Apple Is Worse Than Microsoft

 | Sep 18, 2013 | 4:00 PM EDT
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At this week's Value Investing Congress, none of the fund managers presented on Microsoft (MSFT) or Apple (AAPL), but they did comment on the stocks in the Q&A round.

Microsoft is one of Donald Yacktman's top picks. He is one of the most successful mutual fund managers around, outperforming the market by as much as 4 percentage points per year after fees by investing in solid large-cap stocks with reliable cash flows. But Apple isn't one of his picks.

When asked about this, Yacktman said that he doesn't like Apple because the stock isn't as cheap as it looks. He didn't use the word "value trap," but we believe that's what he meant. Apple owes its $400 billion-plus market cap to its ultra-high profit margins. Essentially, Yacktman believes Apple's profit margins aren't sustainable. Why? Because of the threat from Samsung and the possibility that it will steal market share and force Apple to cut its prices and subsequently its margins.

I made the same case last week. I believe Apple will go below $400 in one year and may fall below $300 in three years. The iPhone used to be one upgrade cycle ahead of its competitors, and consumers didn't mind paying a premium for a superior product and experience. Both of these advantages started to degrade with the launch of the iPhone 5.

Carl Chen and Tom Lu of Temple Honor Asia in Taiwan argued that Apple has priced itself out of the Chinese market and has been losing market share in the region. Chen's thesis is that Chinese consumers don't want and can't afford Apple's super high prices, and Chinese telecom companies don't want to subsidize iPhones.

Perhaps the most influential presenter at the conference, activist hedge fund manager Jeff Ubben of ValueAct Capitol, has a large position in Microsoft, but he didn't want to get into the details of his investment. He did say, however, that Microsoft offers productivity tools to information workers for the price of a steak dinner, and a large percentage of its enterprise business repeats year after year. On the other hand, he said that Apple or J.C. Penney (JCP) start each day with zero sales and "have to run faster every year to keep up."

Most mainstream investors consider earnings potential the primary determinant of a stock's price. Yacktman is bearish about this regarding Apple, whereas Ubben said he thinks the stock is probably fairly valued. The most important takeaway is that both of these fund managers believe Microsoft is a better investment than Apple, despite its problems.

Other activist fund managers, like David Einhorn and Carl Icahn, are attracted to Apple because of its huge cash hoard, and they're seeking a short-term jump in Apple's share price via increased dividends and share buybacks. These are moves in the right direction, yes, but Apple's fundamental problem is still the sustainability of its profit margins. When competitive forces pressure smartphone prices to go down, Apple's margins and profits will fall faster than iPhone prices.

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