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Stock Madness 2005: Apple vs. Microsoft

The following article is part of The Motley Fool's "Stock Madness 2005," a contest based loosely on the annual NCAA College Basketball Tournament, a.k.a. March Madness. From March 17 to April 4, our writers and analysts will engage in head-to-head competition with each other, advocating and arguing on behalf of 64 stocks we've selected as among the most interesting to Foolish investors. You, dear readers, are the fans and referees -- you'll read these exciting duels and then vote for the stock you think is the better investment... and should therefore move on to the next round of play. The company that survives six "games" will be our tournament champion, and its writer our most valuable "coach."

But, please, make no mistake -- "Stock Madness 2005" is a GAME!

Our writers are doing this for fun. They are enjoying the spirit of competition and the art of debate. They are delighting in the search for positives in the companies they've drawn... and negatives in the companies they're pitted against. They are NOT necessarily recommending these stocks as the ones they believe in above all others. As ever, YOU must decide whether the stocks we're writing about -- winners and losers -- are deserving of your investment dollars.

Apple Computer (Nasdaq: AAPL  )
Cupertino, Calif.
52-week low-high: $12.61-$45.44
$33.4 billion market cap

By Bill Mann

The selection committee, it is apparent, has a flair for the dramatic. They knew that an Apple versus Microsoft tilt would be great television. Heck, if I weren't part of it, I'd tune in.

Let's dispense with the elephant in the room: If we are at Round 3 in the Apple/Microsoft tilt, you would have to be hopelessly partisan not to recognize that Microsoft absolutely slaughtered Apple in the first, with Apple making excellent tactical maneuvers in the second so that the biggest question is no longer whether Microsoft will destroy it. The difference between the second round and the first was that Apple chose to quit punching itself.

Apple is the prospector, the trailblazer, and yes, perhaps even a Rule Breaker. Microsoft is the Borg. Apple's technology tends to work extremely well and is intuitive. Microsoft's works with everything, eventually. Microsoft will never, ever, ever come up with a piece of functional engineering as breathtakingly beautiful as the iMac. Still, Apple lost the operating system war. So it went elsewhere.

Its jiujitsu moves are paying off. First and foremost, the smashing success of the iPod digital music players, where Apple has managed to introduce product lines in succession without cannibalizing itself. This was an extremely smart move, since music management has turned out to be a killer app. Apple's iPod and iTunes have become the default as the company has exploited two elements: its design and usability prowess and a marketplace fractured with standard and interoperability issues. If you don't know what operates with what, your default is to go with the one you know works well, and that's the iPod.

You can see how prevalent this tool is by regarding the actions of Apple's competition: Napster (Nasdaq: NAPS  ) has essentially ceded the pay-per-download market to Apple by focusing its marketing on monthly subscriptions -- in my opinion a strategy that is a loser, since Napster doesn't work with, you guessed it, iPods.

What the iPod has managed to do is kick-start and revive the operating system war. If your most cherished technological possession (besides the portable electronic I-Ching, of course) is your iPod, and you're at the point of replacement for your computer, why not consider a Mac? Moreover, Microsoft has helped here with its consistently-under-viral-Spyware-and-adware bombardment Internet browser and email client. People who primarily use their computers for browsing, communications, and music management have a new low-cost, hassle-free, typically awesome product for these purposes, the Mac Mini.

Essentially, Apple has reinvigorated the operating system battle with Microsoft by focusing on everything but operating systems. Given its low level of penetration, it doesn't have to take much of the market in order to make a huge difference to its bottom line.

Apple is unlikely to ever destroy Microsoft. Fortunately, it doesn't have to in order to beat it badly in its carefully selected fields of battle.

Bill Mann owns none of the companies mentioned.

Microsoft (Nasdaq: MSFT  )
Redmond, Wash.
52-week low-high: $24.01-$30.20
$271.9 billion

By Rich Smith

"Past performance is not indicative of future results," runs the party line. Balderdash. Past performance is the best possible indicator of future success, and anyone who tells you different is reading boilerplate passed to him from the legal department.

There's a reason that Microsoft got the No. 1 seed in this division: Common stock in Microsoft is arguably the best investment money can buy. Over its past 19 years on the public markets, Microsoft shares have leapt skyward in value at a compounded annual rate of more than 33% per year -- better than three times the rate of the average S&P 500 stock, and threeand a half times better than Apple's. (That's right, folks. Historically, Apple has underperformed the market.)

If you're reading this series of articles, chances are you're a sports fan. And if you're a sports fan, you like stats. So here are a few more stats to consider when weighing Microsoft against Apple as an investment:

Microsoft Apple
Profit margin 26.0% 5.2%
Return on equity 14.8% 10.4%
Enterprise value-to-free cash flow 18.2 20.4
Trailing P/E 27.2 65.6

So Microsoft's the more profitable company. It's better run. And the only place where Apple scores higher: the price tag. On an EV/FCF basis, Microsoft gives you a 10% discount to Apple. Or if P/E is your preferred flavor of valuation, Microsoft sells for better than half off.

Of course, you know all that already. You've known it for 19 years. So here's something you may not know, and that's of crucial importance to you as an investor: Microsoft is the more shareholder-friendly company. While Microsoft's share count increased less than 1% over the past year, Apple diluted you by 6.7%.

So, investors, how do you like them apples?

Fool contributorRich Smith has no position, short or long, in either Apple or Microsoft.

Well argued, Bill. In fact, if I might borrow a few of your arguments for a moment:

Game: ".Microsoft absolutely slaughtered Apple in the first."

Set: ".Apple lost the operating system war."

Match: "Apple is unlikely to ever destroy Microsoft."

What's to rebut? Game, set, match: Microsoft. -- R.S.

Yeah, whatever. -- B.M.

Who won? Click here to cast your vote.

The Motley Fool is investors writing for investors.

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