phone, and where price matters.

Assuming these matters are dealt with – and Apple under Cook has been a much more methodical, logical company in terms of its product roadmap and treatment of investors, the next question is whether the company is capable of creating a new product category. That's speculative. But even a little hype from an announcement could lead Apple to $500, which would bring its Price/Earnings (P/E) multiple into line with its chief competitors.

Et tu, Microsoft?

Chief among these competitors is Microsoft (NASDAQ: MSFT), which over the last year has become a primary alternative investment.

After disappointing on its most recent quarter, Microsoft is selling at a P/E of 12.38, little removed from Apple's 10.95. To the layman, the numbers generated by the two companies seem out of skew, but Microsoft has over 8 billion shares outstanding, Apple less than 1 billion, so a little long division should get you to value.

The two companies now have relatively similar debt loads, but it should be noted that Apple's debt pf $17 billion was taken out to fund its stock buyback, and it's actually making money on that borrowing since it keeps the dividend rate high. Microsoft's long-term debt total is $12.6 billion, but it is not managed in the same way or for the same purpose.

Both Apple and Microsoft are huge generators of cash, but Apple generates more, even in its present condition, and Microsoft's numbers are still paling. Apple is 75% bigger on the top line, 40% bigger on the bottom line. The only advantage Microsoft has at the present time is that its margins are fatter, albeit marginally.

The main difference between the companies, from an investor's perspective, is that Apple's iOS is earlier in its life cycle than Microsoft's Windows. Apple is better at monetizing its iOS user base than any other vendor, while Microsoft's cash cow is drying up, and there is nothing on the horizon that looks nearly as profitable.

Google, then?

Google (NASDAQ: GOOG) looks like a better company right now than either Apple or Microsoft, but that goodness comes at a price.

Investors are paying nearly 28 times earnings for Google shares, which are regularly flirting with all-time highs. That's more than twice what is paid for earnings in either Microsoft or Apple.

The reason, Google bulls say, is because while software trumps hardware, cloud trumps both, and Google is the dominant owner of Internet infrastructure, now counting for one-quarter of all North America's Internet traffic

Google's stock price is high because it has even fewer shares than Apple – just 328 million against Apple's 940 million. Its margins are equivalent to both its rivals, about 25%, but it's still generating 20% year-over-year growth, while Apple's top line is stalled out and Microsoft's top line is up only 10% year-over-year.

Simply put, Google is priced to perfection, and its business model is due to change. The launch of the Moto X later this year will be backed by $500 million in advertising, which is more than either Samsung or Apple spend on all their products. If Moto X succeeds in taking sizable market share, Google becomes a hardware company, while if it fails to do so, Google fails entirely.

Google, in other words, has become a speculative investment, at least in the near term. 

My Foolish bottom line

I have personally been accumulating Apple shares during the last year, and got out of Microsoft a year ago. I still have 10 shares in Google, but I cut my stake in half when it hit $800 and I am not prepared to buy any more.

Your mileage, of course, will vary. My view is that Apple has some upside potential and very limited downside, while Microsoft has limited upside and some downside, and Google currently has more downside than upside.

All these are good companies, however. If you have a five-year investment horizon, you can buy any of these companies and sleep easily. Take Microsoft for yield, Apple for the combination of yield and growth, Google for growth. But then avoid the media for that entire period because, as former Fed chairman once said when asked by a woman what the market would do, “prices will fluctuate.”  

Dana Blankenhorn owns shares of Apple and Google. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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