A few weeks ago, Microsoft (NASDAQ:MSFT) wowed Wall Street with its announcement that it is acquiring over 800 of AOL (NASDAQ:AOL) patents for over $1 billion in cash. And yesterday, the software giant announced big plans for these newly-acquired patents.
Read on to see whether you should buy into this opportunity.
Company Overview
Microsoft has been around since 1975, which is essentially the dawn of computer software. The company started as a basement operation with Paul Allen and Bill Gates selling simple computer programs for the Altair 8800 microcomputer. Only 10 years later, the company released the first retail version of Microsoft Windows, an Operating System that would ultimately become standard on most home PCs. With the success of Windows as well as Microsoft Office Microsoft has grown into a tech giant that brings in just under $70 billion in sales annually and has 90,000 employees worldwide.
Industry Breakdown
There are 117 companies in the Application Software industry. Of those, Microsoft is largest in terms of market capitalization. In terms of fundamentals, Microsoft Inc.’s 2.5% dividend yield also stands out by being the second highest, as does its 38.2% return on equity, which is third highest in the industry.
The company’s Price/Earnings to Growth ratio and earnings growth also fall in the upper quartile. However, the company posts middle-of-the-road performance in terms of sales growth (69th) and long-term growth rate (68th).
Microsoft’s main competitors are Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) and Oracle (NASDAQ:ORCL). Of these four companies, Microsoft has the highest operating margin, the second highest gross margin and the third highest sales growth.
Earnings Buzz
Last Thursday, Microsoft released third-quarter earnings that topped analyst estimates. Compared with the same quarter last year, profits dipped 2% to $5.11 billion, or 60 cents per share. However, analysts forecast earnings of 58 cents per share, so Microsoft posted a 3% earnings surprise.
Over the same period, the company’s top line climbed 6% to $17.41 billion; this also topped the consensus estimate by 1%. After these operating results were released, shares of MSFT gapped up on the highest volume in three months.
On Monday, Microsoft continued to drum up investor interest by announcing that it will sell 650 of the 925 AOL patents to Facebook Inc. for $550 million. Microsoft management is excited about the agreement because it will allow the company to recoup over half of the initial AOL purchase price while allowing it to keep the most strategically important patents.
Current Ratings
Before you buy any stock, you should always run it through my free Portfolio Grader ratings system. This company has improved notably in the past year; twelve months ago, MSFT was a D-rated stock. Since then, Microsoft has firmed up a number of its fundamentals, including cash flow and return on equity.
In addition, analysts have been more bullish with their earnings estimates, so this company has a strong analyst earnings revisions score. However, there is still plenty of room for improvement in terms of sales growth, earnings growth and operating margin growth. What really makes this stock attractive is that buying pressure remains high for this stock, quite possibly due to the recent AOL patent deal.
Bottom Line: MSFT is an A-rated stock thanks to its strong Quantitative Grade. However, keep in mind that a dip in buying pressure could send this stock down to a B or even C.
Recommendation: Strong Buy
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