A Momentum-ous Occasion

Such does not appear to be the case. I'll explain why in a moment. Apple turned up recently on our Earnings Momentum screen.

Our screen is based on the observation that share prices tend to climb gradually higher for six months to a year following positive earnings news. Researchers have a name for that phenomenon: post-earnings announcement drift, or PEAD. Stocks often jump right away on good earnings news, of course. But the fact that they continue rising suggests investors are slow to fully price in the impact of an upside earnings surprise, or that analysts are slow to raise their remaining projections, or both. Whatever the cause of PEAD, investors who look for positive earnings surprises and recently raised projections while shopping for stocks stand likely to profit.

Our screen looks for just those things as well as strong earnings growth over the past three years and projections for more of the same over the next five. There are other criteria; see our screen recipe for all of them. Use our stock screener anytime to run the search for yourself. It recently produced nine survivors from a starting database of 8,000 companies.

If there's such a thing as an earnings surprise that came as little surprise, it's Apple's fiscal fourth-quarter announcement. The company reported on Oct. 18 that its sales increased 32% and its earnings 27%. Earnings per share of 62 cents topped Wall Street's estimates by 11 cents. In its past four quarters Apple has now exceeded earnings estimates four times by an average of 15%. Analysts, of course, were quick to raise their estimates after seeing the fourth-quarter numbers. They now see Apple's earnings increasing 20% this fiscal year (ending Sep. 30) and 18% next fiscal year.

Apple's Mac computers — particularly its laptops — are gaining share. The company shipped 1.6 million units in its fourth quarter, up 30% year-over-year. That's about four times the industry growth rate. Shipments of iPod music players increased 35%. That growth is expected to slow but not stall as the market saturates. Apple already holds a three-quarters share in the portable music player business. Also, Microsoft launched a competing player called Zune on Tuesday. But iPods have a knack for convincing users to buy Macs. One survey conducted by New York investment bank Needham & Co. in June showed that 8% of respondents who use Microsoft Windows-based computers would switch to Macs if they could run Windows applications. Among iPod owners the rate was 20%.

Of course, Macs can already run Windows and Windows applications via software called Boot Camp, which is free for Mac users to download. That ability will come built in to Apple's next update of its operating system, which is expected in spring 2007. Needham & Co. analyst Charlie Wolf notes that if 8% of Windows PC users indeed switched to Macs, Apple's market share would nearly triple. Some migration seems likely. Why wouldn't a mid-2007 computer buyer choose a Mac that can run any software title rather than a Dell (DELL) or Hewlett-Packard (HPQ) PC that can only run Windows-based software?

Don't say price. Apple has been cutting them. It's seen a shift in sales to company-owned stores and its e-commerce site from resellers. That has boosted margins. The company has reinvested that windfall into making its products more affordable. Entry-level laptops and desktops (with screen built in) can now be had for $1,100 and $1,000, respectively. Wall Street market research suggests Apple's high-end laptops now cost a smidgen less than comparable Dells for 17-inch-screen models and a smidgen more for 15-inch ones.

I'm far from qualified to opine on whether you should buy a Mac for your next computer. (Walter Mossberg at The Wall Street Journal, whose column I rely on for gadget advice, raves about Macs.) But buy Apple shares before you buy Microsoft. They go for 31 times forecasted earnings for this fiscal year, vs. 20 times for Microsoft. You get more for your money. Apple is expected by analysts to increase its earnings by 20% a year over the next five years, vs. Microsoft's 12%. Divide those price/earnings ratios by the corresponding earnings growth forecasts and you get PEG ratios of 1.55 for Apple and 1.67 for Microsoft. That puts Apple's stock valuation on par with the broad market and makes Microsoft look a touch pricey. Of course, that assumes the earnings and growth estimates are accurate. In Microsoft's case they have been pretty accurate of late. Estimates for Apple have been anything but.