3 Reasons You Can Profit From an Underrated Tech Giant

If Microsoft (Nasdaq: MSFT  ) were on a reality show, it would be the contestant who consistently outperforms its flashier rivals to the constant surprise of the viewers. Investors should never overlook three vital factors about the software giant that have resulted in its commanding so many business sectors.

Microsoft innovates
Despite the belief of some commentators , Microsoft is a very innovative company, having come first with operating systems for the cloud, which delivers computing services over a network, and Big Data, the collection of large and complex information packages, as but just two contemporary examples. In its ascension from a garage start-up  to now having the third-largest market cap of any publicly traded company, Microsoft has supplanted competitors such as IBM (NYSE: IBM  ) , Oracle (Nasdaq: ORCL  ) , and Novell in key market segments.

This continues today with the gap between Xbox and Sony's (NYSE: SNY  ) PlayStation broadening in the gaming system segment.  The Windows 8 operating system for smartphones, now being offered through Nokia (NYSE: NOK  ) and others, is projected by International Data Corporation to almost quadruple its market share by 2016.

The following products manifest the evolving innovation efforts of Microsoft:

  • Its Azure was the first cloud-based operating system, long before Google (Nasdaq: GOOG  ) Chrome.
  • Windows 8 SmartPhone, which has contributed to Nokia and its "bounce back" of a 60% jump over the last quarter due to the improved Lumia 920 smartphone, competes against the iPhone 5 from Apple, and the Droid from Samsung/Google.
  • System Center 2012, the only unified platform that offers improved capabilities for managing information technology systems.

While some still claim that Microsoft does not innovate, that is certainly not the opinion of Steve Wozniak, co-founder of Apple (Nasdaq: AAPL  ) . In a recent interview, Wozniak expressed concerns that Microsoft is more innovative than the product developers for Apple. He laments: "I fear that Microsoft might have been sitting in their labs, trying to innovate, with a formula: 'How do we come up with new ideas? Let's not keep doing the same things as before, just the newer versions of them.' They might have been doing that for three years, while Apple was just used to cranking out the newest iPhone and falling a little behind. And that worries me greatly." 

Microsoft dominates
Windows is the world's most popular operating system. Microsoft has sold over 500 million licenses for the Windows 7 operating system. It is also the fastest-selling operating system in history. Almost half of the operating systems for PCs today are Windows 7. 

Microsoft did not start out at the top. It had to dispose of Novell to dominate in the server OS segment . It seized market share from Oracle in the database sector. There have been more than 70 million Xbox 360 consoles sold in direct competition with Sony (NYSE: SNY  ) . For the first time, in 2011 Microsoft sales of the Xbox 360 for the year topped those of Sony's PlayStation 3.

For future growth, the cloud is another area that Microsoft has targeted with Azure, Windows 8, and its tablets Logically, Microsoft has cloud-based advantages through its dominant market share of both Windows for consumers and Windows Server in the data center. There is certainly a formidable challenge from Google, but the institutional presence of Microsoft will be tough to supplant. 

For those companies looking to move up, there is the Microsoft Office 365, which is a cloud-based solution for business operations. Firms using Windows 7 that move to the cloud can now use mobile client systems for better performance and greater efficiency.

Microsoft's financials are great
A great balance sheet and income statement are the fruits of the way Microsoft innovates and dominates. This results in a very balanced business model for Microsoft, with more than one-third of its revenue from the Business Division, one-quarter from server and tools, and about one-fifth from Windows & Windows Live Division.

As the table below shows, Microsoft outperforms the industry average in many areas. Due to its size, it will not have the sales growth rate of smaller rivals. However, its superior earnings-per-share (EPS) growth rate evinces how well the stock has performed. The strong earnings allow for a dividend yield that is higher than the industry average and tops those off Apple, IBM, Oracle, and Google. That Microsoft has been able to maintain a net profit margin over 20% while the industry average has collapsed to just 0.23% is particularly demonstrative of how well it is performing compared to its rivals.

