First I’ve ever heard THAT excuse applied to Microsoft. Do you realize they are sitting on $50B of cash, growing by $10B+ annually?!?

Microsoft’s problem is a lack of innovation, not a lack of resources. They are still trying to reinvent the iPhone and iPad.

Note also that Microsoft’s low dividend payment limits their ability to leverage a higher P/E. They presently offer a 3.2% dividend, which is okay but nothing special for a slow-growing behemoth. Doesn’t matter that their P/E is just 8.5 when they refuse to share most of that cash with their stockholders.

If they pumped a 45% payout rate — safe given the stability of their earnings and financial strength — you would see a lot of ears perking up at the 6%+ yield and I bet the share price would nearly double. The dividend yield mostly offers a “floor” to the stock, so a low dividend payout provides a low floor.

If Apple were to initiate a $5/year dividend, nobody would care. If they were to pay a $20/year dividend, you would see the stock jump.

As has already been said, the money is used to protect the supply chain (eg a few years ago when they bought 67% of the world’s NAND chip memory – was it worth $5 billion?) to invest in collaborative and innovative hardware production methods with suppliers (eg the recent $1 billion deal with Sharp for displays), to buy smaller but technology brilliant companies for their technology (that’s how Siri got to the iPhone) and to be able to survive in hard times without having to cut training budgets as HP have done and to invest in products that they can refine in the market place even if they start out being unpopular (eg Apple TV).

As for the share price, I suspect the old argument used against Microsoft is being applied here, that increasing dividends (or even paying one) could increase demand for the company’s shares from pension funds and other large investors and thus increase the share price.

Microsoft did indeed start paying out dividends, and when Vista flopped their expected new income flows didn’t materialise, and as a two product company with half of their business off kilter they then lacked enough money to sort themselves out so we’ve had quite a few years of pretty flat growth, compared to Apple’s meteoric rise.

A company should never acquire a company just because it is Cheap, they should only do so if the acquisition adds value to their core business.

If they have extra money they should give it back to their shareholders who can invest in all the cheap companies they want.

I long ago reconciled myself to the fact that I won’t own every winner in the market. For that matter, I will rarely own ANY of the big winners. And that is perfectly fine with me as long as I can continue to successfully avoid the big losers. The natural trend of the stock market (even in these weak economic times) is strongly positive as long as you can stay away from those that go bust.

In contrast, I expect the market to separate the winners from the losers in pharma within five years. (Right now the whole sector is trading at a discount.)

Remember that a better company should ALWAYS trade at a higher valuation than one in a similar industry that is less well run. Plenty of examples of that, pricing differences that persist indefinitely (with good reason).

When we’re all dead.

How long is the long run?

In the long run, fundamentals win. :) But like liquidity crises, you need to be in the investment for the long run.

Note that buying Walmart at a P/E of 50 pretty much guarantees you mediocre long-run returns no matter if profits triple over the following decade. The fundamentals of buying an investment with a P/E of 50 are miserable.

In the short run, prices are driven by market sentiment and inefficiencies tend to be persistent for several months.

There’s a lot of comments here about what drives the stock price, and I wish even one of them was consistently true. Then all you would have to do to make money in the stock market is figure out which companies were going to grow their profits, and apply the universal valuation model. But performance and growth take a back seat to emotions and interpretation of external events (the US debt ceiling, Greece, Italy, oil prices, etc.), rendering P/E, cash, growth rate, and all of the other metrics relatively meaningless.

But Apple buying T-Mobile, that’s another story (or wishful thinking).

A stock’s P/E is determined by the relative spread between the firm’s return on equity over its cost of equity capital. The higher the relative spread the higher the P/E.

“Cash hordes” lower your potential return on equity for the next earnings cycle, all other things equal. That decreases the spread mentioned above and lowers your P/E, all other things equal. Here’s where Matt has somewhat of a bit of a point to make, but…

…he ignores leverage. In the real world, you likely would not keep “all other things equal.” Rather, you would maintain your leverage (debt for most companies but essentially working capital for apple) to keep up with the growth of the “cash horde.” Essentially this is the “reinvest for growth” idea. Then, so long as you continue to invest in assets that support your historical cost of equity while earning the same or higher return on equity as before (apple can do this by simply expanding existing operations), your P/E can remain unchanged or even grow, regardless of the absolute size of your “cash horde.”

So to me the question is: can the shrinkage of apple’s P/E be explained by lower return on equity over that same period? That’s the only real way that Yglesias’s “cash horde” argument would make sense.* Nope – apple’s return on equity has steadily increased over the past several years. This round goes to Felix.

-ISOK

*You could also explain this via a significant increase in apple’s cost of equity capital but I’ll let others make that argument if they’d like to.