Microsoft (NASDAQ:MSFT) has been a hotly debated stock for a while now. Its new Surface tablet has been cheered by some and hated by others, along with the new Windows 8 software and the Windows smartphone. CEO Steve Ballmer has been largely inefficient at product development and innovation since he took over in 2000, which has led to the stagnant price action that Microsoft's stock has seen over the last decade. But at some point, Microsoft has to become a "buy." Is that time almost here?
The one main argument Microsoft bulls tend to make is the dividend. The burst of the tech bubble in 2002 and the financial meltdown in 2008 have severely hindered Microsoft's stock performance since the new millennium began. But with a large cash pile, the dividend payments have continued to flow. With a yield of 3.5%, Microsoft does do a good job of raising and paying its dividend, even if the stock performance has been mundane for quite some time. Below is a quick look at Microsoft's annual dividend payouts for the last 10 years:
It's important to note that in 2004, Microsoft paid a special dividend payment of $3 per share, but is excluded in the graph above for visualization purposes. The dividend has begun to rapidly increase over the last few years, at least giving shareholders something to be happy about amidst the lackluster stock performance.
But perhaps shareholders and other investors have another reason to be getting slightly bullish on Microsoft: valuation. While we won't know the full extent of the new products Microsoft has recently launched for several quarters, the company is still a cash cow.
So it lacks innovation and the share price has been stuck in the mud for a while. But eventually it gets too cheap to ignore. Despite the evident flaws that Microsoft has, there are several reasons to own the stock here. For starters, Microsoft still sells a lot of software. Despite the dominance that Apple (NASDAQ:AAPL) has in the technological world, Microsoft still remains a dominant player.
To take this one step further, let's analyze the revenue growth and then later look at the cash flow statement. We'll start with revenues, where we'll examine six fiscal years in total: the previous three years (2009-11), the current year (2012), and the next two future year's estimates (2013-14). Below, the revenues:
Revenues (In Millions):
(*) = Indicates that these are estimates for this fiscal years of 2013 and 2014.
As you can see, Microsoft has done a decent job boosting revenues over the last four years and is expected to increase them over the next two years as well. While these numbers aren't stellar, we're not talking about a mega-growth company either. Microsoft is in a matured state. It is no longer the growth giant it once was, although it is trying to break that cycle with its new products.
Historically, Microsoft has traded with a relatively low P/E ratio -- at least in the past five years or so. I will view Microsoft based on its P/E ratio, in an attempt to see if it has reached the critical "buy" levels that is has in the past. Currently, Microsoft has a trailing twelve month ((ttm)) P/E ratio of 14.6. The industry (Software & Programming) has a P/E ratio of 18.6, suggesting Microsoft is undervalued when compared to its industry and competitors. Taking the P/E ratio one step further, Microsoft's sector (Technology) trades with a ttm P/E ratio of 19.2, again suggesting Microsoft is undervalued compared to its sector peers.
For more visual proof, let's take a look at the charts. Below I have two charts, a 3-year chart and a 5-year chart. On both of the charts I have plotted the ttm P/E ratio and the ftm P/E ratio. I'll present the charts and then discuss them in the following paragraphs. Below, the charts:
When looking at the 3-year chart, I am mainly focused on the ftm P/E ratio, although it does include the ttm P/E ratio as well. Microsoft is trading in what is typically seen as the "bounce territory," when looking at valuation alone. Moving on to the 5-year chart, we can see that the chart is not as visually appealing as the 3-year chart (due to the longer time horizon). However, we can see that when the ftm P/E does go below 10, Microsoft typically rallies back, something many shareholders are waiting for. Below is a table of the P/E ratios for the trailing twelve months, 2013 and 2014:
((ttm)) P/E Ratio
2013 P/E Ratio
2014 P/E Ratio
As you can see on the simple table above, Microsoft has a very low valuation headed into the next two years, especially when considering that it is already undervalued when compared to industry peers. Focusing on 2014, Microsoft trades with an extremely favorable PEG ratio as well. The PEG ratio measures the valuations of a stock, relative to its growth. The figure is derived by dividing the P/E ratio by the annual EPS growth. The EPS growth for 2014 is 11.5%. Below is the equation, with Microsoft's numbers entered in:
8.4 (2014 P/E ratio) / 11.5 (2014 EPS growth) = .73
A PEG reading of 1 would suggest that the stock price is fairly valued. A reading over 1 would indicate a potentially overvalued stock and a reading under 1 would indicate a potentially undervalued stock. With a measurement of just .73, this would indicate Microsoft is trading at an undervalued state when looking out to 2014.