Metric

Microsoft

Industry Average

5-Year Sales Growth Rate

5.74%

12.72%

5-Year EPS Growth Rate

11.92%

11.81%

5-Year Return on Assets

19.50%

13.70%

5-Year Return on Investments

32.90%

22.50%

5-Year Net Profit Margin

28.00%

21.60%

Net Profit Margin Trailing 12 Months

21.70%

0.23%

Dividend Yield

3.50%

1.70%

Source: The Motley Fool CAPS.

For the Foolish investor
Microsoft's profit margin is the key metric to follow. Being far superior to the industry average, it very clearly demonstrates the company's innovation and dominance. Foolish investors should buy Microsoft on the dips, as the dividend yield will add to an even greater total return when the stock rebounds. If the Blackberry 10 smartphone from Research In Motion sells well after its Jan. 30 release,  Microsoft could dip as the market overreacts to a perceived threat in the smartphone market. But it should recover quickly since the Blackberry 10 is more of a threat to Nokia or Apple.

 That will be an opportunity for Foolish Investors to purchase shares at a discount. Microsoft will remain a compelling buy due to its innovation, domination of key sectors, and strong financial performance.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Read/Post Comments (9) | Recommend This Article (4)

Comments from our Foolish Readers

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  • Report this Comment On January 08, 2013, at 10:15 PM, InaFord wrote:

    Nokia is a very good candidate for a big short squeeze.

    Because the stock has been over sold.

    Nokia is the most short sold stock in both Helsinki and New York!

    NOK short interest as of December 2012:

    NYSE

    281 million shares

    Helsinki

    11.38% (with investors over 0.5%, below 0.5% not listed because of EU rules).

    Nokia´s total share number (approximately 3.75 billion shares) covers both New York and Helsinki.

    That makes the sort interest in NOK around 20%!

  • Report this Comment On January 08, 2013, at 10:16 PM, InaFord wrote:

    When now, both China Mobile and China Unicom are subsidizing the Lumia 920 heavily, the 2-year or 3-year contract is starting from

    0 or 1 yuan, and considering only less than 1/5 of Chinese people are using highest-end smartphones, now even middle class Chinese people have a chance to use a highest-end smartphone because of China Mobile´s and China Unicom´s Lumia 920 deals.

    This will result into a huge number of 2-year or 3-year contract users for Nokia in China! Besides, 3G penetration in China is still very low, there is a huge opportunity there.

    Additionally, among the highest end phones, Nokia Lumia 920 is significantly much cheaper than for example iPhone 5 and Galaxy Note II. Nokia has an advantage in both the price competition and the biggest carriers´ backing in China!

  • Report this Comment On January 08, 2013, at 10:17 PM, InaFord wrote:

    Nokia has a brighter future than RIM

    1) BB10 is a bit late!

    2) RIM has been strong in enterprise business, but now RIM will face

    more than tough competition. For example, In China China Mobile sells the Nokia Lumia 920T for 4599 yuan with free wireless charging pad or other accessories, which means the phone costs only 4000 yuan. The phone is very much cheaper than iPhone 5 or Galaxy Note 2.

    In addition, the Lumia 920T has premium malware virus protection hardware built in.

    Therefore, will RIM´s highest end BB10 phone able to compete the price with this Lumia 920T? I really doubt that. And with a 2-year contract, China Mobile offers the Lumia 920T with only 1 yuan!

    3) RIM´s loyal fans will still support BB10 phones, but will that be enough?

    4) Beside Apple and Samsung, RIM will have to compete also with Nokia.

    Now, Nokia with WP8 is in quite a big step ahead of RIM with BB10.

    Nokia has low price point Asha phones and also high-end Lumia phones,

    so can RIM do the same?

    5) RIM will still need to use a lot of money in R&D and marketing in the future, while Nokia

    is saving money in R&D and marketing, because MS shares the expenses.

