MARCH 28, 2020
Link to the Real. It Pays.
We released this piece early on Saturday. On Monday night Cramer agreed:
“Don’t over-think this one. Microsoft is a buy. It may just be the best tech stock in this market.”–Jim Cramer, Mad Money, 3-30-20.
is sneaking in as our attention is splintered. We’re petting the cat and peeling thunder and pouring rain won’t stop that.. We’re now under the gun and if that hasn’t rocked your socks then you’re ready for that chaise lounge helium trip up to the stratosphere. Remember that guy in California and his helium balloon lawn chair? What’s next when both the light and the air grow thin?
Light and air in market terms mean the essentials and the giants: phone, power, and those near a trillion. The smart and savvy warned us earlier that tech would be autopsied in all this. It was. Yet, the Stay-at-Home ecosystem means more of the bigs–more band width, for more remote working, more gaming, streaming, online shopping. Hum, who does all that?
China brewed this virus and it’s now demonstrating this expanding tech truth pushing up behind. We need more not only from VZ, T, and UPS, but also from GOOG, AMZN, and MSFT. That leads us right back to thinking big. When the economic storm boils you wanna bunk with the bigs. That’s why we’re having a “Brain Pill. Two Minutes. MSFT v. GOOG.”
trouble means slide straight to safety. That’s far from over. The realities of Covid 19 feel second only to an asteroid strike. It will abate. That means think. It’s good to put some money in the essentials; utilities, telecoms, or drugs, maybe even food plays, if you can stomach the nonperformance and stupor-producing prices.
But wait, don’t hate. How about tech–the gigantic, the rich, the tech giants? Some have said tech will be dead until our economy gains new momentum. Hog wash. Besides, big is safer, rich is reliable, particularly when the economy’s disrupted. Of course that’s now. Cash is king and cash-flow is life. The bigs cash flow like the Amazon. Yes, like them, and Alphabet all day long, and Microsoft too. How about a head-to-head look? Wonderful Microsoft vs. the essential and fully entrenched Alphabet.
what’da ya gonna pay? Fact. GOOG’s stunningly cheaper on every measure, save one. Price to Earnings/Growth, or PEG. Recall that a PEG of 1 is cheap, while a PEG of 2 is expensive. GOOG doubles that with a 4.67. Meanwhile Microsoft rolls in at 1.92. We love PEG ratios here because tech investing’s solely about earnings growth. Clear winner Microsoft at 41% of the price of Alphabet on earnings growth. That was easy.
A lower PEG ratio means you’re getting more earnings growth for every invested dollar, and dollars are what we’re investing.
are the measure of any enterprise’s ability to create earnings. Every step in this process measures efficiency. Margins are set in percents and measured in basis points. A basis point equals one one-hundredth of one percent. Margins measure operational efficiency, and are also viewed as a gauge of management’s effectiveness.
margins allow for strong cash flow, and robust bottom lines. Each margin reflects efficiency in each phase; gross, operating, net, cash flow, & profit. Microsoft’s margins are massively better than Alphabets–20% to 90% better. Clear winner MSFT.
is king and now is the time to have some, both as an enterprise and an individual investor. Cash flow is precisely what dries up when the economy is disrupted. Apple has more cash than god, yet they’re parked in the middle of the devastation. Market bargains abound now for those with cash. Again, massive cash flows are beloved by investors in times of trouble. Cash is the ability to service debt, to out-last slowing revenue streams, to intelligently capitalize on opportunity, and thus survive.
Both valuation and cash flow are calculated by the share. How helpful is that? Share prices and share counts vary radically. As of pre-market on Friday Alphabet was trading at $1128.00 a share, with 341 million shares outstanding. Simultaneously, Microsoft was trading at $151.60, with 7.606 billion shares outstanding. That makes Google’s share price 7.44x larger in dollar terms. It also means that Microsoft has 22.3x the number of shares. Classic apples vs. oranges.
Google cash flows $65.84 a share vs. MSFT’s $6.96. Given the above that means absolutely nothing. Taken at face value it states that Alphabet cash flows 945% more per share than MSFT. Of course, and the new marathon time is now one hour. Cash flow per share gains meaning only when compensating for variance in share price. Why not shares outstanding as well? Because investors invest in dollars, not shares. Think dollar-cost-averaging.
Investors think by the dollar, not the share. That’s why every valuation metric begins with “price-to.” Think P/E, forward P/E, Price-to-sales, Price-to-cash flow.
Dividing GOOG’s $1128 share price by MSFT’s $151.6 one gets 7.44. Thus GOOG’s share price is 7.44x MSFT’s. Multiplying MSFT’s $6.96 per share cash flow by a factor of 7.44 one gets $51.78 dollar adjusted share of cash flow. Apples to apples.
$51.78 is MSFT’s real cash flow relative to GOOG, at an adjusted dollar-for-dollar amount. That’s $14.06 a share less than GOOG. That means MSFT would need to increase it’s cash flow per dollar-adjusted share price by 27%, in order to match GOOG. These two massive enterprises are both cash flow machines. Both will thrive, yet Alphabet flows more cash by double digits.
is what investors pay for. What has the psst week shown us? Google rose 5% last week, exactly, and dropped 20% over the past 20 trading days. Meanwhile MSFT popped 9.57% last week and has fallen a smaller 13.77% over 20. Over the near term MSFT’s nearly doubling GOOG. How about longer term?
Over the past year Google shareholders have lost -5.3%. Over three years they’re up by 35.5%, and over five by 103%. Alphabet pays no dividend, and never has. Meanwhile Mr. Softie has returned a robust 29.9% to shareholders over the past year. Over three that haul leaps to 141.8% and to 305% over the past five years. Their is no comparison here. Winner Microsoft. They also pay a 1.36% just to hang around. Think the nothing yield on the 10-year treasury before laughing.
So in total what does this picture look like? Over the past year–opps, the three and five also, Microsoft has beaten Alphabet like an all-pro pass rush camping in your back field. Not even the Seahawk’s Russel Wilson can escape Mr. Softie’s share price return. Microsoft has already gone through the government’s anti-trust chipper. Microsoft also isn’t viscerally hated by the EU. Google’s been finer thrice for at least eight billion over the past twenty months. That’s not over.
That’s all good and true. But no one drives through the rear window. What do the estimates suggest? The latest forward earnings estimates put GOOG at 6.3% EPS growth. And Mr. Softie? 18.6%. Clear winner, again Microsoft. We already bought a chunk at lower prices. However, MSFT remains 39% below it’s 52wk high of $190.70 set on February 11th. We like it on a pull back. As always good luck and patient buying.
Cedar Rapids (2011)