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October 21, 2014
Google and Apple: A Tale of Momentum
Google (GOOG) and Apple (AAPL) reported in the past week, kicking off another round of quarterly earnings reports for stocks held in Northlake client accounts. GOOG and AAPL compete directly on operating systems (iOS vs. Android) and the desire to control the largest ecosystem of online consumers. Northlake will continue to hold both stocks in client portfolios, although as explained below there is currently a divergence in the near-term outlook for the two stocks.
GOOG’s earnings were slightly below Wall Street expectations for revenue and EPS with the major concern being a slowing in paid click growth to less than 20%. The stock fell about 3% after the report adding to the decline in the shares that was part of the larger correction in the market revolving around fears of slowing global growth, Ebola, collapsing oil prices, and ongoing geopolitical tensions related to ISIS and Russia.
AAPL had an excellent quarter and the stock is trading up about 2% after rising 2% the day of the report. Revenues and EPS came in above expectations driven by better than expected shipments of the new iPhones and continued strength in Mac sales. Guidance for the upcoming quarter was inline with analyst expectations. In Apple’s world that is better than expected guidance given the company’s history of providing a conservative outlook.
Both of these stocks are quite sensitive to the trend in growth. AAPL shares pulled back as earnings growth stalled and even went negative. The share recovery in the stock this year coincides with a return to earnings growth, up about 20% in the last two quarters. The outlook for continued double digit growth is good given the gradual global rollout of the new iPhones and the likelihood that margins benefit form economies of scale as the product transition matures.
GOOG has 20% growth and, in my opinion, reported a quarter that had little impact on the overall bullish thesis. However, GOOG is seeing slowly moderating growth as search battles for ad dollars with Facebook and in app searches on mobile devices. GOOG also continues to invest heavily to sustain its growth but that is serving to depress margins while new businesses develop.
Investors in growth companies like AAPL and GOOG pay for growth and are especially sensitive to momentum in growth in the short-term. For now, that means investors are willing to be optimistic toward AAPL but cautious approaching GOOG. Over the balance of this year, I think that likely means that GOOG shares continue to struggle while AAPL breaks out to new all-time highs.
For the long-term, I see both companies well positioned, with GOOG arguably in a better position given a clearer path to sustained and consistent double digit growth in revenue and earnings.
I see AAPL trading to north of $120 as earnings estimates for 2015 move toward $8.00. A 15X multiple plus a little credit for over $20 in pre-tax cash per share should support another 20% upside in the shares over the next six months.
GOOG now trades at 17X 2015 earnings estimates without given any credit to over $100 in pre-tax cash on its balance sheet. I believe it will take a slight reacceleration in growth for GOOG shares to move significantly higher and the catalyst for that is likely next quarter’s earnings report. If growth expectations firm up, investors will look ahead to 2016 earnings of around $35 and give the P-E multiple a boost, setting up a move to $600-700 over the next 18 months.
GOOG and AAPL are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. GOOG and AAPL are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.