Dueling Fools A Microsoft Duel
Bull Argument

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Dueling Fools
By Paul Larson (TMF Parlay)
October 17, 2001

Want to invest in the premiere company on the planet? Look no further than software giant Microsoft. In Microsoft we have a company with a stellar business model, a cash horde worthy of a King, and some of the most impenetrable sustainable competitive advantages the free market has ever seen.

Let's first talk about the company's business model. As a software company, once the software is developed, the cost to create additional product is minimal, and the revenue it creates drops almost straight to the bottom line. What company wouldn't kill for the 86% gross profit margin Microsoft enjoyed last year?

These sky-high gross margins also make Microsoft one of the most profitable companies ever known. Even after having to write down the value of some of its assets, last year Microsoft was able to convert $0.29 of every dollar in revenue into after-tax profits. I dare you to find a company anywhere near Microsoft's size that even comes close to this type of profitability.

Microsoft has also been an extremely fast-growing company for a firm its size, and the company's record of growth and profitability is second to none (.xls file). After coming public more than 16 years ago, Microsoft has seen top-line growth in each and every year. Since just 1995, revenues have more than quadrupled.

Looking past the one-time, non-cash charges last fiscal year, the company has also grown its bottom line every year as a public company. Even last year's temporarily depressed earnings were more than five times larger than what Microsoft earned in fiscal 1995.

The reason for the stellar growth and profitability? When you look up "ubiquity" in the dictionary, there is a picture of Bill Gates smiling back at you. The vast majority of the computers on the planet run on Microsoft Windows, and the company has been able to parlay its lead in operating systems to numerous other markets. Chances are you use Microsoft Word to create your documents, Microsoft Excel for your spreadsheet needs, Internet Explorer to surf the Web, and Outlook to check your email.

Yes, Microsoft has an essential monopoly in the sweet spot of the computer industry. In fact, it has several monopolies. This is because the free market, for better or worse, much prefers to use single proprietary standards instead of a mish-mash of incompatible products. Microsoft just happens to be the beneficiary of this effect.

This gives Microsoft a huge and sustainable competitive advantage in the markets it serves. Competitive advantages lead to excess returns, which is what Microsoft has to look forward to for the foreseeable future.

Thanks to the company's past success, Microsoft has amassed a war chest in excess of some $45 billion worth of cash and investments. Debt? Forget about it. This gives Microsoft some very deep pockets to further extend its lead at a time when other companies are available at sale prices. All that cash (including long-term investments), roughly $8.21 per share and growing, also provides a nice floor under the stock.

The only real threat to Microsoft today is its continuing anti-trust headache, but even that potential liability has been greatly diffused. The threat of a breakup has been taken off the table, and the powers that be are pressing for a settlement. A major risk to the company has been reduced to a minor and transient hurdle that will not alter Microsoft's dominant positioning and killer business model.

Investors buying Microsoft today are getting the shares at the same price they traded at back in 1998. The company is expected to earn $1.88 per share next year, which at this writing puts the shares at about 30-times forward projections, which is at the lower end of its historical valuation range.

Microsoft's stock ain't cheap, but this ain't just any company supporting the stock. Quite simply, Microsoft is the most powerful cash flow generating engine the world has ever seen, and owning a share of it has been and will continue to be a pleasant and profitable experience for shareholders. 

Paul Larson owns a PC running Microsoft Windows, researched the company using Internet Explorer, wrote this piece using Microsoft Word, and sent it to his editors using Microsoft Outlook. He also owns a stake in Microsoft. You can see what else he owns online thanks to The Motley Fool's progressive disclosure policy.

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