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Humanizing Tech

"Got $100, Invest in Apple or Facebook?" in Humanizing Tech

Got $750, Invest in Google or Amazon?

I. Apple Versus Facebook

Last week both Apple and Facebook announced their Q2 2016 earnings. Apple was down but beat expectations so their stock price, and therefore market value, went up. Facebook also grew more than the market expected so their price and value went up to new all-time highs.

At this point, Apple is trading at about $104 per share, while Facebook is at $123 per share.

So, if you’ve got an extra hundred or so bucks lying around, which one should put your money into? Apple makes hardware that you likely use every day. And Facebook makes software that you likely spend time on every day.

Let’s refer to our handy-dandy, updated valuation model (note that metric definitions are included further down in this post).

Answer: Buy Apple.

  • Apple is cheaper on a per share basis by $20. If you had $500 it means you could buy 5 shares of Apple but only 4 shares of Facebook, thereby compounding future returns.
  • Apple has about 3x more cash in the bank ($63B versus $23B).
  • 50% of Apple’s market value is covered by real, tangible assets. Facebook only has 10%.
  • Apple is issuing increasing dividends and continuing their share repurchase which fundamentally keeps the market value high over time.
  • Apple has double the economic profit as Facebook (11% versus 5%).
  • The market expects Apple to decline by -15% per year forever while it expects Facebook to grow by +4%. That means Apple ceases to exist in 5 years. The probability of that happening in my mind is precisely zero.
  • Both are innovating for the future. Facebook is investing in ways to connect every human on the planet to the internet and their service to increase ad revenue. But Apple is investing in smart cars, augmented and virtual reality, services, health and wearables. Which one would you rather be a part of? One where people don’t pay for the product they use or the one where they spend hundreds of dollars on (phones) or tens of thousands of dollars on (cars).
  • The choice is clear if you only have $100 and can only invest in one company. Invest in Apple. They are run by long-standing managers who consistently build great products while continuing to create a return.

II. Google Versus Amazon

Google and Amazon also reported their Q2 2016 earnings last week. Both exceeded expectations so their stock prices also went up. Let’s assume you’re rolling in the money and you’ve got more than $100 to invest. You’ve got $750! We can use the same valuation model and framework to compare Google to Amazon.

Answer: Buy Amazon First.

  • Both are mature businesses so both have similar valuation structures. About the same % of real assets, % cash flow, and % terminal values. Thus, we can’t read too much into this metric.
  • Google has a slightly positive economic profile while Amazon’s is slightly negative, but we know that Amazon has traditionally used all of it’s profits to re-invest into the business because they want growth over returns for the moment. So, I’d call this one a wash as well.
  • To that end, Mr. Market is expected about 2x the amount of annual growth from Amazon as it does from Google (6% versus 3%, respectively). Again, that’s due to Amazon’s strategy of growth versus returns. We’ve gotta call this one a wash again.
  • In terms of innovation, I wrote yesterday about what’s happening at Google[X] (smart cars and smart contacts) and we know Amazon is working on reducing their logistics cost by getting into the shipping game. Google competes against Apple. Amazon competes against Alibaba. One is about software and AI. The other is about selling products and software. Two completely different businesses with different dynamics so not sure I can make a point here either.
  • Since I would call them both neck and neck, but operating against two very different aspects of the same market (forget about cloud and video for a moment), I think it’s wise to save up another $750 and have your hands in both.
  • Note that these two stocks are not, what I would call, “on sale” right now so there is a risk buying at this price that both fall in the short term just based on overall market correction. That would open an opportunity for you to buy both stocks cheaper than you would today. However, the alternative is that they keep going up and get more expensive, as Amazon has done over the last 7 months going from $500+ to $700+.
  • Amazon has prioritized increasing cash flow so they’re gearing up to make a big spend soon. Expect this to have a positive long-term effect on their stock price. Buy Amazon first, then keep saving to buy Google second. Amazon’s price is also moving up faster than Google’s.

I’ll leave it to the reader to do the next step in the analysis and compare Apple to Facebook to Google to Amazon and see if your investment strategy starts to change. Once you take a portfolio approach to investing across the entire stack of technology, from data centers to GPUs to hardware, software, shopping, shipping, and social, the change in mindset might surprise you.

I always find it easier to isolate two stocks at a similar price that I’m thinking about and compare them side-by-side. It makes the decision so much easier.

III. Updated Valuation Tool + Metric Definitions

Click the link below to be taken to a Google Sheet that contains the fundamental valuation model I’ve used for a few of the major tech stocks I’m tracking. It’s been updated following the various Q2 2016 earnings releases. It also includes my real portfolio and performance so you can see that I eat my own dogfood.

Stock Price Financial Modeling

There’s a few metrics that you should pay specific attention to on the red Valuation tab. I explain 3 below: economic profit, terminal value, and expected growth.

