Back in early 2009, when it looked like the world as we knew it was coming to an end, I decided that I would nibble at certain stocks in the consumer staples sector. After all, even in a depression, people will still need things like household products and soft drinks.
I knew that consumers would probably try to save money by loading up on "store brand" discounted products, but I also remembered how my kids would react when I came home from the supermarket with a carton of "no name" cola, so I decided to load up on Coca-Cola (KO) stock. But then I realized that I was woefully out of touch with the nuances in the soft drink market.
At my age, carbonated beverages were becoming "challenging" and, in fact, had led me to use a certain product manufactured by Novartis (NVS). So I really wasn't up on the competition between KO and its nemesis, Pepsi (PEP) in the United States, much less the world, as the two companies jockeyed for position in China, India, Brazil, etc. My solution was to buy them both on the theory that one or the other (and, most likely but not inevitably, both) would probably continue to do well even if we were in for a repeat of the 1930s. It has worked out reasonably well.
This brings me to the debate about the future of the PC, the Notebook, the iPad, etc. Apple (AAPL) has certainly been making inroads into parts of Microsoft's (MSFT) market, and this has led some analysts to go so far as to suggest that MSFT is a short. On the other hand, MSFT continues to crank out stupendous cash flow. I have written before about valuation, and I like to back out cash on the balance sheet and look at what investors are paying for the operating company as a multiple of earnings. Analyzed this way, MSFT (having closed Friday at $25.92) has roughly $49 billion of net cash on its balance sheet, which adds up to $5.76 per diluted share. Thus, an investor is paying $20.16 for the operating company net of cash and debt.
Using consensus 2011 earnings of $2.62, we get an EPEE (enterprise price/enterprise earnings) multiple of about 7.7. This ratio bakes in a world of woe and negative expectations. This is just about half of the PE of the Dow Jones public utility index. Thus, MSFT is trading as if it were an electric utility that had just learned of a major malfunction in one of its nuclear reactors, had to contact the state Public Utility Commission for a rate increase, and discovered that Leon Trotsky had just been appointed as the new chairman. Given that MSFT keeps putting out solid numbers, it is hard to justify such a low multiple.
Of course, AAPL has been having a great run and, like MSFT, keeps piling up cash. As of the most recent quarter, it has roughly $65.7 billion of cash on the balance sheet, or about $71 a share. This means an investor is paying $279 a share for the operating company. Once again, the EPEE looks cheap -- roughly 11 times this year's consensus earnings (which AAPL always seems to beat) of $24.34 a share. If AAPL is really about to dominate personal computing to the extent that the MSFT shorts say, then 11 times this year's earnings seems mighty cheap.
The problem is that I really don't know who is right about the future of tablets and notebooks, about the iPad and the PC, and about mobile phones. I suspect that the truth is probably unknowable right now, but will turn out to be somewhere between the extremes being predicted. If the iPad is about to rule the world, AAPL shares are dirt cheap; if it isn't, MSFT shares are being given away. My preferred solution is to repeat the KO/PEP strategy and buy both, because both are cheap and will probably do well from here ... but in one or another of the extreme scenarios the winner will take off like a rocket.
I have tried to think through these valuations and what they mean for the market. I am beginning to think that the Nasdaq and the tech stocks that have dominated it may be in a post-1929 mode, having been wildly overvalued in early 2000, and then having crashed and now being shunned by disillusioned investors -- perhaps for a generation. These valuations certainly do not look like the kinds of things we saw in 1929 or 2000, and it is hard to explain them in light of how far the market has travelled. Investors may have to wait a while to make money on price appreciation here, but that is one of the frustrations of value investing.
Disclosure: I am long MSFT, AAPL, KO, PEP.
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