Is $AAPL overvalued Part 2, or what does Mr Market know?

Almost exactly three weeks ago (April 5, 2012)  I did a comparative study on Apple versus other large technology companies. The answer was "no", and one of the key pieces of evidence was the following table:

Since then, all of the companies in the list have reported their earnings, and we have the situation as below:

What do we see? Apple had smashed expectations, and at this point its trailing and forward P/E is better than that of all of the other names, except Microsoft, which leads rather narrowly, and which has considerably dimmer growth prospects than Apple. Google has done a good deal better than expected (looking at the old and new P/E figures). Both of their stocks have gone down considerably over the last three weeks. Curiously, the best performer of the bunch (by far) is Amazon, which has a crazy earnings multiple, and worse growth prospects than Apple. What does it all mean? I don't know, but Apple looks even more attractive now.

I Love you do death II: Or, hugging the benchmark

In the last post I cast aspersions on Google leadership by comparing Google's performance with that of Apple. This could be viewed as not entirely fair, since Apple sets an extremely high standard, and maybe Google's management, while not in Apple's league, is still very strong? With this goal in mind, let us compare Google's performance with that of S&P 500 (with dividends reinvested) -- we use the SPY ETF as proxy (this will have the effect of making S&P 500 returns look very slightly worse than they really are). Let us see what would happen if our GOOG-r-us hedge fund constructed a dollar neutral portfolio, which was long GOOG and short SPY. Here is what our results would look like:

You see that our fund would have done very well in the first three years of its existence, but it would have floundered aimlessly for the last five years: since mid-2007 Google has been tracking the S&P 500, so its performance has been (in a technical sense) mediocre. To avoid cluttering this post, I will not include a beta-hedged chart, but the results look exactly the same (Google's beta vs the S&P 500 is 0.8, which is good, but hardly a spectacular accomplishment for "the company of the future.")

• On the one hand, this bears out the contention in the last post that the skill set require to start a company is quite different from that required to keep it going, and it seems that Brin-Page-Schmidt have the former but not the latter.
• On the other hand, an even more cynical observer would remark that Google historical performance is exactly what you would see for a fund perpetrating the scan described in a recent post:: very impressive performance from inception, but hugging the benchmark for the last several years.

Either way, not a great argument for giving Google founders any more rope, er, voting power.

I love you to death, or: Monarchy vs Meritocracy

Yesterday, as part of their quarterly report, Google announced that it was going to do a weird stock split, whose main purpose appeared to be to consolidate power in the hands of the founders (Brin, Page, and Schmidt), who currently control 2/3 of the votes of Google. In a letter, the founders explained that they so loved the company that they felt they needed to keep shepherding it, without interference from pesky shareholders. This brings up the obvious question of how well they had been shepherding it, and since everything in this world is relative, who better to compare Google to than its tech rival Apple (whose shares tanked today out of solidarity with Google, demonstrating again the great efficiency of the stock market). It should be noted that through almost all of the period we will be looking at (Google's lifespan as a public company) Apple has been led by Steve Jobs, who had famously sold all of his founder's shares but one when he was fired from Apple, and while he had acquired a fair bit of stock during his second coming, he certainly did not have a measurable amount of voting stock. Same goes for his successor Tim Cook, who, when his options vest will have a princely 0.05% vote. So, how did the two companies do?

First, the obvious price chart:

You will see that GOOG started trading at $100 a share on its IPO day (8/19/2004). Its price doubled to $200 a share in two months, and it is now trading at a bit over $600 a share, considerably below its late 2007 all-time high. By contrast, AAPL was trading at $15 a share (adjusted price, there has been a split in the intervening period) on Google's IPO day, and it is now trading (by a curious coincidence) roughly for the same price as Google. For a total outperformance of 6.5x in the seven and a half years. 

This, however, is only the beginning of the story. First, let us look at Apple's annualized alpha vs Google:

(alpha charted is the simple six month regression alpha).

You will see that Apple has consistently outperformed Google. But wait, there is more. Let's look at the beta of Apple's returns vs Google (after all, if we believe in the Capital assets pricing model, Apple performance should be easily explain by the higher volatility of its returns:

(beta is the six month empirical regression beta, no GARCHes harmed...)

Surprise: AAPL beta vs GOOG (except for literally a few days in 2007) has been much below 1. In other words, Apple's performance flies in the face of CAPM, since its risk-adjusted returns are truly phenomenal.

Those of us in money management business measure risk-adjusted returns by Sharpe Ratio (which is the ratio of mean return to the standard deviation of returns). Google's annualized Sharpe Ratio is a rather unremarkable (if solid) 0.69. Apple's is 1.27 -- essentially double Google's, and very good (given the long period marked by a major recession) for any hedge fund, and without the benefit of the diversification that a hedge fund would have.

So, Steve Jobs managed to run Apple very successfully while not having the ability to pick the board, and did it while enjoying complete control of the company, which the board was more than happy to give him. Jobs had famously said that he did not give a shit about the stock, and yet his bean-counting statistics are far superior. Not only was he allowed to run the company as he saw fit, but Cook is his hand-picked successor. Meritocracy works. But there is more: in 2004, Apple was very much an also-ran computer maker, who had just introducers the iPod. Google already had the monopoly share of internet search at the time of its IPO. In the intervening years, Search (or more precisely, selling advertising on search) remains Google's only serious money-making business. All of Google's other efforts have been attempts to disrupt other people's business at great cost to itself (examples: Google+ is an inferior version of Facebook, Android is an inferior copy of the iPhone, which has not hurt Apple, but destroyed Microsoft's phone business, and contributed to the destruction of RIM, Google apps is a poor attempt to compete with Office, Google Finance is a poor cousin to Yahoo! Finance, Google Play is an attempt to undermine iTunes and Amazon...) The one exception to this is YouTube,which is actually the leader in the field, but I don't know that it actually pays for itself (the amount of advertising is minimal, and the costs, given that video is very storage intensive, must be very high)

Bottom line: Brin, Page, and Schmidt started a great company, but starting and running a great company are, it seems two very different things (Jobs did both, but his second coming was twenty years after the founding of Apple -- he had apparently learned a couple of things in the meantime). So giving the founders control in perpetuity is a stupid idea, and I would not invest in any IPO which does it (that means you, Facebook).