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Microsoft is currently the largest company in the computer industry. With a market capitalization of $291 billion, Microsoft has built an empire by dominating software sales for personal computers. Stock growth over the past 25 years has increased by more than 30,000%. However, Microsoft’s growth has substantially decreased since the market collapse of 2001(Niemond 25 April 2007).
From June 2004 to June 2005, Microsoft saw a 33% growth in net income. However, from June 2005 to June 2006, growth decreased to 2%. Investors consider net income to be the leading indicator for a stock price. To illustrate how the changes in net income affect stock prices, a time line is shown below.
6/30/04 Net income Change $24.65 Stock Growth
12/30/04 $25.89 (04-05)
6/30/05 33% $24.93 1.1%
12/30/05 $25.61 (05-06)
6/30/06 2.4% $23.92 (4.1)%
In Microsoft’s 2004 fiscal year, a 33% increase in net income resulted in a 1% increase in stock price. In the 2005 fiscal year, a 2% gain in net income resulted in a 4% decrease in stock price (Microsoft Inc 2006). As seen, an increase in net income does not automatically lead to an increase in stock price. For growth companies such as Microsoft, stock price is primarily driven by the growth of earnings (25 April 2007).
Investors in the stock market judge earnings growth against two figures: the average industry earnings and the estimated earnings for the company. If analysts predict earnings to be above the industry average, a company’s stock price will usually rise. If companies report earnings higher than predicted, stock price will typically rise even more.
Since 1991, Microsoft’s earnings per share have risen each year. However, the percentage increase in these years has been decreasing (13 April 2007). This trend has not been well received by investors, as indicated by a net 0% change in the stock price over the past seven years.
The promise of a rewarding return from investing in Microsoft stock will be unlikely if current trends do not reverse. Because Microsoft derives the majority of revenue through software sales, the company must either enhance its current products or enter new markets to remain competitive.
Recent data shows that 78% of computer users use Microsoft Windows as their primary operating system. Microsoft has also just released a new operating system known as Vista that competes primarily with Apple’s Mac OSX.
Van Baker, a marketing analyst, believes that the release of Vista may have pushed Microsoft closer towards meeting the higher expectations of today’s computer users.
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The users of the Vista operating system will more likely be drawn from the current users of Windows, rather than from users of Mac OSX. This may restrict Microsoft’s market share because the growth of Vista will result in the erosion of Windows. Microsoft’s market share would remain unchanged if this occurred. Therefore, Microsoft’s short-term changes seem directed towards sustaining market share rather than growing market share.
Dell Computers Inc.
Dell Computers Inc. currently has the largest market share in personal computer sales. Of the $56 billion dollars in revenue in 2006, Dell generated 66% from the direct sales of computers and computer peripherals.
From 2005 to 2006, net income grew by 17%, compared to 15% the prior fiscal year.
In 2005, the stock price declined approximately 24% (Dell Computers Inc 2006). This figure may not be fair considering Dell increased net income growth by nearly 20%. However, the market’s reaction is reasonable since Hewlett Packard, Dell’s closest competitor, saw net income jump by nearly 160% in the same year (Brophy 13 April 2007).
While Dell’s cumulative record over the long term has been positive, the company has not been able to recover from the hits taken early in this decade. Dell has grown around 30,000% over a 25-year period. The majority of this growth took place in the 1990’s. Dell, like Microsoft, also took a hit in the 2000 crash. Over the past seven years, Dell’s stock has declined substantially. In June of 2000, the stock price was approximately $47. The price is currently around $27 (13 April 2007).
For an investment in Dell to be worthwhile we must look at how the management intends to change the company’s direction. For many years, Dell relied on its competitive advantage in providing the best customer service in the industry. Most competitive advantages, however, cannot be sustained indefinitely. While Dell still remains the leader in industry sales, HP and Apple are narrowing this gap.
Dell’s management currently shows no intention to introduce any new major new product lines. Rather, the company will rely on its strategic business relationships to grow sales.
Dell eagerly anticipates Microsoft’s release of Vista. This operating system will be standard on new computers sold by Dell. Provided the new operating system is popular, Dell will likely see a spike in sales.
Dell has also made plans to adjust their distribution channels. The company currently generates most sales over the phone or Internet. Dell recently announced that it will take a “bricks-and-mortar” approach by beginning to sell computers in both Sam’s Club and Walmart stores.
With this move, the company shows a willingness to adapt to the changing demands of customers. For the past five years, Dell had passively watched their market share erode to companies selling in retail stores, such as Apple and HP. Consumers have clearly indicated the desire to be in the physical presence of a computer before purchasing it (Associated Press 8 June 2007).
Dell may be late in altering their sales strategy, but they have certainly chosen a powerful retail chain to channel their product through. Walmart, and its subsidiary Sam’s Club, has remained the world’s largest corporation over the past few years and is known for an extremely diverse customer base.
The management at Dell has also recognized that a dominant position in personal computer sales may not be enough to keep the company atop close rivals. Thus, they have shifted resources into heavily promoting data-storage devices. In the first quarter of this year, Dell led the market in sales growth of these devices, beating out rivals EMC, HP, and IBM. To diversify even further, Dell is seeking to acquire companies that generate revenues through technical support services. Currently, Dell generates 10% of total sales from service revenue (CNNMoney.com, 6 June 2007).
Apple Computers Inc.
