It's Time to Solve This "Great Investment Riddle"

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

Greetings Fools! It’s your lucky day, today I’m going to crack “The Great Investment Riddle” and show you how to beat the market en route.

In fact I’m happy to play “Investment Riddler,” but it’ll be just a moment until my green tights return from the cleaners.

Until then, let's pass the time worrying about Apple

These days, it seems like worrying about Apple’s “next move” has become a sport amongst shareholders doesn’t it? Well let’s be honest, Hecklers love that sport too.

Yep, only Apple (these days) could beat quarterly earnings estimates and grow revenue by 18% and still sell off. In fairness, Apple investors have “jitters” over tightening margins so perhaps the stock should be near 52 week lows.

Or is it the eroding market share in iOS phones (23.6% to Androids 51.3%) that has investors worried? While Apple has grown iPhone sales over 20% in the past year, it still has lost market share in iOS to Google’s Android; much like Microsoft’s (NASDAQ: MSFT) did to Chrome.

I mean, why can’t Apple and Microsoft just be more like Google?!

Now there’s a stock we can agree on! Google (NASDAQ: GOOG) is on an absolute tear, with its stock topping $800. Combining meteoric rises in Chrome and Android with its continued stranglehold on the search market (88% in 2012), Google is a stock everyone wants.

Well, at least they do now.

Come to think of it, before the fruit weren’t there a heck of a lot of concerns about Google’s labor?

That’s right! In April of 2011 Google’s stock dropped below $520 -- as the Street fretted over Co-Founder Larry Page’s return, as CEO. The biggest concerns were Google’s absence in China and (especially) Page’s commitment to invest (spend) money on top talent. Very few analysts predicted the stock would be at all-time highs today; oh, lucky Google, they thought Apple was going to crush you, yet somehow they were wrong.

Armchair Quarterbacks

Sarcasm aside, analysts get it wrong all the time. What you need to know is that “bean counters” don’t understand (or appreciate) what it takes to grow a global powerhouse like Google or Apple. They lack courage to predict what “might be”, so they stick to “what is”.

Most importantly they tend to favor squeezing a lemon for every last drop, regardless of circumstance.

The same analysts who cheer Google now, jeered the “costs” of doing business in 2011, so it’s no surprise that Apple’s “cash problem” has brought on Armchair Quarterbacks. These Heckler’s want to sue Apple for not raising their dividend, but they should stop and ask: “What made Apple a success to begin with?”

Was it paying dividends, or was it pumping cash into in-house R&D? Exactly!

So how can you throw one stone at Apple (NASDAQ: AAPL), for not raising a dividend and another at it for not innovating?

Now, back to that riddle!

As promised, here’s our riddle:

A ‘hem: “How can one find comfort, and even profit, amidst uncertainty”

To profit we need to crack that riddle, as it plagues the tech landscape and the evolving nature of the companies that comprise it.

To solve this riddle, we need to stop trying to prove what we can’t know. Here’s what we do know, however:

1). Good companies have high returns on capital; this indicates that they are able to fend off competition and have enough capital to plow back into R&D.

  • Apple (38.41%), Microsoft (16.61%) and Google (16.61%) demonstrate this while “competitors” like Hewlett-Packard and Blackberry have negative returns.
  • These three companies (Apple, Google and Microsoft) dominate multiple industries.

2). These aren’t “one sector” tech companies. To say they are is like saying McDonalds and Ruth's Hospitality are both “restaurants;” technically true, but there’s so many layers under that “restaurant” umbrella.

  • In other sectors it’s impossible for one small group of companies to dominate multiple sub-sectors, it only happens in “tech”.
  • And they really do dominate those sub-sectors.
  • Even Microsoft, still holds nearly 50% market share in Windows. The company is surrounded by enough negativity to make you think it’s on the brink of bankruptcy. Does this make any sense for a company that’s returned over 7% (EPS and revenue) growth annually, over the past five years?

3). Microsoft is the only real threat of any size and influence to Apple and Google, in any of these growing sub-sectors (hardware, OS, search, software and even cloud).

  • So why does a company like Baidu trade at higher valuation than Microsoft, when the only market Baidu is in is search and it doesn’t dominate it globally? Microsoft’s “Bing” is a complete afterthought—I get that—but it still holds a larger global market share than Baidu’s (3.5%). In fact, Bing only comes in second to only Google, albeit a very distant second.

Don't make this a riddle.

Simply put: to make money in tech we need to accept what we don’t know and take comfort in what we do.

Apple may cannibalize itself, Microsoft may grow slowly, Google may over expand; there’s no way to tell if any of these “micro” events will or won’t happen—stop obsessing!

What we do know is that these three firms have no strong competitors in multiple, growing sectors that they collectively dominate. 

So why not just buy all three?

Sure, doing so will be admitting that you can't guess "precisely right" but you should still beat the market handily.  

Better yet, you’ll actually sleep well at night; and isn’t that the point?

Adem Tahiri owns shares of Google and Apple. The Motley Fool recommends Google. The Motley Fool owns shares of 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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