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.