For nearly every piece of software that Microsoft (NASDAQ:MSFT) produces, there's a competing alternative available, often free. Butting heads against Windows, for instance, there's the "free" Linux operating system, which you can download and install from the likes of Red Hat (NASDAQ:RHAT). Likewise, there are a handful of free productivity suites, like StarOffice and OpenOffice, attempting to horn in on Microsoft's Office package. Yet in spite of competing with folks willing to give away their products, Microsoft manages to sell its wares for substantial profits. In fact, the company's operations threw off over $2.2 billion in cash flow in the last quarter alone. How can that be, if consumers are price-sensitive and Microsoft is going up against the ultimate discount -- free?

The answer is simple. The company excels where few others play -- in providing end-to-end functionality and value. In business, what matters is the total cost of delivering a product or service, not just the sticker price. When you buy a Microsoft product, you get software that is typically:

  • straightforward and easy to use
  • supported by a very large player in the industry
  • automatically patched when a bug or vulnerability gets repaired
  • instantly interoperable with other Microsoft tools and the general public at large
  • stable enough to support ordinary working conditions

All that, put together in a package that delivers the most critical features, is certainly worth something. Specifically, it's worth enough so that thousands of businesses make the decision to go with Microsoft's products over competitors offering lower sticker prices.

Toward a brighter tomorrow
In spite of Microsoft's strong financials and ubiquitous product suite, the past few years have been brutal on its stock. In recent years, almost nothing has gone right for this tech titan. Who would have imagined that digital music would have revived the fortunes of one-time operating system sparring partner Apple (NASDAQ:AAPL)? Or that fellow intellectual property giant IBM (NYSE:IBM) would throw its considerable weight behind the open source movement? Add frequent trips to international antitrust courts and delays in shipping the next generation of its flagship Windows and Office products, and the result is a once-mighty firm that now appears to be hobbled.

Of course, it's precisely that appearance of weakness that attracted Motley Fool Inside Value lead analyst Philip Durell to Microsoft last October. Were the market always rational, companies would be valued solely on their potential future earnings, not their past results. When the market focuses exclusively on such backwards-looking problems (such as Microsoft's), it can easily ignore the future and undervalue the company. That gives you, along with other value investors, an opportunity to profit.

There are three primary reasons to believe that Microsoft's future looks brighter than its recent history. First, both the long-awaited Vista operating system and Office 12 will soon be released, starting another round of must-have purchases. Second, include new technologies like the 64-bit multicore processors now emerging from Intel (NASDAQ:INTC) and Advanced Micro Devices (NYSE:AMD), and there is a real reason to believe that the Windows upgrade cycle will both continue and pick up speed. Finally, having learned how difficult it is to play catch-up, for once Microsoft actually has the first mover advantage in the gaming business. Its Xbox 360 launched late last year, well ahead of archrival Sony's (NYSE:SNE) new PlayStation 3. It's generally believed that Microsoft loses money on each Xbox console sold, and therefore the early months will likely be rough. In the longer run, however, the licensing revenues gathered from game producers and its own titles are expected to more than make up for any shortfall on the hardware.

The Foolish bottom line
Although the headlines may be anticipating more trouble, Microsoft still dominates its industry. With internal and external product drivers pointing to a renewed upgrade cycle, the fear of stagnation that has haunted the business should soon be put at bay. Add its position as the first-to-market on the next-generation video game console, and you have a company poised to excel. The past's bad news is largely priced into the company, improving the likelihood that any future surprises will be positive. What's not to like about that picture?

Do you like the idea of buying companies whose shares have been beaten down so far that virtually any news will be good news? If so, Inside Value is for you. Click here to start your 30-day free trial and see just how we find and buy those firms. Subscribe today, and we'll not only knock $50 off the regular price, but we'll throw in a copy of Benjamin Graham's The Intelligent Investor, as well as access to the Fool's Stocks 2006, absolutely free.

Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Microsoft. The Fool has a disclosure policy.