In addressing the Wall Street Journal’s “All Things Digital Conference D8”, Steve Jobs’ comments on Apple (AAPL) overtaking Microsoft (MSFT) in total market cap: “It’s sort of surreal. It’s a little surreal.” were an interesting choice of words from a man who clearly suffered as Windows ruled the PC world, until recently that is. Steve surely believed that Windows was an inferior product and concept to the MAC. Although the MAC PC is still far behind the Windows PC in units in place, the iPad portends to close the gap.

This prompted Steve Ballmer, Microsoft’s CEO to counter with his prediction that “the era of the personal computer is far from over.” This was said to counter Steve Jobs’ prediction that the rising popularity of the iPad and other devices heralds the decline of traditional PCs. However, as The Wall Street Journal reported, Mr. Ballmer’s argument was more semantics than substance. Microsoft regards tablets as just another version of a PC, like laptops are, and Windows plans to offer a competing product.

The battle of what was once David versus Goliath has now become a war of “Tech Titans.” It’s going to be interesting to see how it all unfolds. On that note, we thought it might be of interest to readers to see how Apple caught up to Microsoft through the lens of the EDMP, Inc. F.A.S.T. Graphs™.

Figure 1 below plots the earnings growth of Microsoft since 1996. In this example, the orange line with white triangles represents earnings multiplied by the growth rate of those earnings (19.2%), and the white triangles connotes fiscal year end. As the EDMP, Inc. F.A.S.T. Graphs™ illustrate, Microsoft experienced impressive growth with modest cyclicality since 1996.

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Figure 1 MSFT 15yr EPS Growth 

In Figure 2 below, we overlay the monthly closing stock prices of Microsoft since 1996. Since the orange line with white triangles represents the PEG Ratio (Price Equals Growth Rate) value for Microsoft, the irrationally exuberant overvaluation from 1996-2000 is clearly evident, by our definition of value. Nevertheless, the correlation between price and earnings cannot be denied as the overvaluation inevitably moved to earnings justified levels.

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Figure 2 MSFT 15yr EPS Growth Correlated to Price

Figure 3 below looks at Apple’s earnings growth over the same period (1996-current). Although the end result of 20.4% earnings growth correlates closely to the 19.2% earnings growth for Microsoft, how it got there is a much different story. From 1996 to 2001 Apple’s earnings were actually quite poor. Apple reported losses in 1996, 1997, and again in 2001.

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Figure 3 AAPL 15yr EPS Growth

Figure 4 below overlays monthly closing prices for Apple since 1996. As the graph shows, price correlates to earnings with occasional bouts of overvaluation and even some undervaluation. Remember, the orange line with white triangles represents PEG ratio, or fair value. Therefore, when the black line touches the orange line the stock is in value, when above the orange line it’s overvalued, and when below the orange line it’s undervalued.

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Figure 4 AAPL 15yr EPS Growth Correlated to Price

For an interesting perspective we have marked Figure 4 with arrows that represent Apple milestones. As most people know, Windows PCs vastly outnumber MAC PCs by a factor greater than 10:1.

This explains Apple’s poor earnings record through 2001. However, things began to change on October 23, 2001 when Apple launched the iPod (red arrow). Then on January 9, 2007 the iPhone was launched (blue arrow), and this is when Apple’s fortunes really kicked in to high gear.

The purple arrow in Figure 4 marks January 27, 2010, when Apple announced the launching of the iPad. As an interesting aside, Apple announced a secret at the D8 Conference. The iPhone was born while Apple was working on the iPad. Allegedly, Steve Jobs said that it would make a great phone, and the iPad was put on the back burner in favor of the iPhone.

Apple Dedicated to Excellence

A great deal of Apple’s recent success can be attributed to the attitude of its founder, Steve Jobs. While many tech companies strive to protect their legacy products, Apple has never been afraid of creative destruction. In other words, they are willing to abandon out-of-date common products and services in favor of new and improved versions. Apple is only interested in providing its customers the best, and most up-to-date products and services possible. Therefore, innovation is part and parcel of the company’s corporate DNA. Instead of trying to protect the past, it is more concerned with building a better tomorrow.

Although many of its competitors are developing products and operating systems to compete with Apple, we believe they will surely fail unless they adopt Apple’s mindset. However, a major characteristic of technological advancement is the leapfrogging of one company’s developments over existing technology. Therefore, the prudent and diligent technology investor needs to be in constant vigilance regarding new technologies that could threaten their existing portfolios. It would be naive to believe that any company or person, including Apple or Steve Jobs, to be impervious to this possibility. On the other hand, so far so good, regarding Apple’s most recent momentum.

Conclusion

Although Apple currently seems to have the lead in technological advancements, let’s not forget that Microsoft has formidable resources and has dominated for many decades. It’s true that Apple has now overtaken Microsoft, in terms of market cap. However, much of this can be attributed to valuation. Microsoft currently trades at only 13.3 times earnings, while Apple trades at 21.8 times earnings. Based on recent growth, this is justified. However, it would be irresponsible to ignore this valuation discrepancy. Current estimates expect Apple’s five year growth to exceed 18%. If this happens, then arguably Apple is fairly priced to only modestly overpriced today, in our opinion.