1. Economic Profit

  • Every company wants to get a return on its investments (ROIC), whether on the employees they hire, the money they put into R&D, or their sales and marketing spend. It’s all in the name of growth, without destroying value.
  • The WACC (weighted average cost of capital) is a shorthand for how much it costs the company to get that return. For example, you can go out and borrow a bunch of money from the bank to buy a bunch of houses because interest rates are low, in hopes that you’ll flip them for a profit. But that means the longer it takes to sell, the more interest you have to pay on that loan. And then the housing market collapses and you default on your loans. That’s risk. That’s the cost of capital. Nothing in this life is free, not even money.
  • ROIC minus WACC equals Economic Profit. You’re looking for companies that have a high economic profit. That excess profit is like a money tree for companies. If it’s positive, you just keep investing all day like. Simplify it. I invest $1 in social media to get 1 customer to buys my lemonade for $5. That’s a return. Apple’s return has always been good. It did surprise me that Nike’s is so high, likely due to their brand and constant material innovation.

2. Terminal Value (as % Stock Price)

  • This is what’s left over when you add up the value of all the real assets the company owns plus the 5 years of constant cash flow the standard business operations is expected to produce.
  • When this metric is a high %, it means Mr. Market places much of the value of this company in the future. And whenever Mr. Market thinks about the future, it thinks about growth. It’s a dangerous proposition when most of the company’s value depends on achieving this high growth expectation. Because it’s almost never achievable. It would be like me expecting you to grow your Facebook friends and Twitter followers by 100 people per year, every year, for the rest of your life. Doesn’t that just make you itchy?
  • On the flip side, a business with a very high % of real assets and low % in terminal value means you’re dealing with a mature business with almost no market expectation of growth. It could be ripe for a decline, or in some instances, ripe for a turnaround or for stealing share from competitors. The latter is one reason I invested in T-Mobile.

3. Expected Annual Growth Implied in Stock Price

  • If it’s negative or double digit negative like Apple, that could be a signal that the stock is incredibly undervalued and an opportunity to make a return based on my thesis of BOSAH (Buy On Sale And Hold).
  • If it’s positive and in the double digits like Tesla, it means the market may be expecting an annual growth rate every year forever that is simply unatainnable by any publicly traded company. That means it could be overvalued and you wouldn’t want to buy the stock right now.

Note that I’m not using definitive language here. That’s because nobody really knows for sure, not even the management teams or founders inside these companies. No one can predict the macroeconomic climate. No one can predict customer demand or supply constraints.

We’re also not insiders so we will never have a perfect grasp on everything happening inside the company. For example, Elon is building big battery factories with lots of robots. He’s building the product that builds the product. But that’s all we know about it so we have to trust that he’s doing the right things for the future of Tesla. Thus, we only use these metrics as a guide, news stories as a divining rod, and our gut to make the right call.

So far, my analysis has proven correct, as I’ve got about a +16% return year-to-date in 2016 and am one of the top investors on Openfolio and beating the market by about 10% (i.e., alpha).

But remember, that could also be due to just the market’s long-term march up and to the right. Humans innovate, we build tools, we create new markets and products, and our wealth and knowledge as a species increases. If you hold all your money in cash in a bank account, you will lose 3% per year, every year, for the rest of your life due to nothing more than inflation.

At least with the stock market, you’ve got a fighting chance.

IV. A Note About the Stock Market

The stock market is currently at all-time highs. I don’t mean that in a recent sense of the word, but rather in the entire history of the stock market sense. Below is a graph of the Dow Jones Industrial Average (30 large company stocks) and the S&P500 (500 medium and large company stocks) over the last 100 years.

The first thing you’ll notice is that they’re essentially the same picture. The second thing you’ll notice is that the right side is much larger than the left.

Remember that whole Great Depression thing? Notice how it doesn’t even feature on this graph? That’s because our world has created so much wealth over the last 100 years that it really doesn’t matter. We had a small pie of money back then. Now the pie is much bigger and we’re creating more every day. Everyone benefits from that bigger pie to eat.

Buffett has said that the quality of life in the US had increased 5x since that time. And it will continue to increase like that into the future. So it doesn’t matter who becomes President over a 4-year period. You can’t stop the chugga chugga train of progress.

It also, as you can see, doesn’t matter too much at what price you buy when you look at holding onto an investment for a long time period.

To prove this point, Buffett did an analysis of stocks versus bonds versus cash to see if it mattered which one you invest in. He looked at the returns by each asset class over varying time periods. Short ones. Long ones. Starting in this year versus starting in that year. Ending over here, or ending over there. In short, he tried all the combinations.

No matter what starting point, end point, or holding period Warren Buffett chose, the returns from investing in stocks always outweighed bonds or cash.

Buffett goes so far to say you should hold 95% of your cash, not in a bank savings account where you’ll lose 3% per year from inflation, but in stocks so you get the benefit of the steady market returns. Sure, some periods will be downturns but as the strategy says, you should be happy when that happens. Because it’s a firesale on new Nikes and new Apple products.


You get the benefit of lower taxes (capital gains after holding more than 1 year) and you get the benefit of compounded interest. The only way you lose in the long term is if the entire world goes to crap. And then, is money really what you’re worried about? Or are you trying to figure out how to get fresh water, and defend your food from pirates?

— Sean


Personal Hedge Fund, Q2 2016 Update

Got $100, Invest in Apple or Facebook? was originally published in Humanizing Tech on Medium, where people are continuing the conversation by highlighting and responding to this story.

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from Sean Everett on Medium http://ift.tt/2avVSVv