  • Report this Comment On January 08, 2013, at 10:22 PM, InaFord wrote:

    Nokia´s Asha phones are competing with low-price androids. Asha phones have many smartphone features and thousands of Nokia´s most popular apps right now and also Facebook and Twitter etc, and even 40 most popular games in the world for free in these phones. Asha phones are only about $60 without any contract, while cheapest android is still about $100.

    Nokia is also saving money in R&D, because it has teamed up with Microsoft.

    Nokia is actually a BUY and hold for 2013.

    Reasons:

    1. China Mobile deal

    2. Nokia is now getting royalty payment also from RIM

    3. Lumia 920 is heading to more markets

    4. Budget WP8 phone Lumia 620 is hitting the markets this month

    5. Nokia is likely launching a tablet. I don´t expect much, but even some Nokia´s loyal fans around the world will buy some Nokia´s tablets, that is a good gain for Nokia.

    6. According to CEO Stephen Elop, Nokia is planning a lot of interesting things with Verizon!

    China Sets 100 M 3G Customer Goal

    People’s Republic of China – the biggest telecom market in the world by subscriber base has set an ambitious goal for the forthcoming year. Additionally, the East Asian country expects 3G subscribers and broadband Internet to collectively propel growth in 2013. According to China’s Ministry of Industry and Information Technology (:MIIT), the country expects to add 100 million 3G subscribers with the number of broadband Internet users to increase by 25 million in the coming year.

    China Mobile is planning to offer Nokia Corporation’s (NOK) Lumia 920T at a very low cost, which is expected to increase its 3G customer base even further.

    At over $4, Nokia is a good bargain.

    Nokia has spent over $55 billion in R&D alone, now Nokia´s market cap is only about $15 billion. A couple of years ago, Nokia was still about $15.

  • Report this Comment On January 08, 2013, at 10:25 PM, InaFord wrote:

    Nokia has “low end competitive Asha phones and high end competitive Lumia phones”. Apart from that, Nokia has other business units like Navteq, NSN and intellectual property rights.

  • Report this Comment On January 08, 2013, at 10:28 PM, InaFord wrote:

    At this price, NOK is undervalued.

    Morningstar´s analysis about Nokia:

    Estimated price: intellectual properties over 1 euro per share (Motorola´s patent portfolio was worth about $5.5 billion); other business parts (smartphones, featurephones, NSN) at least over 1.50 euro per share.

    And NAVTEQ´s price not included (Nokia bought NAVTEQ with 5.7 billion euro). All in all, even in this case, Nokia share price would be at least over 2.50 euro, excluded NAVTEQ! And Nokia´s net cash is now 3.6 billion euros.

    In other words, the sum of parts of Nokia and net cash are worth much more than its market cap now, which means NOK share is right now heavily undervalued.

    Nokia Is Extremely Cheap

    The company has since partially offset these fears with excellent cash management, restructuring aimed at reducing costs, and more recently, its better than expected 3rd quarter results. The company achieved operational profitability (1.1% non-IFRS) with better than expected revenues, triggering a 20% increase in stock price. As the table below shows, these factors have enabled Nokia to maintain a healthy interest coverage ratio and quick ratio (nearly equal to the industry average), dispensing any immediate liquidity concerns.

    Company

    Industry

    Sector

    Quick Ratio (MRQ)

    1.16

    1.62

    1.64

    Current Ratio (MRQ)

    1.28

    1.96

    3.01

    LT Debt to Equity (MRQ)

    48.76

    22.29

    10.61

    Total Debt to Equity (MRQ)

    66.45

    39.67

    19.69

    Interest Coverage (TTM)

    4.9

    4.91

    164.78

    Figure 1: Financial Strength/ Reuters

    Valuation

    Nokia is currently operating at a loss and the sell side expects the company to become profitable, somewhere in 2014. The stock is very volatile, as can be assessed from the 100% run in the last 6 months. I believe Nokia’s share price will continue to fluctuate with short term catalysts and it’s still pointless to value the stock on 2014 earnings given the uncertainty. Instead, investors should value the company on a worst case scenario. I believe at this point, Nokia’s biggest assets are its impressive patent portfolio, Cash, NSN and Navtaq.

