You should buy this unloved US tech stock today
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Associate Editor
David Stevenson Jan 23, 2012
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Microsoft: downright cheap
Turn your computer on and there's one word I can almost guarantee you'll see: Microsoft.
It's the world's top software company. For positively ages, the company's Windows operating system has been the industry standard for the PC business.
So you'd think that Microsoft (Nasdaq: MSFT) shares would have been a rip-roaring success in recent years. Yet the complete opposite is true.
Since the dotcom boom at the turn of the millennium, the company's stock price has halved. Many people now shun Microsoft as being at best a very boring investment.
The good news is, this could be about to change for the better…
How Microsoft fell from grace
January can be a pretty miserable month. But for US stock market watchers, it does have one redeeming feature. It's the first quarterly 'earnings season' of the year. In other words, it's when America's finest companies update us on how business has been.
So far, the latest earnings season has gone pretty well. Most firms' profits have beaten analysts' forecasts. That in itself is no great shock. Managements have become very good at giving investors 'guidance' on future earnings which – surprise, surprise – they then succeed in beating.
But when one of the firms that's growing sales faster than expected is US software giant Microsoft, it's well worth taking notice.
Why? Because this is a company that's widely viewed as being 'past it'.
Windows is no longer the driving force that it used to be. As Preston Gralla says for Computerworld, Windows' "glory days are clearly gone".
On top of that, the PC market is having a tough time, due to the recent flooding in Thailand, which has disrupted supplies of equipment. And analysts are fretting, among other things, that Microsoft can't compete with rival Google on web searching tools and smart phones.
Yet Microsoft's overall revenues for the last three months of 2011 rose by 5% versus the same period last year. In other words, the firm must have found something else to take up the growth baton.
Looking at the details – I'll keep it brief - Windows-related revenues dropped by 6% on last year. But the Online Services Division's sales grew by 10% year-on-year. Sales at the Server & Tools unit rose by 11%. And the Entertainment and Devices Division enjoyed a 15% rise in sales thanks to its Xbox operations.
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Not bad for a company that's 'past it'
In short, Microsoft keeps on finding ways to deliver the goods when it comes to sales figures. As Laurence Latif says in The Inquirer, these numbers "are pretty impressive for a company that has been painted as being in crisis".
Sure, the firms' profits in the last quarter were down a fraction on 2011. But history shows that's nothing to get too concerned about. Take a look at this chart.
Source: Bloomberg
This shows Microsoft's earnings per share (EPS) from continuing operations over the last 20 years. Sure, there have been one or two hiccups. But broadly, we're looking at a picture of a progressive profit growth. Since 2000, EPS has trebled.
And that's where it gets interesting. Because normally, strongly rising EPS should boost a company's value. But in fact, over that same period, as I mentioned above, Microsoft's share price has fallen in half. That's because rising earnings have been more than offset by gloomy investors becoming less willing to pay up for those earnings, which has driven down the price/earnings ratio.
That spells opportunity for canny investors.
Microsoft is now downright cheap
Nowadays, Microsoft has become like a utility, rather along the lines of an electricity or gas provider. Windows has a virtual monopoly. It would be too costly for either computer suppliers or users to switch to anything else. So Microsoft's operating system will be a 'cash cow' for the foreseeable future.
What's more, the company isn't standing still. Over the coming year, it plans to launch several new products, including the latest operating system Windows 8. And the management is optimistic about the future.
Yet despite this, the stock has fallen so far out of favour with investors that it's now downright cheap. On a current year price earnings (p/e) ratio of just over ten, Microsoft shares now offer outstanding value for a business with such a vice-like grip over its own market.
And there's another benefit here for new buyers of the stock. Like other utilities, Microsoft is now rewarding its shareholders with a decent income stream.
Since 2005, the company has hiked its dividend pay-out by 150%. While that only leaves the prospective yield at around 2.5%, there's plenty of scope for future dividend growth. Not only is Microsoft producing oodles of cash, it's already very well minted. At the end of last year, the balance sheet contained a cash hoard totalling $40bn.
Add it all up, and you have just the sort of solid defensive stock that makes complete investment sense in today's tricky market. The shares have run up 10% since we tipped them three months ago, but we'd still be keen on adding more now. Further, if the dollar continues to climb against the pound, you'll pick up a currency gain too.
Just as an aside, if you like the idea of building a portfolio of high dividend paying shares in the UK, do take a look at The Dividend Letter. It's written by my colleague Stephen Bland, and the aim is to provide you with a growing income for life. You can find out more here.
• This article is taken from the free investment email Money Morning.
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