Question

Microsoft and Apple around the 2012 launch announcements of the Surface Tablet and the iPad 2. At the end of the financial quarter prior the announcements of the tablet computers,
the Price-to-Earnings (PE) ratio of Apple was 38 and the PE ratio of Microsoft was 53. At the end of the quarter after the product announcement the PE ratio of Apple was 61 and the PE ratio of Microsoft was 56.

Describe the change in PE ratios between the quarter prior and the quarter after the announcement. What does the movement in PE ratios suggests for each
company? Also, explain what drives the PE differentials between Microsoft and Apple – why are they so different between the two companies?

Answer 1

A large Price-Earnings(PE) Ratio number may suggest confidence in the firm by investors, but it may also indicate that the stock is costly and perhaps overpriced.

So, the change in PE ratios between the quarter prior and the quarter after the announcement, in this case suggest that with the new product of Apple, the investors are more confident about the future stream of income from iPad 2. Whereas, with the new Surface Tablet of Microsoft, the investors are looking forward to a good future return but not too much optimistic with the value creation, based on the current value of the PE ratio.

Hence, the movement in PE ratios suggest that Apple has huge growth potential in terms of value creation with its new product and Microsoft has growth potential with its new product but to a limited extent.

Generally, the driving factors for PE are the stock price and the company's EPS. PE differentials between Microsoft and Apple is due to the market they cater to and the product, how they segment them. They are so different between the two companies because of the market share they enjoy and the segment they cater their products to, their own set of customers.