Yesterday afternoon, Apple’s market value surpassed Microsoft’s.
For those who were around in the 1990s, this is a remarkable, watershed event, one that was basically unthinkable a decade ago.
A decade ago, Microsoft was worth 35X more than Apple was: $556 billion to $16 billion. In the intervening 10 years, Microsoft’s value has been cut in half, while Apple’s has risen about 15X.
(Microsoft has also paid out at least ~$40 billion in dividends, so the company’s value collapse isn’t quite so stark, but it has still been a rough decade).
Stock market value is more about the future than about the present or past, so it’s worth asking whether the market’s current opinion about the relative value of these two companies is an accurate reflection of the future…or whether it’s a complete hallucination, like the market’s assessment a decade ago turned out to be.
How do we ask (and answer) that question?
One way to begin is to look at the companies’ relative cash flows and growth prospects and think about what the market is saying will happen to them in the future.
All else being equal, the market’s assessment that Apple and Microsoft are worth about the same amount (ignoring the relatively minor difference in their cash and debt balances) means that the market thinks Apple and Microsoft will generate about the same amount of cash for shareholders over the next 100+ years.
Is this reasonable?
Let’s take a look at where things stand now.
In the past year (through March), Microsoft has generated about $21 billion of free cash flow (cash from operations less capital expenditures). Apple, meanwhile, has generated about $12 billion. Right now, therefore, Microsoft is generating about $2 of cash for every $1 of cash that Apple generates.
If Apple and Microsoft were to go on generating this amount of free cash forever, Microsoft would be worth about twice what Apple is worth–and the current market values would be way out of whack.
Of course, Apple and Microsoft won’t generate this amount of free cash forever. If recent trends continue, both companies will continue to increase the amount of cash they are generating, with Apple’s free cash flow growing at a much higher rate. If Microsoft’s competitive position continues to erode, moreover, Microsoft’s free cash flow might stop growing (or even start to shrink) at some point, which would make it easier for Apple to catch up. Still, given the huge current difference between the companies’ free cash generation, it will take Apple a while to close the gap.
The theoretical value of a company is the present value of all future cash flows that will accrue to shareholders. So if Apple continues to close the free-cash-flow gap with Microsoft over the next few years–and then eventually surpasses it–the current market values make sense. Of course, thanks to risk, opportunity cost, and inflation, dollars that shareholders get today are worth a lot more than dollars shareholders think they will get in 10 years, so for today’s market values to make sense, Apple has to catch up and pass Microsoft’s cash flow within, say, 5-10 years.
Based on the companies’ relative positioning in the market, the relative market values seem reasonable. Apple is positioned to capture a huge share of the growth of mobile and tablet computers in the next decade and to continue to gain share in laptops and desktops. Microsoft, meanwhile, is exposed to major competitive threats to both its Windows operating system business AND its Office juggernaut, and, combined, these products generate the vast majority of Microsoft’s cash flow. So, again, the market’s current assessment of relative future cash generation seems reasonable.
But before Apple shareholders get too comfortable, it’s worth, once again, looking back 10 years.
A decade ago, it seemed reasonable to think that Microsoft would continue on its inexorable path to world domination and Apple would disappear into the annals of history. That’s why the market valued Microsoft at 35X Apple–because that scenario seemed reasonable.
But look what happened: Microsoft did continue to grow, but at a much slower rate, and its once-unassailable monopolies began to come under attack. Apple, meanwhile, pulled off one of the most amazing turnarounds in corporate history, creating several huge new markets in the process.
From today’s perspective, the market’s current forecast seems as reasonable as the one a decade ago did. If history has taught us anything, though, it is that we should expect the unexpected. And between Apple’s key-man risk (here’s looking at you, Steve!), Google’s Android, Microsoft’s enormous financial resources, and one of the most rapidly evolving competitive landscapes in history, anything can happen.
So step right up and place your bets!
Business Insider Emails & Alerts
Site highlights each day to your inbox.