Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Microsoft (Nasdaq: MSFT  ) .

Hard times for Mr. Softy  
The world's largest software company appears to have delivered a blowout quarter at first glance.

Revenue climbed 8% to $17.37 billion. Earnings soared 30% -- or up by an even more impressive 35% on a per-share basis to $0.69, given aggressive share buybacks over the past year. Analysts were expecting a profit of $0.58 a share on only $17.25 billion in revenue.

It's at this point where bulls should replace their rose-colored glasses with magnifying glasses. As they work their way down the income statement, they'll see that Microsoft is setting aside less than a third of the amount that it set aside during last year's fiscal fourth quarter as a provision for income taxes. Head a few lines higher, and you see that operating income grew by only 4%. Operating margins are contracting, though thanks for playing along, Uncle Sam.

There's more uninspiring news as we work our way through Microsoft's divisions. Revenue and operating profits slipped in its high-margin Windows business, and even a rushed upgrade to Windows 7 is unlikely to improve matters. PCs just aren't selling the way they used to, my friend.

Microsoft continues to lose money in its online businesses. How does a company lose $728 million on $662 million in revenue? It's selling a ton of low-margin Xbox 360s and Kinect controllers, but that division was barely profitable during the quarter.

Office and Microsoft's server software are holding up well, but is that enough to justify an enterprise value of nearly $200 billion?

I'm fully aware that plenty of my fellow Fools -- including several of our Motley Fool newsletter services -- are bullish on the software giant. I see some of the company's merits, and I'll concede that at least Microsoft isn't as outrageously priced as it was at the front end of the stock's lost decade. However, I have yet to be won over by any argument that suggests that Microsoft will be more relevant in three to five years than it is today.

Last night's report only validates those concerns, as its two fastest-growing subsidiaries just happen to be its least lucrative parts.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three replacements.

  • Apple (Nasdaq: AAPL  ) : If folks aren't buying Windows-fueled PCs, what are they snapping up? Well, Apple posted a 14% year-over-year spike in Mac unit sales in its latest quarter. Sales of its "good enough" computing devices -- iPads and iPhones -- more than doubled. Microsoft trades at just 10 times fiscal 2012's projected profitability, while Apple fetches a slightly higher multiple of 13. When one company is coming off a quarter where operating profits climbed 4% while the other posted a 122% surge, is there any doubt where your money should be right now?
  • Google (Nasdaq: GOOG  ) : Vanquishing Microsoft's operating system seemed heretical years ago. If anyone can do it these days, it may very well be Google. It won't be Apple, since its proprietary high-end MacOS and iOS platforms won't play to the mass market. Computer operating systems in a few years may mirror today's smartphone market, with Google's open-source solution appealing to the masses and Apple cornering the market for those with money to spend on a more premium experience. Hardware makers are throwing their support behind Chromebooks and Android tablets in a way that didn't seem possible for a non-Windows operating system just a few years ago. Would Hewlett-Packard (NYSE: HPQ  ) have spent $1 billion on Palm if it didn't smell a vulnerability in Microsoft to make Palm's webOS work across its product lines? Big G smells it, too. Google isn't as cheap as Microsoft -- trading at 15 times next year's bottom-line estimate -- but it, too, is worth a hefty premium to Mr. Softy.
  • Activision Blizzard (Nasdaq: ATVI  ) : The country's leading video-game company was "thrown away" in this column nearly two years ago -- and it was the right call. Despite the market's massive rally in that time, shares of Activision Blizzard have barely moved higher. The video-game industry has been in a slump, and few players are excelling. The Xbox and its motion-based Kinect controller are selling well, but why invest in the low-margin side of the business? Software is where the real money will be made. Smaller rival Electronic Arts (Nasdaq: ERTS  ) has made the smarter moves in social gaming and app development, but the top dog will be the one to lead the industry back. Trading at a reasonable 13 times next year's earnings and with another Call of Duty installment on the way in few months, it's time to dust the stock off and put it back on the table. 

I'm sorry, Microsoft. Your shares may seem cheap, but they're not inexpensive.

The Motley Fool owns shares of Google, Activision Blizzard, Microsoft, and Apple and has opened a short position on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Microsoft, Apple, Google, and Activision Blizzard, creating a bull call spread position in Apple, and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (17) | Recommend This Article (9)

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 23, 2011, at 12:03 AM, rockhat wrote:

    I use Linux almost exclusively on the desktop, and am no fan of Microsoft. But this is what you don't get: With control of Microsoft Office, Microsoft can kill anyone else.

