by Tom Taulli | October 28, 2013 6:30 am
With its fiscal first quarter earnings report, Microsoft (MSFT) showed it can still find ways to get investors excited. In early trading, the stock shot up more than 6%.
The past few months have been tumultuous for the software giant. Shares of Microsoft stock have zig-zagged as the company announced the retirement of CEO Steve Ballmer, along with a disappointing fourth-quarter earnings … which included a $900 billion write-down for the Surface RT tablet.
No doubt, MSFT is taking aggressive moves to get things back on track, including announcing a major reorganization of its divisions. That should mean more consolidation, a focus on mobile and hopefully even more upside for Microsoft stock.
So is it time to buy shares of MSFT? Let’s take a look at the pros and cons:
Broad Platform: MSFT has strong product lines in massive market categories, which should continue to experience nice growth. For the cloud, the company has offerings like Skype, Outlook, Dynamics ERP and Dynamics CRM. But perhaps the biggest advantage is the massive MSFT cloud infrastructure, called Azure. Only a few players have this kind of scale, namely Amazon (AMZN) and Google (GOOG). MSFT is also poised to benefit from the Big Data megatrend. Its SQL database business crossed above $5 billion last year and is now the No. 2 player behind Oracle (ORCL).
Growth: Even though the perception is that MSFT has lost its creative edge, that assessment seems misplaced. The fact is that the company continues to develop breakout products. One is the recent launch of Outlook.com, which now has more than 400 million users. Then there’s SkyDrive, which has more than 250 million users. Or take a look at Office 365; it’s the fastest-growing business in MSFT history and recently hit an annual sales rate of $1 billion.
Financial Strength: Microsoft stock is an exemplar of financial stability. For the 12 months ending June 30, MSFT cranked out nearly $37 billion in operating cash flow. As a result, it has ample resources to pay an attractive 3.3% dividend. Plus, the valuation of MSFT stock is also fairly cheap. Shares are trading for just 12 times forward earnings and 14 times trailing earnings. Rival SAP (SAP), for example, has a forward P/E of 21 and trailing P/E of 25.
PC Decline: The shift from traditional desktops and laptops to tablets and smartphones is ongoing. According to a recent report from Gartner, PC shipments in Q3 dropped by 9% to 80.3 million on a worldwide basis — the sixth consecutive quarterly decline. The problem, of course, is that the Windows operating system is mostly PC-focused. And MSFT has been slow to figure out mobile.
IT Spending: Last week, IBM (IBM) announced a terrible earnings report. It missed expectations on revenue by a stunning $1 billion. But IBM’s weakness was more than just about poor execution. With the overall uncertainty in global economies, we’re seeing a general resistance to make to make commitments for IT purchases. And the recent budget showdown in DC was also no help. IBM also felt pressure in China. While the company blamed this on the government’s reform efforts, there may also be indications of a harder line on technology imports. These combined headwinds will all affect MSFT stock as well.
Leadership: Ballmer’s tenure at MSFT has been a mixed bag. While he pulled off successful deals like Skype and built the Xbox franchise, he still failed to capitalize on mobile. Instead, the spoils went to companies like Apple (AAPL), Google, Qualcomm (QCOM) and Samsung (SSNLF). And when he announced his retirement, MSFT stock shot up 7%. This is why the choice for the next CEO of MSFT will be critical. The successor needs to understand how to manage a complex organization, and how to aggressively fight for market share in the mobile space. If Wall Street thinks the candidate doesn’t fit the bill, MSFT stock is likely to come under lots of pressure.
On paper, the mobile strategy for MSFT looks hopeful. In terms of market share, however, it’s negligible.
But Microsoft can certainly become a player in the market by leveraging its massive assets, such as Office, and its tools and infrastructure. For example, the company is already making strides in the high-growth area of mobile device management for enterprises. And more importantly, MSFT has shown that it can find ways to catch up in key markets.
So should you buy MSFT stock? Yes, given that MSFT is trading at an attractive valuation, and that the company has tremendous resources to devote to mobile, the pros outweigh the cons.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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