Is Microsoft the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Microsoft (Nasdaq: MSFT  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Microsoft.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 10% Fail
  1-Year Revenue Growth > 12% 13.6% Pass
Margins Gross Margin > 35% 79.2% Pass
  Net Margin > 15% 30.8% Pass
Balance Sheet Debt to Equity < 50% 20% Pass
  Current Ratio > 1.3 2.45 Pass
Opportunities Return on Equity > 15% 44.3% Pass
Valuation Normalized P/E < 20 13.04 Pass
Dividends Current Yield > 2% 2.5% Pass
  5-Year Dividend Growth > 10% 7.2% Fail
       
  Total Score   8 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Microsoft comes close to perfection with eight points. The company faces plenty of future challenges, but for now, the software giant continues to cash in on its dominant position in PC operating-system and business software.

Microsoft's Windows and Office software products have dominated the industry for a long time, and they make up a huge portion of the company's revenue. Between them, the two products made up almost 60% of Microsoft's sales in its 2010 fiscal year and were responsible for almost all of the company's operating profit.

The challenge Microsoft faces is to follow up those successes with future growth. Its Bing search engine has made only minor gains against Google's (Nasdaq: GOOG  ) leading position, and it lags behind Apple (Nasdaq: AAPL  ) and many others in mobile devices like smartphones and tablets. The company's recent partnership with Nokia (NYSE: NOK  ) to adopt the Windows Phone 7 platform in Nokia phones is an effort to make a difference in the space, but many see it as a desperation move on Nokia's part.

Things aren't all dire for Microsoft. Its Kinect system has been a huge success, selling 10 million units since its release. But given the company's huge size, it takes bold, broad-ranging initiatives to make a big difference to its bottom line. 

Microsoft has done a great job of squeezing every dime from its landmark products. By itself, that's been good enough to bring it close to perfection, and if the company can find growth drivers going forward, that could be enough to get it to the top.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Microsoft to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Microsoft and Google are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers pick. Apple is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a bull call spread position on Apple and a diagonal call position on Microsoft. The Fool has written puts on Apple and owns shares of Apple, Google, and Microsoft. 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 Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (6)

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 March 11, 2011, at 12:58 PM, melegross wrote:

    A lousy article indeed. One of the other indicators must be the stock price itself. Is it rising, staying the same, or falling over some period of time?

    Not only has MS's stock not been rising, but it's been falling. Taking inflation into account, the stock is worth a fair amount less than it was in the past.

    What is the realistic case for assuming it will be rising? You can't go by the technicals, they really don't matter that much. Stock prices are emotional as much as technical. People don't think MS a growth stock anymore, and they are correct.

    This is a terrible investment, and it has been since the beginning of the century.

  • Report this Comment On March 11, 2011, at 1:01 PM, TMFHousel wrote:

    "This is a terrible investment, and it has been since the beginning of the century."

    Of course, most people aren't investing today for the past decade, but the coming decade.

  • Report this Comment On March 11, 2011, at 1:28 PM, phoebe44 wrote:

    I continue to add to my Microsoft position a little at a time every time the market puts it on sale. Maybe >> people don't think MS a growth stock anymore >> but the financial statements and only the management team knows for certain what the future holds.

    If you doubt, ask Apple!

  • Report this Comment On March 11, 2011, at 1:54 PM, techy46 wrote:

    Microsoft trading range 24-28 which is 16% plus 2.5% dividend. So accumulate going down (<26) and sell going up (>27). If MSFT pulls off Nokia deal and W8 for ARM by early 2012 and breaks 29 then strategy will change. Same with Intel 18-22 which is 22% plus 3.5% dividend. If INTC penetrates ARM market with ATOM Medfield and breaks 24 by Fall 2011 then strategy will change. Pretty boring but profitable.

  • Report this Comment On March 12, 2011, at 7:42 PM, melegross wrote:

    You guys are odd. All MS has been doing over the years is go down. So accumulate all you want, it's a buyers market.

  • Report this Comment On March 13, 2011, at 1:10 AM, techy46 wrote:

    @melegross - you need to look at the 9-12 mo cycles, it's not a buy and hold, IMO nothing is.

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