Microsoft (MSFT – Free Value Line Research Report for Microsoft) is a household name with a dominant market position and plenty of financial resources to back its business. That said, the company, a tech darling years ago, isn’t as “sexy” now as Internet companies, such as Google (GOOG) and more recent social networking companies like LinkedIn (LNKD – Value Line’s Coverage Initiation Article on LinkedIn).
The perception of Microsoft as “mature” might be partly behind the company’s relatively stagnant share price over the past 10 years, or so. The pattern of bouncing between about $20 and $30 dollars a share, give or take, is quite clear when examining the Graph. The range is startling in its consistency, too, as the yearly high and low prices across the top of the Graph make clear.
That Microsoft’s shares would be confined to such a tight price range seems odd, however, when examining the earnings history. Indeed, in 2001, the high price for the year was about $38 on earnings of $0.90 per share (this figure can be found in the historical portion of the Statistical Array). The high price in 2010 was about $32, but earnings more than doubled to $2.10 per share. Although a P/E ratio of 35.3 in 2001 might have been a little rich, the 9.6 times earnings that investors were willing to pay in 2010 seems at the unduly deflated.
Interestingly, the Value Line Cash Flow Line, the solid line on the Graph, is an excellent display of the change. In 2001, and through 2007, the line was below the price chart for Microsoft shares. This often suggests shares that are overpriced. That said, over that span the spread between the two was narrowing. In 2008, the Cash Flow line briefly went above the share price and has been above the share price since mid-2010.
Still, perception is important in the stock market and the perception of Microsoft has clearly changed. Many view it as part of the old and not a participant in the new. The old being personal computers, and the new being the Internet and social media. To some extent, this is clearly true. However, Value Line analyst Charles Clark starts his Analyst Commentary off by saying “Microsoft continues to run well operationally,” before going into a list of positives. True, many of the positives are from such mature businesses as the Windows operating system and the Office software collection, but investors need to ask if that should diminish how well those businesses are performing? And, even if the answer is “yes,” is the recent price reflecting an overly negative outlook?
Note that Microsoft has a very low level of debt, at just 17% of the capital structure (shown in the Capital Structure box). In fact, much of that debt has been taken on to return cash to shareholders in the from of dividends and stock buybacks. On the surface, that sounds bad, taking on debt just to pass it through to shareholders; however, Microsoft has done so because it has material cash reserves in its foreign operations that it would have to pay taxes on if it were to bring the cash back to the United States. Coupled with the current low-interest-rate-environment, it makes financial sense, although it may seem perverse, to take on debt rather than repatriate cash. Thus, as the Current Position box makes clear, the company has some $57.4 billion in cash. It has just $11.9 billion in debt.
Earnings growth, meanwhile, has been impressive over the past decade. The absolute dollars and cents can be seen in the Statistical Array, while the annualized growth rate of earnings and revenues can be found in the Annual Rates box. Growing at 13.5% and 11% rates, respectively, revenues and earnings are clearly not issues for Microsoft. Moreover, Clarke’s 3- to 5-year projections call for continued solid growth on both fronts.
Add to the deft financial performance the fact that Microsoft has never been a company to sit idly by and watch others succeed. In fact, the company once came under great scrutiny on the antitrust front for using its dominant position in operating systems (Windows) to compete unfairly in the web browser market. While that may seem a distant memory, and one can debate the legality of the company’s actions however one wants, it is clear that Microsoft is a fierce competitor.
Thus, the company has offerings in the mobile phone space and is making attempts to compete better with Google (GOOG) in the advertising space by teaming up with the likes of Yahoo! (YHOO) and AOL (AOL). Although that may sound like teaming up with has been Internet brands, it shows that Microsoft is willing to take novel approaches in its efforts to compete, even if that means partnering with those that were once enemies.
Clearly Microsoft is not an investment for everyone. However, for those seeking a company that looks undervalued based on the company’s underlying performance—even if the business seems mature—this stock seems like it might be worth the investment.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.