In another attempt to show Microsoft is continually growing, let's look at its cash from operating activities. This is considered by many investors as the most important piece of information from the cash flow statement. I will show the last four years, from 2009-12, and how Microsoft has been able to continually grow this figure.
Cash From Operating Activity
Cash From O.A.
The chart above helps bring it all together for me. When looking at the long-term charts, I can visually gauge when and where Microsoft will hit that critical "buy" zone that I have been talking about. But by using the table above, coupled with the revenue growth table and valuation measurements, I know stepping into Microsoft is a safe play.
How To Play
Currently, there are no options setups that I particularly like, but I do prefer to sell put options on Microsoft. My goal would be to receive assignment on one of these cash-secured puts, although it has yet to happen so far. Still, the premium received is nice, and I am okay if that's all the ever happens. I prefer to sell the $25 strike put when Microsoft is trading in the mid- to upper-$26 range.
The contract typically sells in the $.30 to $.50 range when I am targeting it. Typically, the contract has about 35-45 days left until expiration. Again, if an opportunity were currently present, I would outline the trade, but it is not. If assigned -- meaning if Microsoft were to close below $25 on the expiration day -- my cost basis would be relatively low, in the $24.50 to $24.70 range. At this price, I would be more than okay owning shares of Microsoft.
With Microsoft's most recent earnings report, it provided a much needed boost to the tech giant to lift it from its current trading range. Still, there's not an options setup I'm particularly fond of. If the stock trades back down to the $26 range, I would again be a put seller. If the new breakout holds, I would wait to see the price level that Microsoft can hold, before selling puts.
Microsoft once took the world by storm with its monopoly-like dominance on the software market. It's not that this no longer exists, it just doesn't present the growth that it once did. That's okay for some investors though. Not all investors are looking for the volatility or frustration that comes with owning growth giants. Just look at the ride Apple investors have taken in the last year.
To tell you the truth, I don't think Microsoft will really hit a home run with any of its new products. That's not to say it won't, or that it's not achievable. I'm just simply stating that I don't see it happening. Perhaps the Nokia (NYSE:NOK) phones will catch on and sell millions upon millions of units, in which case Microsoft will make a lot of money based on the agreement between the two.
Furthermore, when looking at tablet sales for Microsoft, the numbers come in extremely light. The Surface tablet reportedly only sold 1 million units in 4Q 2012. 1 million? And everyone is on Apple's case when it only sold about 20 million.
But hey, maybe the Surface tablet will work out. Perhaps consumers will want computers and notebooks that can easily sync with their tablet's, with all of the devices running the Windows 8 software. The tides may turn, this time in Microsoft's favor. However, historically Ballmer has dropped the ball -- pun intended -- and has failed with many of Microsoft's ventures. I'm honestly surprised he's still the CEO.
Despite the failures of recent products, as well as any future failures, Microsoft still pays a juicy dividend, and is rapidly approaching valuation 'buy' levels. The explosive growth is long gone, but Microsoft is a solid, fundamentally sound business flush with cash. Without any of these products working out, it will still generate substantial cash, which will help it maintain the price range it has been in for the past several years.
Sometimes consistency is better, depending on the investment goals. And Microsoft is consistent. Right now, shares yield about 3.3% with a $.23 quarterly dividend. The kicker? Microsoft has the potential to reach its growth "sweet spot" once again. If one or more of its new products -- the Windows Phone, Surface tablet or the new software -- really takes off, expect the share price to go with it. The way I see it, buying Microsoft below $25 or $26 is a steal, based on valuation and dividend payouts.
One of the many current products is essentially a "lotto ticket" for future capital gains. If none of them pan out, Microsoft will continue to roll in the dough, kick it out to shareholders in the form of a dividend, and likely float in the same range it has been for quite some time. Right now it is at the bottom of that range. Again, it is not for every investor, but Microsoft is presenting a good buying opportunity based on valuation levels.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.