A year ago, we asked if Microsoft (NASDAQ: MSFT) was a value stock and the answer was yes. This would have been a big shock to any investor 15 years ago. But times have changed. Unfortunately, Microsoft has made many mistakes over the years. They have allowed younger rivals to take charge, just like MSFT once did to IBM (NYSE: IBM).
As shrewd investors, we need to look past some blemishes to find true value. Often, good stocks to buy come with dents on them. The question is how serious are they and at what price?
Shares of MSFT took a small hit last week off the news that the head of Windows is leaving. Microsoft also had a poor earnings report a few weeks ago. The stock is currently at $26.73.
Let's look at some numbers. Microsoft is expected to earn $3.21 per share for next year's calendar year. Microsoft's fiscal year ends in June, but we're using the calendar year for easier comparisons. This means that Microsoft is selling at just 8.4 times earnings, while the S&P 500 is selling at 12.2 times next year's earnings. That's a steep discount.
Meanwhile, Microsoft continues to generate strong cash flow. We really like the 15% bump of their quarterly dividend (from 20 to 23 cents per share) a few weeks ago, bringing the yield to 3.4%. We believe this gives Microsoft a fair value of $40.
Of course Microsoft may drop further. However, if investors build a diversified portfolio of several stocks going for good prices, over time they should perform well.