DealBook: Comparing the Valuations Behind Amazon and Apple Shares

And people wonder why it’s hard to understand the stock market.

Take a consumer sitting at home buying stuff on Amazon.com with his iPhone. To him, Apple’s product is a clear leader in the market, while Amazon is the retailer he uses most. Amazon’s shares are up nearly 40 percent over the last 12 months, while Apple’s are down nearly 30 percent over the same period. So why have their stock prices diverged so much when both companies appear to be at the top of their game?

Growth is the most common answer you’ll hear. When a company convinces investors that its earnings can keep going up, an enthusiasm grows around the shares, and they tend to perform well. Wall Street analysts expect Amazon’s earnings next year to be 66 percent higher than the forecast for 2013. They project a 10 percent uptick for Apple.

But there’s another conversation you need to have.

It revolves around whether the market has already factored the hoped-for growth into the stock price. It is possible to pay too much for excellence.

There are all sorts of ways to gauge how much credibility investors ascribe to a company’s “growth story.” One is to look at what investors are paying now for a company’s free cash flows, or the hard dollars it takes in from profits (minus the spending it does on plant and equipment). The results are stark. Apple’s stock market value is nine times last year’s free cash flows. On this metric, Amazon is at over 300 times. Sane investors would never touch a stock with such a dear valuation unless they felt cash flows were going to soar in the future.

And this brings us to the part of investing that usually separates winners from losers: guessing whether companies will actually do what we expect them to.

Amazon’s believers don’t mind that it’s spending such huge amounts on setting up new operations for its retail and data businesses. At some point, hopefully in the not too distant future, that spending will fall as the expansion reaches its limits. In that case, Amazon will be churning out much bigger cash flows as it enjoys near unassailable dominance.

Sure, but how wondrous will those cash flows be? Amazon’s operations produced $4.2 billion of cash flows last year. Let’s generously assume 10 percent annual growth for them, which would take them to $5.1 billion by the end of 2014.

Let’s be kind again and assume that capital expenditures fall a lot, to, say, $1 billion a year, from last year’s $3.8 billion. Free cash flows in 2014 would therefore total $4.1 billion.

Now, remember, at this future point, Amazon’s growth in free cash flow will have slowed a lot. Investors will probably decide to attach a lower valuation to the company. Being generous, let’s assume they value those hypothetical 2014 free cash flows at 21 times, Google’s multiple today. That would give Amazon a market worth of about $86 billion. That’s 30 percent lower than today.

Of course, the stock market believes what it wants to believe. It may well decide to remain starry-eyed about Amazon and give it a much higher valuation for years to come. But Apple’s recent drubbing suggests even the strongest runs can end nastily.

Common Sense: Comparing the Tax Bite With Obama and Romney

Would you pay more or less in tax? And how would that stack up against the richest Americans like Warren Buffett, who’s currently paying a lower rate than his secretary?

Considering how central these issues have been to the campaign, it’s curious how hard it is to come up with answers, perhaps because both candidates want voters to believe that someone’s else’s taxes may have to rise, but not theirs. Whether Mr. Romney’s math adds up and whether taxing the rich would make a dent in the deficit might make an interesting public policy debate, but those issues further obscure the most basic question, which is what effect the proposals will have on each of us.

I’m not saying voters should simply vote their pocketbooks. But I would at least like to know how much I’m being asked to pay and what I might expect in return. This has been especially true since I discovered this year that I paid a rate in federal income tax that’s nearly twice as high as Mr. Romney’s. As I said then, I’m not faulting Mr. Romney for taking advantage of the existing tax code, but that disparity continues to rankle.

Tax reform and the related issue of economic growth have been major themes in the campaign that will end on Tuesday. The economy has taken center stage, and both candidates have been making much of tax platforms that aim to spur growth and job creation while promoting fairness. Mr. Romney has been the more ambitious, calling for sweeping tax reform that would lower rates while broadening the base by limiting unspecified deductions and loopholes. “Tax policy shapes almost everything individuals and enterprises do as they participate in the economy,” he says on his “Mitt Romney for President” Web site.

President Obama has called for a return to the top rates that prevailed in the Clinton administration and higher rates on capital gains and dividends. “We can’t get this done unless we also ask the wealthiest households to pay higher taxes on their incomes above $250,000 — pay the same rate we had when Bill Clinton was president,” Mr. Obama said last month while campaigning in New Hampshire. “We created 23 million new jobs, and we went from a deficit to surplus. That’s how you do it.”

So what would the impact of their tax proposals be? After consulting several tax experts, I did the calculations both on my own returns for 2009 and 2011 as well as for the wealthiest 400 taxpayers.

For the Romney plan, I took the proposals from his Web site that apply to taxpayers with adjusted gross incomes over $200,000: a 20 percent cut in the top rate (to 28 percent from 35 percent); dividends and capital gains taxed at the existing preferential rate of 15 percent; and the abolition of the alternative minimum tax. Mr. Romney hasn’t said what itemized deductions he would abolish or limit, but he has said he might cap or eliminate those deductions for high-income taxpayers.

Mr. Romney has mentioned a cap on deductions of $17,000, and has also said: “One way, for instance, would be to have a single number. Make up a number, $25,000, $50,000. Anybody can have deductions up to that amount And then that number disappears for high-income people,” meaning high-income people would be allowed no itemized deductions.

So in the spirit of Mr. Romney’s comments, I eliminated all itemized deductions. I retained the self-employed health insurance deduction and the deduction for contributions to a qualifying retirement plan. So far as I can tell, Mr. Romney hasn’t proposed abolishing those.

I took Mr. Obama’s tax proposals from his proposed budget and subsequent campaign statements, in which he has called for a return to Clinton era rates of 36 percent (for single taxpayers in roughly the $200,000 to $400,000 bracket) and 39.6 percent for those earning over $400,000 for both ordinary and dividend income and a 20 percent rate on capital gains. While Mr. Obama has talked about repealing the A.M.T., he hasn’t actually proposed doing so and has only suggested indexing it to inflation, so I retained the A.M.T. in the Obama calculations.

I assumed the Obama proposals would raise my rate and the Romney plan would lower it. But the Romney plan actually increased my rate to 25.5 percent from 22.2 percent in 2011, and to 27.6 percent from 26.7 percent in 2009. The Obama plan raised it even more substantially, to 30.6 percent in 2011 and 29.3 percent in 2009.

Including the minimum tax in the Obama plan had a significant impact. If Mr. Obama abolished it, my rate under his plan fell to 29.7 percent in 2011 and to 26.7 percent in 2009 — lower than the Romney plan, in fact, in 2009. If Mr. Romney allowed me the $17,000 in itemized deductions he has mentioned, it would have only a negligible impact, lowering my rates 0.5 percent.