Reasons to buy
Microsoft is a cash generating powerhouse. The company prints over a billion dollars of cash flow per month. Moreover, Microsoft has a ttm profit margin of 28 %, an operating margin of 39%, and a return on equity of 54%.
In addition to those very attractive profitability ratios, Microsoft has very little chance of declaring bankruptcy in the foreseeable future – zero chance in my option – which is very important given current market conditions. With a debt/equity ratio of .06 and a current ratio of 1.52, Microsoft is about as solvent as water! This software giant also has 20 billion in cash and only 2 billion in debt. The large cash position is great because it gives Microsoft the option to acquire other companies or buyback their stock at depressed levels. You Always Have Other Options right?* Tell that to Jerry Yang!
In addition to sound solvency ratios Microsoft is currently yielding 2.7%, and sports a trailing twelve-month price/earnings multiple of 10.1 compared to an industry average multiple of 14.1.
Aside from strong fundamentals Microsoft also has a several interesting prospects. Firstly, Microsfot has signed a deal with major health insurer Aetna that will allow patients to access their health record via Microsoft’s HealthVault platform. Microsoft is also looking to expand their exposure to the rapidly growing search advertising field – either organically with Live or by the acquisition of a search platform such as Yahoo’s.
Reasons to be wary
A large portion of Microsoft’s revenues come from selling software such as the Windows OS and Office suite. This software is typically sold when someone buys a new PC. The global slowdown will indubitably mean slowing PC sales growth even when we consider emerging market growth. Moreover, piracy is a huge risk for Microsoft going forward. In China, Most Windows OS’s (90% according to one study) are pirated. Everyone knows the Chinese do not fully grasp the concept of intellectual property rights. If you want evidence of this just take a stroll down Canal Street - “Gucci!, Prada!, Gucci!, Prada!”. I foresee the relative ease at which programs can be pirated as becoming a bigger and bigger problem as Microsoft expands its software business into the poorer emerging markets.
Another risk is that posed by search giant Google. Not only does the GOOG control about 70% of the search market but it is also starting to infringe upon Microsoft’s territory via browser based applications such as Google Spreadsheet (which is like Microsoft’s Excel). Though these browser based applications are not a real threat yet, they could become one in the future.
Despite the risks I like MSFT because of its strong cash position, ability to generate additional cash, and strong product pipeline.
*Yahoo! Is commonly mistaken to be an acronym for You Always Have Other Options – when really it is an acronym for Yet Another Hierarchical Officious Oracle.
Disclosures - None
