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Better Buy Now: Apple vs. Microsoft

By Andrés Cardenal - May 31, 2016 at 8:00AM

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Microsoft is more predictable, but Apple offers superior upside potential.

Apple (AAPL -1.80%) vs. Microsoft (MSFT -1.32%) is one of the most-iconic corporate battles in business history. The two companies have had their ups and downs over the decades, and they're both facing slowing growth nowadays. Which one is a better purchase at current prices: Apple or Microsoft?

The sleeping giants

Microsoft and Apple are among the most-powerful and influential tech companies in the world, but they're both being hurt by disappointing top-line performance lately. This is related to business size to some degree, because it's increasingly difficult to sustain rapid growth from a gargantuan revenue base. However, changing consumer trends in the tech industry are also a major risk for investors in both Microsoft and Apple.

Microsoft used to be the undisputed king in the tech business, but the company fell way behind the competition in key areas -- such as mobile -- during the last decade. However, things are clearly improving for Microsoft since Satya Nadella was appointed CEO in February of 2014, transforming Microsoft into a more-dynamic and consumer-centered business.

Windows 10 is outpacing adoption of any of the company's previous operating systems. There are more than 270 million monthly active devices running on Windows 10, and management believes the company is on track to reach 1 billion devices by 2018.

The company is also doing a sound job at adapting Office to the cloud-computing paradigm. Commercial Office 365 customers surpassed 70 million monthly active users last quarter, growing by a vigorous 57% year over year. Cloud-computing infrastructure is another area where Microsoft is finding promising growth venues: Constant-currency revenue from Azure grew by a staggering 120% last quarter. 

Image source: Microsoft.

On the other hand, the PC industry is struggling, as low-cost alternatives flood the market, and global consumers are increasingly using a wider array of devices. In this context, Microsoft produced $20.5 billion in revenue last quarter, a 6% decline versus $21.7 billion in sales during the same quarter last year.

Apple is doing even worse on the revenue front. The company reported $50.6 billion in sales during the quarter ended in March, a worrisome year-over-year decline of 13%. Apple makes nearly 65% of its total revenue from the iPhone, so this product has a huge impact on overall performance. The company sold 51.2 million iPhones last quarter, a decline of 16% versus the same period in 2015.

After nearly a decade of rapid growth, the smartphone industry is clearly slowing down. According to data from IDC, worldwide, smartphone shipments were nearly flat in the first quarter of 2016. Making things more complicated for Apple, the iPhone 6 was a massive success for the company in 2015, and this makes year-over-year comparisons challenging in the current year.

Apple has a remarkably loyal customer base, so iPhone sales could improve as consumers renew their iPhone models in the years ahead. Besides, the company is expanding into different products and services, and there are strong reasons to believe that Apple is actively working on an electric car. While short-term growth depends on the iPhone, Apple enjoys tremendous brand power, and the company has an impressive track record of successful innovation over the years.

It's not too hard to imagine how Apple could drive improving sales over the middle term, but the fact remains that sales are moving in the wrong direction right now. There is no clear horizon as to when the company can reverse the declining sales trend.

Apple or Microsoft?

One big difference is that Apple stock is much cheaper than Microsoft at current price levels. Apple trades at a remarkably inexpensive forward price-to-earnings ratio around 10.6 times earnings forecasts for the coming year, while Microsoft carries a much higher forward price-to-earnings ratio around 17.6. This is probably reflecting the fact that most investors consider Apple riskier and more unpredictable.

Apple is heavily exposed to the iPhone, and sales have been quite volatile during the last several quarters. Overall industry growth is decelerating, and foreign-currency fluctuations are hurting performance in emerging markets. Trying to predict Apple's sales in the coming quarters is quite a challenging task. 

Image source: Apple.

Nobody is expecting explosive growth from Microsoft in the middle term, but the company seems to be making sound progress at adapting to the key industry trends such as cloud computing. Microsoft is arguably a more-predictable business than Apple.

For investors with long-term horizons, it all depends on what kind of growth you expect Apple to produce during the coming years. If you believe that Apple is facing a permanent decline in revenue, then no price is cheap enough to invest in the company, and Microsoft looks like a much-safer choice.

On the other hand, if Apple can jump-start growth on the back of improving iPhone sales and/or growing revenue from other segments, then the stock should offer huge upside potential from current levels. Apple stock will most probably outperform Microsoft by a considerable margin under such a scenario.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
$136.72 (-1.80%) $-2.51
Microsoft Corporation Stock Quote
Microsoft Corporation
$256.83 (-1.32%) $-3.43

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