Buying Microsoft Here

There seems to be some perverse human characteristic that likes to make easy things difficult. - Warren Buffett

And this investment should be an easy thing. Microsoft (MSFT) is now trading at $19.82 with a market capitalization of $176.31 billion. Financially, it is a very strong company:

My investment strategy here is to buy Microsoft at $19.82 and write (sell) a covered call for Jan 2010 with a strike price $15.00, a one-year leap that will fetch a premium of $6.40. The net cost of holding the stock will be $13.42. The investor has an obligation to hold the stock until January 2010.

What are the different scenarios that can happen in the next year?

Worst-case scenario: Every investor understands this scenario, so I am just writing it to be clear. If for some reason the company stock price goes to $0, the investor will lose $13.42.

14.4% return scenario: If the covered call is exercised some time between now and January 2010, the investor will make a profit of $1.58 per share. In other words, the buyer of the covered call will purchase the stock at $15.00 per share and the investor’s cost price was $13.42. The investor will collect dividends too. Including dividends, the return will be approximately 14.4% (11.7% profit + 2.7% dividend).

Covered call is not exercised: This means that after one year we are holding the shares at a cost price of $13.42. Let us add 15% to our cost price, because we were holding for the past year and we think our money is precious, which means ($13.42 + $2.03) $15.43.

Is the company undervalued at the investor’s cost price or not ? Let's see the financial metrics at the cost price of $15.43:

Even if Microsoft misses the earnings by 50%, the price to earnings multiple will be 14; that is still decent for a company like Microsoft.

To summarize, in the case where the option is exercised, the investor will make 14% return or will be holding the stock at a valuation of $130 billion. Remember, it includes 15% premium of our cost price.

So, what are you waiting for?

Disclosure: Author holds a position in MSFT. He is a very small individual investor and does not work for any financial firm.

Comments

[vicsin:]

Not a very bright move. To have to hold on to a stock like Microsoft for a year to make 1.58. Ridiculous, one piece of good news about the economy and you can make that 1.58 in 2 days and that will happen several times in the next month or two. Microsoft is an excellent company and to do this is akin to stepping over dollars to pick up pennies. Why not at least sell the 20, even still though not very bright.

Jan 14 09:17 AM

[jenny:]

I like how you layed this out clearly with the best/worst case scencarios. Although a year for 1.58 does sorta seem like pennies. But hey in this market some people will take what they can get. MSFT has had a sorta rocky past month, sentiment everywhere. Investors seem to be getting more bullish on MSFT (www.predictwallstreet....) although on this chart I noticed in the past month sentiment was pretty bearish when the price shot up so who knows. And what about that possible Yahoo deal looming?

Jan 14 02:33 PM

[Infinite loop:]

Ignore the "poor perception" of MSFT at your own peril. If MSFT is so great, then why has the stock dropped 68% over the past 10 years while the company has grown revenue 100% over that same time frame?

Until you learn Behavioral Finance, you're doomed to follow the heard off the cliff.

Biased Data Mining is a fools game..... But I wish you luck all the same.

Jan 14 03:04 PM

[Tom B:]

You can't get 2.7% return somewhere else? Maybe some company that actually makes a product or two going out and worth buying?

Jan 14 04:47 PM

[donzelion:]

Perhaps in fifty years, folks will be speaking of MSFT much as they speak of JNJ today..old, steady, reliable. I own both MSFT and INTC, both dominant, wide-moat entities in their field. Of the two, I'd say MSFT's moat is the wider one - and MSFT has this odd habit of adapting and dominating every time the market changes to make their destruction inevitable... I would like to see MSFT come up with a better plan than buying Yahoo though (c'mon, Yahoo? Puhleaze...try NYT, for instance...and give it away free on the next Zune/e-book reader).

Jan 15 09:29 AM

[Tom B:]

Intel has a moat: AMD, it's closest competitor, offers no substantive adavantages. Typically, AMD's chip offer no adavantages at all.

MSFT has no moat: 100% of their business model revolves around people be too technologically uniformed or timid to dump MSFT's products. MSFT has the same "moat" GM thought it had before they got rolled over by Toyota and Honda. Further, if this "cloud" thing catches on, MSFT falls further behind, because online work requires reliability and security and MSFT does not DO reliability OR security.


On Jan 15 09:29 AM donzelion wrote:

> Perhaps in fifty years, folks will be speaking of MSFT much as they
speak
> of JNJ today..old, steady, reliable. I own both MSFT and INTC,
both
> dominant, wide-moat entities in their field. Of the two, I'd say
MSFT's
> moat is the wider one - and MSFT has this odd habit of adapting
and
> dominating every time the market changes to make their destruction
inevitable...
> I would like to see MSFT come up with a better plan than
buying
> Yahoo though (c'mon, Yahoo? Puhleaze...try NYT, for
instance...and
> give it away free on the next Zune/e-book reader).

Jan 15 09:54 AM