Is It High Time to Dump Microsoft?

"[T]oday the iPhone brings in more revenue than the entirety of Microsoft. No, really."
 -- Kurt Eichenwald

Even for diehard Microsoft (Nasdaq: MSFT  ) fans, that statistic has to sting. In his Vanity Fair takedown of Mr. Softy, Eichenwald points out that while Apple's (Nasdaq: AAPL  ) iPhone racked up sales of $22.7 billion for the first quarter of this year, Microsoft -- all of it -- managed just $17.4 billion.

It's not just about Apple, though, as the piece further points out that other tech upstarts, including Google (Nasdaq: GOOG  ) and Facebook (Nasdaq: FB  ) , have also "whizzed by" as Microsoft has "fallen flat in every arena it entered: e-books, music, search, social networking, etc., etc."

Facebook has come to dominate social media -- a key online battleground that Microsoft has precious little stake in. Google has stayed well ahead on search but has also waded into the prime Microsoft sweet spot of productivity software. Amazon.com, which doesn't get much billing in the article, has also come to dominate major tech areas despite its retailer roots.

In short, the picture doesn't look good for the onetime king of tech.

But while Eichenwald's missive is an interesting read and highlights some very real risks for Microsoft -- most notably the capability of CEO Steve Ballmer -- there are a few areas where the article clearly misfires.

Microsoft cool? Really?
In the article, Eichenwald refers to Microsoft as "the onetime icon of cool." I had to do a double-take. An icon of cool? I have a very hard time recalling when it was that the software giant behind the Excel spreadsheet program was the cool kid on the block.

Sony -- with its Walkman, Discman, and, later, the PlayStation -- was cool. Nintendo -- in the days of the NES and Super NES, long before the Wii reinvigorated the brand -- was cool. Motorola -- whose mobility division is now owned by Google -- had its turn at cool when it delivered the RAZR. I'd even go as far as to say that Research In Motion, at the beginning of the BlackBerry era, had more cool vibe than Microsoft ever had.

But you don't have to buy into my personal assessment of cool. The numbers tell us all we need to know. This year, Microsoft reported total revenue of $70 billion. Of that, $19 billion came from the Windows PC operating system, $17 billion came from the Windows Server operating system and other server products, and another $22 billion came from productivity software -- mainly MS Office. Right there you have the lion's share of Microsoft's revenue. If we go back to fiscal 1998, the company didn't break out as many divisions, but it was a similar tale. The company's revenue back then came almost exclusively from two areas: Windows and Office.

Maybe I'm the one out of the loop, but operating systems and productivity software don't sound particularly cool to me. If we look to Apple as a model of cool (because it is), the company's OS X may be a great operating system, but hipsters, geeks, teenage girls, rich middle-aged men, yuppies, and everyone in between aren't obsessed with Apple because of OS X.

In short, Microsoft isn't cool, but it never was. In fact, it's the distinctly uncool company's efforts at being cool that have led it to some of its most notable blunders.

The cold shoulder from Warren
Eichenwald makes the mistake of highlighting Warren Buffett's lack of interest in Microsoft as an early warning sign.

"[I]nvestor Warren Buffett, the 'oracle of Omaha,' didn't get Microsoft," he writes. He goes on to note the concern of an "unforeseen transformation in the tech market" that would blindside Microsoft. This was a concern that "made sense to Buffett."

To be fair, Eichenwald is probably correct that Buffett had that concern about Microsoft. But this is a half-truth by omission as Buffett has that concern about every tech stock. Buffett is nothing if not a principled investor, and he's steadfastly avoided investing in tech companies because he doesn't believe he has any special skill at assessing the rapid changes that disrupt the tech universe time and time again. In the 1999 letter to Berkshire Hathaway (NYSE: BRK-B  ) shareholders, Buffett wrote:

Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I have no special capital-allocation expertise. For instance, we bring nothing to the table when it comes to evaluating patents, manufacturing processes, or geological prospects. So we simply don't get into judgments in those fields.

Buffett didn't invest in Microsoft, but he also didn't invest in Google, Apple, Amazon, or Facebook.

Peruse the Berkshire portfolio today and you'll find a hefty stake in IBM, a onetime tech powerhouse that Buffett jumped on only after it overhauled its business model to become a predominantly services-oriented business. Beyond that, the large positions Buffett claims are still focused on easy-to-understand, dependable companies such as Coca-Cola and Kraft Foods.

Stock-Versus-Company 101
Finally, Eichenwald falls victim to an all-too-common investing misunderstanding of confusing the fate of a company's stock with the underlying fundamentals of the business. He writes: "And the performance showed on Wall Street; despite booming sales and profits from its flagship products, in the last decade Microsoft's stock barely budged from around $30, while Apple's stock is worth more than 20 times what it was 10 years ago."

There's no question that Apple has been the more successful company over the past 10 years. However, if we look at the numbers for Microsoft, between fiscal 2002 and this year, the company's revenue has increased 160%, or 10% per year, while profits -- if we exclude the non-cash writedown in the most recent quarter -- have quadrupled, increasing nearly 15% per year. Most companies would kill for those numbers.

When it comes to the stock's performance, though, Eichenwald neglects to consider the part that valuation plays in the equation. In 2002, even in the depths of the dot-com bust, investors were still, on average, willing to pay more than nine times Microsoft's revenue to own shares. That was wildly optimistic. Over the past decade, that nosebleed multiple has acted like a counterweight to the growth of the company when it comes to the stock's performance. It was exactly the opposite case for Apple, as its shares changed hands at a mere 0.5 times revenue in 2002.

The fact that Microsoft's stock "barely budged" over the past decade has a lot more to do with the unsustainable valuation on the shares 10 years ago than terrible performance from the company.

Money, meet mouth
I've got my money where my mouth is on this one. Not only have I given Microsoft a thumbs-up in my Motley Fool CAPS portfolio (accountability is key!), but I also have real money in it through my personal portfolio.

That said, for a great many investors, whether or not they think Microsoft is doomed, it's still Apple that's front and center. For those who own Apple or are thinking about jumping in, Motley Fool tech expert Eric Bleeker has issued a report picking apart the Cupertino giant to help investors figure out whether they should buy, sell, or run screaming. Get your copy of this premium report.