Microsoft Might Be One of the Cheapest Stocks Out There

I don't know much about technology. I don't follow the industry. I don't know the jargon. My wireless router wasn't even password-protected until about a month ago -- I just couldn't figure the damn thing out.

But I do know that Microsoft (Nasdaq: MSFT  ) looks cheap. Really cheap, in fact. And the numbers are so compelling that you don't have to know much about technology to make the case (thank goodness).

Ctrl-Alt-Delete
What gets me excited about Microsoft boils down to this: Apple (Nasdaq: AAPL  ) is slowly taking over the world. That makes it easy and popular to write Microsoft off as a dinosaur heading toward irrelevancy, like Toyota vs. GM.

But lost in this overly simplistic comparison is a simple truth: Microsoft is outrageously profitable, its balance sheet is bulletproof, and its stock trades at a valuation that makes sense in only the most offensively cynical scenarios.

Start by looking at some basic statistics:

Metric

Value

Market Cap

$220 billion

Share Price

$25.00

Cash per Share

$4.24

TTM EPS

$1.93

Forward P/E Ratio

10.9x

Past 5-Year Growth Rate

11%

Next 5-Year Growth Rate (expected)

9.3%

Source: Yahoo! Finance.

Here you have a $25 stock, with 17% of that value made up of cash in the bank. Back out the cash just sitting there collecting dust, and you get an enterprise value of about $20.75 per share. Simple math: That's 11 times trailing earnings, which is perfectly insane given how low interest rates are.

And what do you get for this unloved stock? A company that still commands more than 90% market share. A company with a near monopoly, where both consumers and corporations realistically have to use Microsoft Office to remain relevant. By any stretch, a company with one of the most powerful moats in the world.

I won't argue that Microsoft's potential to change the future surpasses its nemesis, Google (Nasdaq: GOOG  ) . Again, I'm naive in this area. But winning investments often have nothing to do with how fast a company can innovate and grow earnings. It's about investing when valuations work in your favor. And that can happen to even boring and slowly dying companies. Altria Group (NYSE: MO  ) , for example, outperformed Google over the past five years. I bet it will over the next five years, too.

Pick your odds
When a stock like Microsoft trades around 11 times earnings in a zero-interest rate environment, you can throw around some wild scenarios that still leave the probabilities of success in your favor.

If Microsoft never again grows earnings from now until the end of time, shares would still be a bargain. If it lit $10 billion of cash on fire just to watch it glow, shares would still be a bargain. If Google Docs takes off like wildfire and Office sales fall 50%, Microsoft's total net income would fall by roughly 25%, in which case shares would still roughly match the valuation of the broader market. Create your own adventure: You can torture a range of possibilities and still struggle to come up with a scenario where Microsoft's shares aren't reasonably cheap. That's when investing gets fun.

And many of the folks who do actually follow Microsoft (and can work a wireless router) aren't remotely this pessimistic. Average analyst earnings estimates are anything but ominous:

Year

2011

2012

2013

EPS Estimates

$2.32

$2.61

$3.05

Source: Capital IQ, a division of Standard & Poor's.

Our Foolish tech expert Eric Bleeker also thinks doomsday forecasts for Microsoft's Office are bunk. As he wrote this week:

Microsoft's business unit is being pitched as future roadkill by some, but I think the cross-sale opportunity on the applications surrounding Office is misunderstood. Given better tie-ins and having partners sell their product line as a fully packaged solution, the company has some great opportunities to expand its revenue away from the Office suite. Really, it's just following the path of its large IT peers. Microsoft is trying to become a one-stop shop for clients' needs.

Low hurdles
The world's best investors, most notably Warren Buffett, have made their fortunes scooping up unloved companies the market has written off. Charlie Munger, Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) other co-chairman, advises that "You're likely to be happier and gain felicity by aiming low." Microsoft shareholders are currently aiming low. Happy future returns seem like a good bet.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Altria and Berkshire Hathaway, and will own Microsoft shares fairly soon if no one can talk him out of it. Berkshire Hathaway and Microsoft are Motley Fool Inside Value picks. Google is a Motley Fool Rule Breakers recommendation. Apple and Berkshire Hathaway are Motley Fool Stock Advisor choices. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Berkshire Hathaway and Google, and has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (28)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 16, 2010, at 3:17 PM, 1caflash wrote:

    I don't know about Microsoft, but I did use about 25% of my cash and buy more of the fine stocks that are consistent dividend payers on July 16, 2010. I didn't hit the lows. I believe that if you're hesitent to buy on the down days, then why be in the stock market? I did save plenty of firepower just in case day-traders keep lowering the prices and giving us more bargains. I also noticed that there seems to be no general panic. I'm looking forward to nice dividends in September 2010.

  • Report this Comment On July 18, 2010, at 1:43 PM, Tradersinfo wrote:

    Um...there is a general panic, when gold ("hedge of the century", "buy gold", "invest in gold", "insure your cash with gold", etc) is also going down! What is it when all primary commodities are going down? What do you call it when precious metals, the all-so-precious metals are going down? One of my positions in CDE (silver miner) was wrecked by the havoc in commodity markets, that is the result of general, all-round selling. Anyways, it is amusing to see Motley Fool suddenly starting to pitch Microsoft after I brought people's attention to its cheapness! Amusing.

  • Report this Comment On July 18, 2010, at 7:01 PM, TheDumbMoney wrote:

    (reads article)

    (nods head vigorously)

  • Report this Comment On July 19, 2010, at 12:46 PM, FreeMortal wrote:

    No password for your wireless router? That's rather frightening. Hope you don't use the same username/password for everything. Gyeah! How do I know this is the real TMFMorgan and not some impostor from Ukraine plugging Microsoft and giggling to himself "I am inveeencible!"

    I generally agree with the OP though. Microsoft has been dismissed by geek and muggle alike. Just recently they suffered a huge setback in the smartphone department. Yet the company is still capable of its old tricks of spotting trends and muscling its way in. They are well prepared for cloud computing and are pushing a good line of services through their channel partners.

  • Report this Comment On July 19, 2010, at 11:07 PM, hilled wrote:

    Microsoft is in trouble. Ballmer has dropped the ball on the company's most important projects. Microsoft is dead in the water with their mobile strategy. The first release of the new Windows mobile is a step backwards with no multitasking, and not even a copy/paste feature. Users want to listen to their Pandora while surfing the web or checking e-mail....it's not going to happen on the Windows phones.

    Their tablet strategy is a disaster. They announced lots of products in Feb. that never materialized. Vendors have been flocking to other platforms. Toshiba has an interesting device coming out, but it's an awkward try (hinged like a laptop, but with no physical keyboard).

    What's Microsoft going to do? Windows 7 tablets? Win 7 Mobile tablets? Nobody knows.

    I think MSFT is going to be stuck in a rut for at least 3-5 years. That's how long it will take them to fix their mobile strategy, which is the big growth area now. They have the talent, management just needs to let them soar.

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