Donald Yacktman might not have the same name recognition as a Warren Buffett or a David Einhorn, but when he speaks about Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT), we listen. According to Yacktman’s Yacktman Asset Management, he was named “Portfolio Manager of The Year” by Morningstar in 1991, and Yacktman Fund Service Class (MUTF:YACKX) has beaten the S&P 500 by over 3.5 percentage points in the last decade. Yacktman Focused Fund Service Class (MUTF:YAFFX) has generated nearly 4 percentage points of outperformance over this time.
With a 13F portfolio in excess of $20 billion alone, it’s no secret that Yacktman is a major force in the market place, and with that load of cash, he consistently makes large bets in the large-cap equity space. Historically speaking, he’s been pretty good at picking bigger stocks, which isn’t the case for every money manager we track. Some, like this one for example, are better in the small-cap space.
For mainstream investors who prefer to focus their efforts on stocks with the highest levels of liquidity, Yacktman’s style is perfect.
Any time we can get his insight into the Apple Inc. (NASDAQ:AAPL) vs. Microsoft Corporation (NASDAQ:MSFT) debate, that’s a bonus.
As we’ve mentioned over the past couple months, the first day of the Value Investing Congress was held in New York yesterday, and we were in attendance. Jeff Ubben, Mick McGuire, Alex Roepers and Michael Castor are just a few mega-investors sharing their best ideas, in addition to the Winklevoss brothers.
In his presentation on Monday, Donald Yacktman revealed that he prefers Microsoft Corporation (NASDAQ:MSFT) to Apple Inc. (NASDAQ:AAPL) from an investment perspective. Why, you may ask?
Well, it all comes down to the margins.
After mentioning that his “hat’s off to Steve Jobs, he hit 4 home-runs in a row,” Yacktman stated that he doesn’t think Apple can sustain its current, high profit margins. We discussed this scenario at the end of last year, and so far, we’ve been dead on the money. Shares of Apple stock are down over 15% year-to-date, and a growing number of investors are turning sour on the company’s next two smartphones: the iPhone 5C and the iPhone 5S. The critics vary, but boil down to complaints that the iPhone 5S is too similar to the 5, while the 5C isn’t priced properly.
Accounting for about two-thirds of Apple’s total profit, smartphones are the No. 1, 2 and 3 priorities for the company. We had this to say about the iPhone a few months ago:
Apple Inc. (NASDAQ:AAPL) used to be once step ahead of its competitors. Not anymore. The iPhone 5 isn’t the clear choice over Samsung Galaxy S III and iPad has several credible alternatives. Steve Jobs’ tenacious pursuit of perfection was the key ingredient of Apple’s success. We will probably find out in a year or two that Apple won’t be able to come up with another game changing product such as Apple TV.
Furthermore, it’s clear that while Wall Street’s estimated earnings growth is flattening, it’s still very possible that even the most bearish analyst is over-estimating Apple’s ability to maintain margins while pursuing a proportionally higher level of top line revenue. Most analysts think that earnings can grow by 20% a year through 2018–which implies a forward P/E near 10x and a PEG near 0.50–but it’s important to realize that a significant chunk of this discount would disappear if, let’s say, earnings grew by 10% annually instead.
In the conference yesterday, one of the attendees asked Yacktman why he holds Microsoft Corporation (NASDAQ:MSFT) but not Apple Inc. (NASDAQ:AAPL) in his equity portfolio, and his answer was interesting. Essentially, Yacktman said that Microsoft’s profit margins are protected, i.e. there aren’t competing viable operating systems or Office products, while Apple’s margins are not. Assuming Samsung’s smartphones are close substitutes to Apple’s iPhone, the company is theoretically more vulnerable to a shift in consumer preferences and/or a prolonged lack of innovation.
In this same light, Microsoft Corporation (NASDAQ:MSFT)’s forward earnings valuation is nearly identical to Apple’s, but Wall Street believes five-year annual earnings growth will be less than half that of Apple (8.7% vs. 20.2%).
For any readers out there betting that margin compression will push these numbers a lot closer together than what Wall Street currently expects, it might not be a bad idea to learn more about Yacktman’s stock picks here. Do you think Microsoft is a better tech investment than Apple Inc. (NASDAQ:AAPL) moving forward? Or do you disagree, favoring the mindset of someone like David Einhorn?