Yes, that is an intentionally provocative headline. I did buy shares of Microsoft (NASDAQ:MSFT) last week for the first time in my 35-year investing life, and I'll share the reasoning today. But I hope that you responded with a combination of both "Hmm, I'd like to see why" and "Who cares what that so-and-so does?"
So what?
Many readers generously keep in touch to help me think and grow as an investor. Recently, a retired broker with decades in the business very thoughtfully took me to task for owning Altria Group (NYSE:MO) and UST (NYSE:UST). He strongly objects to owning tobacco shares -- and has every right to do so. (I've thought long and hard about it, believe me.)
He maintains that the strongest advice to anyone is what a person does. He believes that when people see that I own certain stocks -- every Motley Fool employee discloses all stocks they own on their online profile -- they will follow the example. He thinks no amount of disclaimers will change that.
I respectfully disagree.
We at The Motley Fool believe firmly that you should know where our money is, not just our mouths, and we tell you -- in a disclosure policy second to none. But no person here invests exactly as any other -- we are a Motley Fool indeed. So it's doubly important that when you see a stock, you examine its context by following our writers and analysts. Their bios and archives are readily accessible by clicking their picture wherever they appear and by using the "Browse Stories by Author" drop-down menu on our main page (mine is right here). Get a flavor for how they size up investing.
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No investing philosophy, unless it is just a carbon copy of someone else's approach, develops in its complete form in any one day or year. In my own case, it grew over a considerable period of time, partly as a result of ... logical reasoning, and partly from observing the successes and failures of others, but much of it through the more painful method of learning from my own mistakes.
As any parent who was ever a child knows, no matter what you do or how much you teach, the most important lessons are taught by one's own experiences. We want to be a part of those with you every day, but we know that at the end of that day, you will walk your own walk.
Why Microsoft?
So how does Microsoft fit in my personal investing sauce?
I've long admired Microsoft for its dominant business position, high gross and net margins, strong free cash flow production, sparse but smart acquisitions (such as Great Plains Software), and its move last year to a software subscription model. I've been excited by its innovation, even when forays into other businesses haven't succeeded. Great ideas mean the occasional great failures.
But I haven't considered the company for purchase until recently because the stock was overvalued and management continued to use stock options heavily for compensation when the arguments for such an established company to use them had passed.
Then two things happened: Matt Richey analyzed its more favorable valuation for our "Stocks for Mom" Mother's Day feature, and management made the smart decision to grant actual stock in the form of restricted shares rather than stock options. Last week, I bought the first shares I've ever owned and plan to add periodically.
Right for you?
Should you buy Microsoft right now? It depends on your strategy, your needs. For me, a stock must fit into various ways that I manage risk and return in three broad categories of stocks: dividend-paying and large, dominant companies that can still grow; small-cap value; and informed speculations.
Take that last category, which includes companies that represent great risk for many reasons. For example, a newer and unproven company may have great promise and may be growing aggressively, but it may not succeed. Another with complex products presents great risk because even a potentially world-changing technology can be superseded by the next innovations that will certainly come someday. Microsoft is not a rip-roaring sexy "tech" stock, appropriate for the more speculative part of your portfolio. No longer enough sizzle (risk) for the steak (upside).
It doesn't fit the second category, either. Hardly small cap, Microsoft is neck and neck with General Electric (NYSE:GE) as the No. 1 or 2 company in the U.S. by market capitalization each week.
What about that dividend?
Microsoft fits into the first category that includes large, dominant, or dividend-paying companies that still have potential for growth. The company is so dominant a business and consumer brand -- who doesn't know the company or see it when they sign on in the morning? -- that it is unlikely to be displaced. Matt persuasively makes the case in his "Stock for Mom" piece that not only does its core business offer a predictable, growing revenue stream, but it continues to explore other ventures with growth potential, too. It will fail in some and succeed in others, but it's not managing for a yawn. And Matt makes an excellent case that it's currently undervalued.
But there's an interesting twist on the dividend side. While the current dividend -- $0.08 a share or 0.29% -- is, like Intel's (NASDAQ:INTC), visible only with a microscope, Microsoft is a huge cash machine that will undergo more and more pressure to increase that dividend payout. As long as it keeps the free cash flowing, increasing the payout won't seriously hinder its ability to invest in its own or others research and development and maintain a reserve against possible litigation losses.
Here's how the last four years might have looked if Microsoft paid out 33% of its free cash flow in dividends each year:
Fiscal Year Ending 6/30 2000 2001 2002 2003* ($bils. unless noted)Cash and equivalents $23.8 31.6 38.6 46.2**Net cash from operations $11.4 13.4 14.5 17.5-Tax benefit from stock options $5.5 2.1 1.6 1.3-Capital expenditures $0.9 1.1 0.8 0.8 =Free cash flow $5.0 10.3 12.1 15.3Payout ratio 33% 33% 33% 33%Cash for dividends $1.7 3.4 4.0 5.1Basic shares $5.2 5.3 5.4 10.7***Dividend per share $ 0.32 0.63 0.74 0.476/30/03 stock price $80.00 73.00 54.70 25.64Dividend yield 0.40% 0.87% 1.36% 1.84%
*First three quarters annualized.
**As of Q3 2003.
***2-for-1 split 2/18/2003.
No, a 1.84% dividend is not huge, but this shows the potential for a small, though growing, dividend -- a dessert, not the main dish of stable growth.
With its ability to produce consistent and growing FCF (with the potential to return a reasonable share to stockholders in a larger and now lower-taxed dividend), financial statements I can understand (as opposed to General Electric's, for example), and management that has taken some positive steps, the stock price will follow. I learned from my colleague Matt's thinking, but in the end made my own decision to include this stock in one category of my portfolio.
But whether Microsoft is for you is up to you alone. Two great places to start are with the company's financial statements and our discussion board, where other Microsoft investors share options and resources such as this provocative interview with company senior management.
Have a most Foolish week, and thanks for reading!
Writer and senior analyst Tom Jacobs (TMF Tom9) writes commentary on Fool.com each Tuesday and short Takes throughout the week when issues catch his attention. He welcomes your comments at [email protected]. For individual financial advice, enjoy your free TMF Money Advisor trial today! Tom owns shares of Microsoft, Altria, and UST, and others you can find in his profile . The Motley Fool isinvestors writing for investors.