    My colleagues at work cannot operate without Excel and PowerPoint. Secretaries and professionals of all sorts cannot operate without Word. I hate these programs and seldom use them, but MOST people live by them. If Microsoft had ported Office to Linux, Windows might be dead. Microsoft did port Office to Macs. If they hadn't, Apple would be dead.

    Same thing will happen with tablets. Everyone will eventually want their table to be compatible with Windows and MS Office. Microsoft controls Office, and will not port it to Android or iPads. As a result, Windows tablets (with Windows 8) will eventually win out.

    Don't underestimate the power of a monopoly. Mr Softy never innovates, never gets there first. But they will eventually kill you.

  • Report this Comment On July 23, 2011, at 1:49 AM, JokerJoey wrote:

    Microsoft will not win this one if only for the reason that the iPad is eating Windows PCs' lunch and will continue to do so. The iPad will sport its own set of spreadsheet and word processing apps (Jeez, but I hate that abbreviated term! ugh!) if only for the fact the if Microsoft doesn't eventually create a version of Office (or its components) that can be bought at a reasonable price in the App Store, another group or groups will put together enough programs that will do the same stuff.

  • Report this Comment On July 23, 2011, at 5:58 AM, forexnutca wrote:

    I will still buy a pc, but may buy a tablet too.....tablets will NOT replace pc's for those of us that sit down and type, game, program, design, and utilize the pc for what it's meant for. For those who are casual internet browsing folk, the tablet may takeover, but Microsoft can buy their way into the space.

  • Report this Comment On July 23, 2011, at 7:20 AM, sept2749 wrote:

    I like MSFT and I'd much rather throw away ATVI. No movement for several years, very small dividend and I know nothing about video games nor do I find them interesting, However, I find MSFT very interesting. I also LOVE Apple and have been holding some since 2009. Msft and Apple are totally different models but MSFT is not what anyone can call shabby.

  • Report this Comment On July 23, 2011, at 9:38 AM, rockhat wrote:

    Just a comment about another group putting together MS Office-like tools and selling them for less.

    I once thought that would happen.

    In fact, Open Office did that years ago (and the cost is FREE) -- and how many people use it? Almost no one. Why? Because MS Office is a world STANDARD. You simply can't change a standard once it becomes a standard. If you change to the Open Office program like MS Word, no one else has it. You can't send them your copy and they be able to read it. Same for Open Office equivalents of Excel and PowerPoint.

    And once a person learns Excel and PowerPoint, they become Excel and PowerPoint addicts. They CAN'T quit.

  • Report this Comment On July 23, 2011, at 11:49 AM, jekoslosky wrote:

    I tossed out ATVI almost two years ago, too (which I wrote about here: http://bit.ly/kezIoL ). But I'm not sure I'm ready to put it back on my watchlist.

    Is there really an impetus to push the stock higher now?

    It's been a while since I really looked at the gaming stocks. Am I failing to see what might now be firing up a new cycle in the industry?

  • Report this Comment On July 23, 2011, at 2:53 PM, demodave wrote:

    Rockhat,

    I think you misuse the term "standard" with respect to Microsoft. It can't really be called a world standard if it is not open in such a way that other programs can open/manipulate/save documents without data loss. In that respect, Microsoft is proprietary. (I'm not saying that's a bad or wrong things, just not a standard.) Realistically, Microsoft is more of a "generally accepted practice". And as such, even though it is "winning" (for which I do give some credit), it is entirely derivative and unoriginal.

    I'm definitely with Rick on this: I don't see Microsoft being *more* relevant in 3-5 years than it is today. By the same token, IBM, which is probably not something a lot of individuals talk about anymore, is up pretty well over the last 5 years. Microsoft, not so much. I guess there is a reasonable difference between relevance and enterprise value. *shrugs*

    DD

    PS I voted for AAPL. :)

  • Report this Comment On July 23, 2011, at 5:19 PM, peter2480 wrote:

    Rockhat,

    Once upon a time there were Wordstar and Multiplan. In this world nothing is unassailable, not even Rome!

  • Report this Comment On July 23, 2011, at 7:42 PM, forexnut wrote:

    AAPL wasn't relevant until the IPOD- Microsoft doesn't have the struggles of producing widgets, but the KINECT is a very interesting I/O device that could potentially change a lot in interaction with technology.

    I look at how many mistakes MSFT has made over the years, and yet the company is still a cash cow....that is MOAT. Ballmer has run the company like a ham, and yet the company still performs well. Imagine for just a second, that MSFT got a new CEO that ran the company well, or the KINECT being used in the medical industry. There is so much that can happen over the next decade....

