The market capitalization of a company isn’t always the most important factor to consider when investing.
By Sameer Massis
Here’s an investment question to consider: Two years ago, would you have invested in company “A” which had zero debt, an income that increased by 61 percent, and which had just become the world’s largest firm with a market cap of $600 billion? Or would you have invested in company “B” which had 16 percent debt, and whose income had decreased by 27 percent? You may be surprised to learn that if you bought stock in company “A” you would have had a cumulative 4.8 percent return, whereas company “B” would have provided a whopping cumulative 46.2 percent return over the last two years.
It’s even more astounding to know that company “A” is Apple, the tech giant that gave us the iPod, iTunes, iPhone, iPad, and the next generation Macs. While company “B” is Microsoft, whose most notable innovations have been confined to Windows 1 through 10. Furthermore, it was during the last two years, and specifically by Q4 of 2013 with $80 million sales, that Apple computing devices surpassed for the first time the number of Windows PC sold globally. Even though both the stocks of Apple and Microsoft trade as a similar P/E valuation of 16, the main difference in their stock performances lies within their underlying businesses.
Apple primarily sells to consumers, and its sales are susceptible to changes in their tastes and whims, as well as general seasonality like holiday shopping and the overall economic cycle. All this results in wide gyrations in the sales numbers as consumers chase the next hot trend, whilst Apple tinkers its next technological innovation.
In contrast, Microsoft’s flagship product Windows is a remarkably reliable revenue generator. For instance, in the last five years, the division responsible for the ubiquitous operating system has generated around $19 billion in annual sales—consistently. This represents the majority of Microsoft’s “Devices and Consumer Licensing,” which makes around 24 percent of its $80 billion in annual sales. The key to its sales consistency remains in its software licensing to the Original Equipment Manufacturers (OEMs) of the PC market.
Despite what technology pundits continue to call archaic, and likely to experience decline, the PC market continues to be the mainstream. The fact is that tablets and the like will not replace the PC because each has its niche market, and unique, though somewhat coinciding, customer base. The tablet has its portability advantage, but the PC has a wider scope of functionality.
Boring is Beautiful
It’s worth noting that Microsoft’s Business division produces more than twice the revenue and profit than its Consumer division. In essence, Microsoft Office, Exchange, SharePoint, Project, Vision, and Dynamics raked in $39 billion in net profit for the company, over the last 12 months. On average, over the last three years, its Business division was responsible for 63 percent of its gross profit. Hence, Microsoft is a business-oriented rather than a consumer-oriented company.
Herein lies the secret to its consistent sales: selling to businesses is more predictable than selling to consumers. That’s why B2B (business-to-business) business models generate more consistent sales than B2C (business-to-consumer). Businesses buy products for their reliability and durability, while chasing the upgraded software even if they only offer a small step up in functionality. Businesses need to use the latest software at least to maintain their image, and protect against Internet vulnerabilities.
Thus, since its inception, it was an intelligent business strategy for Microsoft to integrate with the PC manufacturers. Microsoft sold Windows to the computer makers—whoever they were—and computer makers sold to the consumers. With this, its software integrated seamlessly with our use of the computer, and its product names became entrenched within our everyday lexicon. “Windows” and “desktops” stopped referring to physical objects, while “Word” and “Powerpoint” are the essentials that we bring to every meeting.
In contrast, consumers may buy on a whim, and their buying decisions are often not purely rational. We don’t need Apple products, but we find ourselves wanting them. It started with Apple’s unique marketing approach in which it launches every product with a worldwide show. As we look with awe on the next sleek presentation, we buy into the idea, we purchase the product, and we use it—often addictively. In fact, psychologists coined a name for this: “nomophobia” or “no-mobile-phone” phobia. This is the state of desperation, and unfocused attention when separated from your smartphone, and left in constant need to check the online world. According to a survey by the Huffington Post and YouGov, 64 percent of people between the ages of 18 and 29 sleep with their tablet or cell phone in bed with them.
Even though Microsoft Corporation did not make its cofounder Bill Gates the greatest inventor, it did make him the richest American. With an estimated net worth of $81 billion, Forbes ranked him the richest man in America in 2014 for the twenty-first straight year in a row. He was even the richest man on the planet for 16 of those years, only superseded by telecom mogul Carlos Slim Helu of Mexico for a brief few years.
This is even more formidable, considering that since 2000 Gates has donated in excess of $30 billion through the Bill and Melinda Foundation to help with child causes and disease elimination. Gates has declared that eventually he intends to give away all his fortune.
Both himself and his wife Melinda are not interested in keeping money for themselves, nor for their three children. Even if their prodigious rate of giving is not enough, their foundation even started “The Giving Pledge” which invited other wealthy individuals to join them and donate at least half of their money to charity. So far, 127 high-net-worth individuals have already signed up on the pledge, including notable names like Paul Allen, Warren Buffett, Michael Bloomberg, Mark Zuckerberg, Sheryl Sandberg, David Rockefeller, and Ted Turner.
Australian moral philosopher Peter Singer had a few insights on these general altruistic acts of selflessness. He posits that for those who can afford it, charitable giving is a moral obligation that is on par with saving a life. This is based on the tenet that all lives are created equal. He offers the following metaphor to explain further: If you pass by a child drowning in a shallow pond. You didn’t push the child in, but you can pull him out to save his life. However, to save him, you would need to get into the pond and your clothes will get wet, and may get ruined. What would you do? You would save the child of course. However, this is the same moral decision that we are faced with when we spend our money. Thus, it is surprising how we may spend money on luxury goods rather than give some of it to charity, which may save someone’s life.