Microsoft (NASDAQ:MSFT) has seen consistent growth in its revenues in the past many quarters. Unfortunately, the net income hasn't been growing at the same pace. The gross income has increased similar to the revenues but the Selling & Administration expenses have strained the net profit margin. This is due to the increased cost of human capital and increase in the number of employees.
The company has been adding on more debt to its capital structure in the recent years. In 2008, the company had no debt on its books, but it has been increasing since that year and has risen to $10.7 billion in 2012. The company's long-term debt to equity ratio is at a low of 0.16. But this ratio has been increasing rapidly as the company has been repurchasing shares to balance out the stock options exercised. The high profit margin enables the company to cover for the interest that needs to be paid. The main motive behind taking on more debt has been to increase the return to the shareholders, but this is not a long-term solution for the company. The company also tried to grow through making acquisitions in the recent past but they haven't been successful till now. But the high current ratio of 2.6 enables the company to meet its short-term obligations without any hitches and even the most liquid cash ratio is as high as 1.93.
This company has a liberal policy of dividends and has been distributing a significant amount since the turn of the millennium. In 2012, $6.4 billion of profits were distributed as dividends at a gross yield of 2.63%. The five year dividend growth of more than 15% presents itself as an attractive opportunity for fixed income investors. The company has used its profits from operational activities to balance its investing and financing activities. The company doesn't prefer to keep a large amount of unused cash and invests it in short-term investments in order to earn additional income for its shareholders. The purchase of such investments has increased from $ 21.1 billion in 2008 to $57.6 billion in 2012. The cash component of the current assets stands at $2 billion as compared to the short-term investments worth $61 billion.
Another good thing about the company is it frequently repurchases its stock. On an average, it has repurchased nearly $10 billion worth of shares in the last 5 years. This has been offset slightly by the exercise of stock options, but the net effect of change in capital stock remains negative. Apart from profits from operations, additional debt has been used to continue such exercise in order to present itself as an attractive investment to the prospective investors. The company is secure when it comes to cash and cash equivalents as it has a huge amount of short-term investments. This will help the company to meet its additional capital expenditure. The company has the ability to add leverage to the capital structure because it maintains high profit margins across all the segments.
With the world slowly moving from PCs to hand-held devices, it is important for the company to take a proactive action in this direction. They face tough competition from Apple (NASDAQ:AAPL) in the PC market. Coming to handheld devices, Android is the leader. The revenue source is slowly shifting to handheld devices. Although the company has taken steps by inking agreements with major manufacturers like Nokia (NYSE:NOK) and HTC, they are still a long way from getting a strong grip in the market.
Microsoft has been successful in increasing its revenues despite facing many challenges in this mixed economy. It has taken steps to make itself more lucrative for the investors by adding on debt. The only cause of concern for the investors is coming from the declining net profit margins front.
The company is also trying hard to adapt to the handheld market by establishing Windows as a major competitor to iOS and Android, but it is still far behind both of them. Though the company has made consistent profits and has increased its cash reserves to an enormous amount, there is still a concern for its revenue sources in the coming future. At current P/E of 13.07, it is trading at a notable premium compared to other stocks in this sector. I do not see a huge capital gain in the short or the medium term unless the company makes a breakthrough product offering to its customers. If the company was to make any such acquisition in order to enhance its portfolio and increase its competency in the war of the mobile platforms, the stock could outperform its competitors. The company provides a handsome dividend and will continue to do so in the future. I recommend holding the stock, but buying the stock at current levels is not a smart move for investors.
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.