Microsoft (NASDAQ:MSFT) is up about a $1 a share today in midday trading. The company delivered an earnings report after the bell Thursday that beat investor expectations. I predicted this in a recent article arguing that the slowdown in PC sales was fully baked into its cheap stock price. I understand the low expectations investors have for Mr. Softie. Other large cap tech stocks that were once darlings like Microsoft in the '90s such as Dell (NASDAQ:DELL) and Hewlett-Packard (NYSE:HPQ) have fallen on hard times, have declining sales and are fighting for their lives. Even IBM Corp. (NYSE:IBM) is having a challenging time even showing meager revenue gains, which is cratering the stock today after a disappointing earnings report.
Microsoft is different from these tech giants in two very important ways. First, it is still showing solid revenue growth, which is projected to be in the 7% to 8% range annually over the next few years. Second, it has a huge amount of cash/short-term marketable securities on its books (now around $70B). IBM and Hewlett-Packard have tens of billions of net debt and Dell has a much smaller net cash position (around $4B). This allows Microsoft to pay a much higher dividend (3.2% currently), sport a triple A credit rating (higher than the U.S. Government currently) and gives it incredible financial flexibility. It could use this cash to make a significant acquisition (or several) and/or increase dividends/stock repurchases.
In addition, investors are missing how resilient the giant from Redmond is in reality. There are three important things to remember when looking at this aspect of Microsoft's various product lines and business model. First, Microsoft is showing very strong growth in some of its businesses outside of Windows and Office. The unit that includes its market leading Xbox product line and Skype saw revenues rise 33% Y/Y in its recently completed quarter. Backend services (Server and Tools) were also up over 11% Y/Y.
Second, product development for Microsoft is very different than it is for an Intel (NASDAQ:INTC) or Apple (NASDAQ:AAPL). If Intel wants to develop a new generation of chip, it has to spend billions in capex to buy the equipment and build the plants (a new Fab can cost $5B) to be able to produce the new chips. The company needs to produce huge volumes of the new chip to make back its investment before it starts to generate solid profits/cash flow. When Apple launches a new product it has to coordinate among dozens of component makers, sign them all to confidentially agreements and coordinate a huge supply chain, which has been very challenging at times and has led to shortages in key products like the iPhone. Microsoft creates software, which requires less capex, does not have the same coordination complexity across suppliers and generates much higher margins than hardware. It also can take a successful product like Office and move it to the "cloud" like Office 365. This cloud offering is now running at better than a $1B annual run rate and offers the side benefit in that it can drastically cut down on piracy in emerging markets (90% of Office software in China is pirated currently).
The final way Microsoft has more flexibility/resiliency than some of the older tech giants is it can partner with hardware manufacturers more effectively with less risk. A perfect example of this is its relationship with Nokia (NYSE:NOK). Microsoft is providing support and software to partner with the Finnish smartphone maker to develop Windows 8 powered phones (Lumia). This is an important effort for Microsoft as it could provide an important new revenue stream. However, it is a "bet the company" moment for Nokia whose failure could doom the company. Which position is the stronger one?
Given all this MSFT deserves a substantially higher stock price. The stock provides a three plus dividend yield and it has raised its dividend payout by better than 12% annually over the past five years. It should also announce its next dividend hike by the end of the third quarter. It is growing revenue in the high single digits and is priced at around 7x forward earnings if one subtracts its huge cash hoard. Combined with its resiliency, it is a stock that should attract value, income and growth investors to a greater extent than it currently does and why I rate the stock as a "Strong Buy."