This is part of The Motley Fool's annual "Stocks for Mom" special.
Microsoft (Nasdaq: MSFT)
Trading at $26.13 as of May 2, 2003
Mom, the stock idea I have for you is one of the most successful and perpetually underrated companies of all time: Microsoft(Nasdaq: MSFT). Thank goodness you're out of touch with the Wall Street way of thinking, because otherwise you'd probably think a company this big and well-known couldn't possibly be undervalued. But pay no mind to that nonsense.
Investors are overlooking the obvious -- which is that Microsoft continues to find new avenues of growth, all the while spinning out absolutely jaw-dropping amounts of free cash flow. Add in a stock that trades at a low multiple to that free cash flow, and you have the makings of a market-beating investment. It's really that simple, but I know you're detail-oriented, so let me fill in the gaps for you on my investment thesis.
The past three years have been tough for technology companies, but Microsoft has shown a unique ability to grow through these tough times. Despite all the woes in IT-land, it has grown its top line by 12.8% annually from 2000 to 2002. And this year, fiscal 2003 (ending in June), it is on its way to another year of double-digit revenue growth, probably around 13.2%.
This year's strong growth has been in no small part due to Microsoft's switch to annual subscription-based pricing of its software, which began in July 2002. Its large business clients were "motivated" to switch to the subscription plan or risk facing much higher prices when their license renewals came due. Such strong-arm tactics caused consternation among many of its customers, but in the final analysis they paid up. That's the power of a monopoly, and that's why Microsoft is underrated in my book.
This new annual fee form of software pricing is a boon for the company, as it positions itself to deliver very reliable revenues and earnings in the years ahead. Gone are the lumpy results and business uncertainty caused by one-time license fees. Now, whether Microsoft has a major innovation or not, the revenues and earnings will keep rolling in. It's an investor's dream come true: a predictable, rising earnings stream.
But Microsoft isn't just resting on its laurels. In the past year, the company has been hard at work on a number of new initiatives:
- The Tablet PC promises to be a digital replacement for your legal pad.
- The Xbox Live online gaming service has attracted more than 350,000 subscribers -- an impressive start since its Nov. 15, 2002 launch.
- Smart watches feature local weather forecasts, stock quotes, traffic information, and sports scores, for example, all at the flick of a wrist.
Finally, and most importantly, Microsoft offers a good investment value. For starters, the company has an amazing war chest of cash and investments worth $59.2 billion, or $5.45 per share. Then, when you back out that sum from the current stock price of $25.80, you find that Microsoft has a price-to-free cash flow (P/FCF) of 15.7. That's a discount to the S&P 500, which carries a P/FCF of 17.9.
How could Microsoft, with such unparalleled dominance and good growth prospects, not deserve at least a market average P/FCF multiple? If Microsoft were granted a P/FCF multiple of 17.9, it would be worth nearly $29. And there you have it, Mom -- an investment in the world's greatest legal monopoly has the potential to deliver a 11% return, just assuming an average valuation.
Happy Mother's Day!
For all moms -- and non-moms -- who want to discuss Microsoft, bring it to our award-winning discussion boards (free trial required).
Matt Richey ([email protected]) is a senior analyst for The Motley Fool. At time of publication, he held no shares in Microsoft. For Matt's best stock ideas and exclusive in-depth analysis each month, check out our newsletter, The Motley Fool Select . The Motley Fool is investors writing for investors.
A Stock for Mom represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts.