Apple’s financial trend over the past 25 years has been almost the exact opposite of Microsoft’s. Through the 1990s, growth was stagnant and market share was nearly non-existent. When the crash of 2000 hit, Apple suffered substantially more than both Microsoft and Dell. Apple’s stock price plunged 50% in just a few days. However, unlike Microsoft and Dell, Apple has fully rebounded since the crash and continues to grow rapidly.
From 2004-2005, Apple’s net income grew by 380%, compared to 50% in 2005-2006. A stock price time-line is provided below.
9/30/04 Net income Change $19.38 Stock Growth
3/30/05 (04-05) $42.80 (04-05)
9/30/05 380% $53.61 176%
3/30/06 (05-06) $62.75 (05-06)
9/30/06 50% $76.98 44%
(Niemond 13 April 2007)
When comparing this chart to Microsoft’s, the importance of net income as the leading indicator becomes more apparent. A comparison shows that the market greatly rewards stocks that grow well above the rates of their competitors.
Apple’s stock price has risen 1000% in the past five years, while, Dell’s and Microsoft’s stock has remained unchanged. However, from the early 1990’s to the early 2000’s, Apple’s stock grew only 100%. Therefore, in the 1990’s growth averaged 10%, and in the 2000’s growth averaged 100%. To most investors, this is a highly favorable trend because the company’s growth is exponential (13 April 2007).
The large increases in sales growth and income over the past five years indicate a well designed and executed business plan. Apple initially put itself back in the spotlight by revolutionizing digital audio with the introduction of the iPod. Shortly after, the company put a new spin on the personal computer with the introduction of the Macbook.
Apple has been able to differentiate its strategy from competitors’ by emphasizing the needs of the user. For example, market analysts at Apple determined that one aspect of personal computing that intimidated new users was the set-up and installation process. Apple responded by introducing the Macbook; a “plug-and-go” computer that simplified the set up by pre-installing all major software, and reducing the complexity of external devices. Essentially a user could buy a computer, take it home, plug it in, and operate it immediately.
Another illustration is their response to customer service needs. Apple recognized that Dell maintained a competitive advantage over them in customer service by maintaining a 24-hour tech support line that was free of charge. Furthermore, they provided fast, free shipping on all repairs. Apple copied the customer service function of Dell, but also added one important feature. Apple’s retail stores now employ staff members to specifically address customer service needs including technical support, repairs, and product tutorials.
Apple continues to diversify its product mix. Their most recent addition was AppleTV. This device allows users to transmit video from their iPods to home televisions. If Apple can revolutionize digital video the same way it revolutionized digital audio, the company may be able to create a whole new market for downloadable digital video.
Furthermore, in one week Apple will release the highly anticipated iPhone. The phone is an all-in-one device that combines the features of an iPod, a PDA, and a cell phone. The phone may have a limited market considering a retail price of approximately $600.
Provided that the Vista software is well received, Microsoft and Dell will likely maintain their existing market share in personal computing and software. An expansion of market share will be unlikely. This is because the majority of new users of Vista will be drawn from existing users of Microsoft Windows.
Apple, on the other hand, continues to find ways to attract new users. In the past month, Apple made available its Safari Web browser on the Windows operating systems. Over one million copies were downloaded in two days (Yared 2007).
A major obstacle Apple has to overcome in attracting new users is convincing Windows users that learning to operate a Mac will not be a complete relearning process. In fact, Microsoft’s Windows Office operates almost identically on a Mac as it does a PC. Now that Apple has offered their Internet browser for use on a PC, Windows users may test the complexity, or lack thereof, of Mac software without actually purchasing a Mac. This is one step towards easing the apprehensions of PC users.
Further mitigation of this fear has been facilitated by the use of iTunes, Apple’s audio software used to purchase MP3’s and sync iPods. Not only does Apple dominate the portable MP3 player market with a 70% market share, but also leads the market in MP3 sales, with more than 2.5 billion songs downloaded (Yared 2007). Most of these downloads have been initiated from Windows users.
The success of Apple’s release of the Leopard operating system can only help strengthen their growth. The release of the new system, in conjunction with the release of the iPhone and new Macbook, are all viable sources of market penetration for Apple.
While Dell and Microsoft are now more focused on maintaining current market share, Apple continues to focus on increasing market share. Investors favor growth companies that show increasing trends in earnings. Therefore, because Apple has created multiple approaches towards increasing earnings, its stock is currently the most attractive among the three.
Apple Computers Inc. September 30 2006 10-K Annual Report. OneSource. Accessed June 15 2007
Associated Press, Dell to Sell Computers at Sam’s Club, 8 June, 2007, Words count,
Bishop, Todd. 2006. Apple to Unleash a Leopard Attack. SeattlePI.com. 8 August 2006
Brophy, Theresa. DELL INC. The Value Line Investment Survey. 13 April 2007
CNNMoney.com, Dell Seen Expanding Services. 6 June 2007, Words count.
Dell Computers Inc. March 15 2007 10-K Annual Report. Thompson One Banker, accessed June 15, 2007
Microsoft Inc. June 30, 2006 10-K Annual Report. Thompson One Banker, accessed June 15, 2007
Niemond, George A. APPLE INC. The Value Line Investment Survey. 13 April 2007
Niemond, George A. MICROSOFT. The Value Line Investment Survey. 25 April 2007
Yared, Georges. 2007. 3 Reasons to Buy Apple Now. The Motley Fool, 15 June 2007