This week I was in Paris doing some quality finance training for a new client AdaCore. AdaCode is a private software business that builds software tools for their clients, based primarily in Paris and New York.
Paris was pretty cold and rainy during my visit. I brought my wife and two youngest children on this trip. Paris was great even in the rain, the food is always great in France. I think the ingredients that go into their breads and pastries are the best the world. Even my gluten intolerant wife could not resist.
The training was great. I taught a team of top managers in the company. For my sample companies I used Microsoft, Apple, and IBM. Three big name technology companies that have a long and interesting history. It is interesting to look at these businesses financially as well.
Apple for a technology based product company had incredible margins. Their products and services are hugely probable and yet their stock trades as a pedestrian P/E of 11 the last time I looked. Microsoft is also a high margin business but that is to be expected with a software based business. IBM on the other hand has ok margins but nothing on the magnitude of the other two. In spite of lower margins and a less than stellar history over the last decade IBM is still trading at a higher P/E multiple than Apple. Why?
Sometimes we tend to focus too much on the margins of a business. There is more to running a good business and producing for shareholders than just profit and in Apple’s case cash flow. It is not enough to produce for the shareholder. A good business will take what has been produced and put it to work to produce more. If not the business should pay it out to the shareholders. Apple is a classic case of producing and then sitting on its assets. In the case of Apple, that equates to holding over $200 billion dollars in investments and cash on its balance sheet. A number the business world has never seen before.
Microsoft generates a lot of cash too, although not as much as, Apple. What does Microsoft do with that extra cash? They either pay it out to shareholders or make acquisitions. In fact, about 10 years ago Microsoft paid out a one-time dividend of over $30 billion. While Apple has finally started to pay dividends it is not paying out enough in dividends and stock buy backs to even offset its annual increase in cash. Many investors wonder when Apple will finally start to use the cash or pay it out. While everyone waits, Apple’s stock is priced like a low growth utility business with a low P/E multiple.
The lesson from the Apple example and the group at AdaCore is this. When you make profit and generate cash in a business, you need to put that cash to work in reinvestment or give it back to the shareholders. It will be interesting to see when Apple figures that out.
So merci to Paris and their stunning sights, good food, and good football (soccer). We did take in a Paris Saint Germain game. It was a great week for Paris and a great week of finance with my friends at AdaCore. Hopefully we will see them again in New York City.