Re-Energized Microsoft Presents Opportunity For Investors

Apr.11.13 | About: Microsoft Corporation (MSFT)

After being a market leader in the technology sector for a decade, Microsoft (NASDAQ:MSFT) has now been a backbencher for some time now. And this is not about its core business, but about its non-core smartphone business, which is now the most attractive segment in the market. The company has been unable to tap into the exponentially growing smartphone industry in the last decade. The good news, though, is that its search engine Bing has been picking up and is now the third most popular search engine in the world. That is not an irrelevant statement because as we will see shortly, Bing has a lot to do with Microsoft's inroad into the smartphone industry.

Microsoft will release its quarterly earnings on the 18th of April, 2013. Analysts expect the earnings per share to grow at the fastest pace in the last two years, 77 cents/share i.e. 28% higher than the 60 cents it earned a year earlier. These expectations stem from the optimism regarding the company's progress and climb in market shares in various businesses it has forayed into.

The closing price of the stock on 9th April was $28.58.The stock is currently on a bull run, probably due to the market expectations from the rise in earnings in the last quarter. But the question is how the stock will perform over the next few quarters, amidst the rapidly launched innovative products by its competitors almost every day.

Core Business

Microsoft's core business of desktop/laptop operating systems, which provides a platform for a number of proprietary software like Microsoft Office Suite, has been greatly helped with the launch of Windows 7 in the last few years. But, due to a not so successful reception of Windows 8 by consumers, the company has been planning to come up with an improved version quickly to sustain the core business advantage in the near future.

This spontaneity in releasing improved versions (Windows 7 after Vista) builds a positive impression about the company in the minds of the investors. One limitation for Microsoft has been reluctance to launch the iPhone compatible office suite. This has been repelling a lot of faithful Apple (NASDAQ:AAPL) consumers away from Microsoft. This is effectively a substantial loss in the marginal earnings, and ultimately the bottom line. Overall the core business of the company, especially the Windows division, is expected to provide sustainable earnings to the company in the foreseeable future as well.

Smartphone Business

Microsoft signed a deal with Nokia (NYSE:NOK) to provide a Windows platform in Nokia devices, in order to counter its competitors Apple and Google (NASDAQ:GOOG) in the smartphone platform segment. Though the combined market share of Google and Apple is almost 90%, the market share of Microsoft is gradually increasing with the help of the recently launched Nokia Lumia devices. It is expected that the company will soon occupy the third place in the mobile OS industry. The deal is also expected to increase the company's revenue from the use of Bing in Nokia's devices with the help of mobile ads.

Microsoft also launched its Surface tablets last year, which has now picked up sales and is expected to increase the income after tax of the company by at least $3 billion. Surface has been well received by the consumers and the sales are expected to pick up even further. The company is famous for taking its competitors head-on and that reflects the company's confidence in its products. Microsoft recently took Google to court regarding privacy issues in some of its Android run applications, a move that could attract consumers to its competing Windows 8 applications. This might now help in the increase of earnings for the company, and it will help it to make some non-users interested in Windows 8. These developments over the past few months should affect the company's bottom line positively and therefore should give sufficient returns to the investors.

Fundamental Analysis

The P/E ratio of the company is the lowest among its peers in the industry. The PEG expected for the next 5 years is 1.11. Its EPS growth rate is higher when compared to the software industry or to even the whole technology sector. The company's EBITDA margin is at nearly 40%, compared with 19% for the S&P 500. The P/S ratio of the company is 3.48 as compared to an industry average of 2.84. These factors signal that the stock is fundamentally undervalued and is expected to reach its fair value sometime in the future.

The operating profit margin for the company was 0.35 in the last released quarterly results, which is higher than both Apple (0.33) and Google (0.27). Even its gross profit margin (0.75) is higher when compared to the industry average (0.69). The dividend yield of the stock was 3.2%, which is among the top five yields in the industry. The company's long-term growth rate for five years is 22.62%, which is believed to be high for the industry. All these figures suggest that the company is poised to perform well fundamentally in the long term.

What buy Microsoft?

The company is making inroads in the smartphone platform segment with the help of Windows 8-enabled Nokia devices. Despite being a late entrant in the industry and losing out on an amazing growth opportunity in the last decade, it has become a noticeable competitor to the market leaders. It is the fastest growing mobile OS in 2013 so far. With some mid-end Lumia phones still to be launched, the market share is expected to increase further. Though the future of this business for the company is far from being certain at the moment, recent progress should make the investors bullish in the medium to long term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.