    I have used three recent patent sales to get an approximate value per share for Nokia’s current patent portfolio.

    $ millions

    AOL (AOL) Patent Sale

    Vringo (VRNG) Purchase

    Nortel Networks

    No. of Patents Sold

    800

    500

    6000

    Sales Value

    1100

    22

    4500

    Price Paid Per Patent

    1.4

    0.0

    0.8

    No Nokia Patents

    9500

    9500

    9500

    Patent Portfolio Value

    13063

    418

    7125

    Shares Outstanding

    3830

    3830

    3830

    Per Share ($)

    3.4

    0.1

    1.9

    Average Price Per Patent

    0.79

    Average Patent Portfolio Value

    7316

    Average Per Share Value ($)

    1.91

    Figure 2: NOK Source: Google Finance

    As the calculations show, the patent value per share of Nokia’s patents comes down to $1.91 per share. According to Nokia’s disclosures, the company ended Q3 with gross cash of $11.5 billion (EUR 8.8 billion). The Q3 results also indicated that Nokia had EUR 288 in currently maturing debt and EUR 1.1 billion in short term borrowing. Deducting other liabilities, we arrive at a net cash position of $4.7 billion (EUR 3.6 billion). This comes down to a per share amount of $1.22, and adding the per share patent value of $1.91, the value of cash and patents together is $3.13.

    Bottom Line

    Nokia still trades way below its salvage value. The company’s patents and net cash, alone are worth $3.13 per share. This of course does not include Nokia’s Navtaq business and NSN (Nokia Siemens Network). These divisions continue to be profitable, despite problems of Nokia’s smartphone division. In Q3 NSN sales were EUR 3.5 billion and operating profit was EUR 323 million; the operating profit of location and commerce segment was EUR 37 million. The combined value of Navtaq (3x sales for $3 billion) and NSN (0.5x sales for $7 billion) is around $10 billion ($2.6 per share). This gives us an approximate per share value of $5 for NOK. Therefore, Nokia is still trading at a discount to its salvage value and is an excellent value opportunity.

    M.S./SmartEquity

    Nokia´s total share number (approximately 3.75 billion shares) covers both New York and Helsinki.

    That makes the sort interest in NOK around 20%!

    Nokia is a good candidate for a big short squeeze!

    Usually, NYSE tech stocks are at least 2X valuated value. In this case, NOK share price should be at least around $10.

  • Report this Comment On January 08, 2013, at 10:44 PM, pixelrebel wrote:

    NASA's openstack platform has been available 2 years before Microsoft released any cloud software. Openstack is now the standard for cloud software solutions. Microsoft, is once again simply copying the innovators in a timely matter. Big Data is also the territory of companies like Quantum. Again, Microsoft follows suit. Two horrible arguments for Microsoft's innovations.

  • Report this Comment On January 09, 2013, at 12:10 AM, TimKnows wrote:

    RIMM is going to take Apple to the cleaners, even MS will do well this year as Apple has nothing to offer.

  • Report this Comment On January 10, 2013, at 10:05 AM, jyates13 wrote:

    Regarding Pixelrebel's comments, Azure from Microsoft far surpasses Openstack in the number of users. The same is true for the Big Data sector and competition from Quantum. The timing can be debated, but not the number of uses of size of the market share for each company. I do feel that Microsoft has been very innovative in The Cloud and Big Data, as stated in my article. Both are so sprawling, that many claims can be made as to timing.

    For the comments on Nokia by Inaford and TimKnows, we will all know much better in the time period after the Blackberry 10 is introduced, which is supposed to be on January 30. Nokia's share are up today as results for the fourth quarter came in better than expected.

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