The Strange Valuation
of Microsoft Compared to Apple on July 4, 2017
Question: Below are statistics on market cap, PE
ratio, stock price target price, and comparison of target price to current
stock price for two companies, Microsoft and Apple.
Note, Microsoft has a PE ratio of 30.08 while Apple has a PE
ratio of 16.83. This is a bit odd because Apple is viewed as a growth
company and Microsoft if viewed as a value company.
What would the market cap of Apple be if it had the same PE
ratio as Microsoft?
What would the market cap of Microsoft be if it had the same
PE ratio as Apple?
Do the valuations of Microsoft and Apple seem reasonable to
you?
Financial Statistics for MSFT and APPL


MSFT

APPL


Value

526.31

748.19

PE ratio

30.08

16.83

Price

68.17

144.02

Target Price

74.63

158.95

Target Price over Price

9.5%

10.4%

Analysis: The easiest way to get value of Apple if it
had he PE ratio of Microsoft is to multiply the current value of Apple by the
ratio of the Microsoft to Apple PE ratio.
(30.08/16.83) x 748.18 billion = $$1.337 trillion dollars.
Similarly, the easiest way to get the value of Microsoft if
it had the PE ratio of Apple is to take the current value of Microsoft and
multiply it by the ratio of Apple to Microsoft PE ratios.
(16.83/30.08) x 526.31 billion = $0.295 trillion.
The other way to solve this problem is calculate total
earnings and multiply by the PE ratio of the other stock. Total earnings can be obtained by dividing the
market cap by the PE ratio.
Note:
MKTCAP=Price X Number
of Shares
(Price x Number of Shares)/ (Price/EPS)
= Number of Shares X EPS = Earnings
The total earnings of
Apple are $44.6 billion.
Multiply Apples Total Earnings by Microsoft’s PE ratio of
30.08 and get $1.337 trillion.
Discussion of the
Market’s View of Apple and Microsoft: it
is very unusual for Microsoft to have a PE ratio that is this much larger than
the PE ratio for Apple.
Apple is the growth company. It is in fact, the single largest holding of
VUG, Vanguard largecap growth fund.
Microsoft is the value company. It is in fact the single largest holding of VTV,
Vanguard largecap value fund.
I looked at the average PE ratios of the 25 largest holdings
of VUG and VTF. I excluded one firm with negative earnings. The average stock PE ratio was nearly 11
points higher for the growth stocks than the value stocks. The difference was not significant because of
outliers and a large standard error.
Still growth stocks tend to have higher PE ratios than
comparable value stocks.
This is not so for Apple and Microsoft.
Why?
I am not sure.
Here are some potential reasons.
Apples product line may be a bit riskier and too dependent
on the iphone.
Risk averse portfolio managers and pension funds may limit their
stakes in a single company and this risk aversion may limit the growth of the
largest stock. There may in fact be
dollar limits on the amount of a single stock that can be held by a portfolio
and such rules would limit buying of more Apple Stock.
Apple’s dividend is relatively small.
Apple has some tax problems with the EU and potentially with
the U.S. government.
Still even after considering these factors it is obvious to
me that Apple has a lot more upside than Microsoft. I can’t justify the much higher PE ratio for
Apple. Also, Apple has much more upside
than Microsoft and I can’t trust the nearly identical ratios of target and
current price for the two stocks.
My recommendations are to take profits from Microsoft and cautiously
increase shares of Apple should the market continue to dip.
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