Will Microsoft Fumble Next Quarter?

There's no foolproof way to know the future for Microsoft (Nasdaq: MSFT  ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result. Rest assured: Even if you're not monitoring these metrics, short-sellers are.

A cloudy crystal ball
I often use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- days worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Microsoft do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Microsoft sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter (EOQ) receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars (DSO) indicates a trend worth worrying about. As another reality check, it's reasonable to consider what a normal DSO figure might look like in this space.

Company

LFQ Revenue

DSO

 Microsoft

$16,195

64

 Apple (Nasdaq: AAPL  )

$20,343

20

 International Business Machines (NYSE: IBM  )

$24,271

36

 Google (Nasdaq: GOOG  )

$7,286

44

Source: Capital IQ, a division of Standard & Poor's. DSO calculated from average AR. Data is current as of last fully reported fiscal quarter. LFQ = last fiscal quarter. Dollar figures in millions.

Differences in business models can generate variations in DSO, so don't consider this the final word -- just a way to add some context to the numbers. But let's get back to our original question: Will Microsoft miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Microsoft's year-over-year revenue grew 25.3%, and its AR grew 12.3%. That looks OK. End-of-quarter DSO decreased 10.4% from the prior-year quarter. It was down 25.8% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short, profiting when they eventually fall. Which way would you play this one? Let us know in the comments below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Google and Microsoft are Motley Fool Inside Value selections. Google is a Motley Fool Rule Breakers recommendation. Apple is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Apple, Google, International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 18, 2010, at 7:54 PM, dannyg101 wrote:

    This article possibly might make me cancel my subscription to Motley Fool

  • Report this Comment On November 18, 2010, at 8:14 PM, h359368 wrote:

    Love'em or hate'em Microsoft seems to have a few things going for it these days:

    - Kinect: Microsoft's XBox accessory has sold 1M units in 10 days and on track for 5M units in Q4 according to IDC.

    - Windows 7: Close to 250M copies sold to date and counting. The fastest selling OS of all time according to MS with holiday sales yet to be counted.

    - Windows Phone 7: By most accounts a good entry in the smartphone space that will get stronger over time with updates. I've personally talked to WP7 owners who love the devices and WP7 interface.

    - Cloud: MS's best kept secret. Office is now "in the cloud" along with Exchange, SharePoint and many other infrastructure and development apps. Users can subscribe to Office for a few dollars a month or get ad supported office free via MS Live.

    Considering MS pays a decent dividend and trades for a much more reasonable valuation than other high profile IT companies, this seems like a good safe investment.

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