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This article is part of our Rising Star Portfolios series.
Well, we're up and running with the Messed-Up Expectations (MUE) Portfolio, my answer to the Fool's call to investing and (hopefully!) beating the market. As of last Friday, both of my picks were up: Transocean by 6.9% and Power-One by 1.9% -- even better, as of the 18th, the portfolio as a whole, including cash, was outpacing the market.
Right now, the amount of cash not invested yet is putting a pretty big drag on what I believe the portfolio is capable of doing, so I've been on the lookout for additional companies to invest in.
But where to look?
The first two companies I selected are from the energy sector of the market: oil and solar, respectively. While I think there are other intriguing possibilities there, I don't want to get too concentrated in one sector. If energy companies take a dive, I don't want to be too badly hurt.
One sector with a lot of companies to look at is technology. And one company in that sector that is pretty popular around Fool HQ is Apple (Nasdaq: AAPL ) . And I have to admit it is intriguing, what with the innovation it's shown over the past several years, defining the portable music player and the smartphone, and re-energizing the tablet market. Plus, the iTunes store has (finally!) gotten the Beatles. But from a MUE perspective, it just doesn't have what it takes to land a place in my portfolio.
At Friday's close of roughly $307, it has 17.5% annual growth of free cash flow (FCF) priced in for the next five years, 8.7% for the five years after that, and 2.5% terminal growth (at a 15% discount rate). That 17.5% level is pretty steep, and while the market might be underestimating what it is capable of -- after all, it's done an average of 49% in annual FCF growth for the past five years -- I don't think it's underestimating it by an overly large amount.
Hopes -- high and otherwise
Further, the MUE Port isn't just about numbers. Investor psychology plays a big role, too. Right now, Apple is the market's darling, and that leads to high expectations. Similar darling accolades are often given to other tech companies, such as Juniper Networks (Nasdaq: JNPR ) right now -- nearly 32% annual FCF growth for five years required at today's price.
On the other hand, there's Microsoft (Nasdaq: MSFT ) . At Friday's closing price of $25.69, it has only 5.3% annual growth of FCF for five years and then 2.5% from then on priced in (also at a 15% discount rate). That's not nearly as big a hurdle as what Apple faces to justify its price.
As for investor psychology, after rocketing upward from a split-adjusted $5 per share level to about $60 in the late 1990s, Microsoft's been trading for much of the past decade in the $20 to $30 range. That's given rise to a lot of investor apathy.
Yawn, so what?
But the company hasn't gone nowhere. It's increased FCF from $10.5 billion at the end of 2000 to $24 billion over the past four quarters. Meanwhile, its P/E ratio has compressed from the mid-60s in the first quarter of 2000 to less than 12 so far this quarter. This reminds me of what Coca-Cola (NYSE: KO ) underwent in the late 1970s: It traded flat for seven years, and investors became totally apathetic about the stock. Meanwhile, it continued to grow earnings. Then starting in 1982, the share price began a strong move upwards.
While history may not repeat, it does often rhyme as Mark Twain put it, and that would be good enough to make some money on the tech giant.