  • Report this Comment On July 23, 2011, at 8:11 PM, INEAUX wrote:

    MS Office might be the standard, today, but that doesn't mean it'll be in corporate suite five years from now. One half of a decade can bring a lot of change.

    In 2006, iPods were Apple’s shining stars. The iTunes Store was nascent. And most computer users viewed iMacs, Mac Books, and Mac Pros as unfathomable instruments. (The iPhone debuted in 2007.)

    Five years from now, iPads, Chromebooks, smartphones, laptops, etc. will be a part of the seemingly distant past. Instead, a password, a thumbprint, or a credit card sized tool will allow us to employ any dumb terminal (like a TV or stationary kiosk) as a portal to the Internet. Or we may use devices that are as light, thin and malleable as a piece of linen.

    However we connect in 2016, the majority of our data and almost all of our software will be in that large and enigmatic cloud. Cumbersome operating systems and mammoth memory will move to technology museums.

    And, one half a decade from now, should Office continue to be the business standard, Microsoft (or Dell or HP or any number of technology companies, for that matter) will be no more than a bit (pun may be intended) player. The future goes to innovative organizations like Apple (i.e., Google, Netflix, and Amazon) who've already created the map.

  • Report this Comment On July 23, 2011, at 10:16 PM, bglasco wrote:

    If Microsoft pooped gold bricks you would find something to complain about... Microsoft has an extremely bright future as no one else has the capacity or the ability to innovate in such a diverse fashion. Apple and Google are both over hyped and while their stock is extremely overvalued, their hay day won't last much longer. Microsoft is gaining momentum and I can see them gaining ground and market share leaving everyone else in the dust!!!

    Just because you hate the company, you shouldn't allow your personal feelings to impact your editorial integrity.

  • Report this Comment On July 24, 2011, at 2:52 AM, jcanuck66 wrote:

    Very possibly one of the worst analysis I have ever seen, on this site or otherwise. I'm not even sure where to start on this one. The company reported significant growth in all areas except Windows. The Entertainment and Devices division, which is responsible for those low margin Kinect/Xbox devices you mentioned, doubled its operating income to over $1.3B in a year.... The deal with Nokia will mean, even if Nokia lost 50% of it's market share, 50 million new devices per year running Windows. I could go on, but I think you get the point. Glad I'm not relying on you for my ongoing investment advice.

  • Report this Comment On July 24, 2011, at 9:57 AM, David369 wrote:

    In the last 10 years MSFT stock price has stayed mainly between 25 to 30 dollars while AAPL has gone from 8 to almost 400 dollars. MSFT might be a great company but it would not have made me any money for the last 10 years. I see no reason to expect MSFT to do any better in the next 10 years. AAPL, who knows, but at least their track record has been great in the past and I would put my money there before I would even consider MSFT.

  • Report this Comment On July 24, 2011, at 11:31 AM, cimarron430 wrote:

    For the past ten years I have have owned MSFT (and AAPL for just a couple). One has flatlined after loosing 25% of it's value and the other, well, everybody knows that story. I hung on to my value-dropping shares of MSFT thinking that the talent and the resources there would eventually find the "right stuff" and make a comeback. At this point, I have lost faith entirely in the prospects of MSFT. Yes, Office is a staple in the corporate and academic worlds, but Apple's new Intel chips allow people to use their Macs to speak Office interchangeably, and thus fit into that "standard." When Apple made that change, I decided to fold my MSFT tent. In my opinion, there is nothing left at MSFT but a bright history.

  • Report this Comment On July 24, 2011, at 12:18 PM, shamapant wrote:

    Google Docs, and iWork are slowly making their way through the gates. I am pleasantly surprised that you had the guts to throw MSFT away at this 'value' of a pricing, I agree whole heartedly

  • Report this Comment On July 24, 2011, at 5:26 PM, pscholte wrote:

    I'm writing this on an HP, not an iMac but I will tell you it is a "cloudy" Apple world. Microsoft is ONLY hanging on due to thier early lead and momentum. Their software is awful. Don't any of you tell me you never see "Internet Explorer has stopped working" or "Microsoft Excel has stopped working" "Windows is looking for a solution." "Drat, for the millionth time, Windows cannot identify the error." The Apple "trust me" commercial when Windows 7 came out was SO right!

  • Report this Comment On July 25, 2011, at 11:26 AM, goscuderi wrote:

    Well Mr. Munarriz, it would appear that Mr. Davenport strongly disagrees with you and every other Softy naysayer in these posts. Personally, I own AAPL, GOOG and MSFT and at this point I wouldn't sell any of them.

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