There's Value in Microsoft

| About: Microsoft Corporation (MSFT)

Benjamin Clark and Jonathon Ritchie submit: Our company-of-the-week this week is Microsoft Corp. (NASDAQ:MSFT).

This week, I thought I’d use a little bit different approach to assess the company of the week. Specifically, I want to bring Warren Buffett’s approach and strategy into play a little more. Using Robert Hagstrom’s The Warren Buffett Way, I have compiled a list of six business and management tenets with which to assess the company.

Business & Management Review:

1. Is the business simple and understandable?
This is a question that is dependent on each investor’s understanding of the business. For Warren Buffett, Microsoft probably would not pass this test, as it is a technology company, and he has traditionally stayed away from technology. However, I feel I understand Microsoft’s business plan and strategy, and believe it to be simple enough to be worthy of further research.

2. Does the business have a consistent operating history?
Microsoft has been in business for 30 years, and has been an industry leader for over 15. The company has not changed its approach significantly over time, but has gradually adopted new strategies and opportunities. Overall, I believe the company has had a consistent operating history.

3. Does the business have favorable long-term prospects?
Long-term, I believe Microsoft will continue to be an industry leader. Though competition is growing from other operating systems vendors, it is hard to imagine a world in which the majority of computers do not run some version of Microsoft Windows. The company is also pursuing other endeavors, in attempts to compete with Apple Computers (NASDAQ:AAPL) and Google Inc. (NASDAQ:GOOG).

4. Is management rational?
Recently, Chairman and Chief Software Architect Bill Gates announced he will be stepping down and taking on a reduced role with the company. Current CEO Steve Ballmer will be increasing his control over company management. While on the surface this appears to be a change that could cause uncertainty over the future of Microsoft's management, I believe the transition will be beneficial in the long-term. It is apparent the company has been preparing for this leadership change for some time now, and Ballmer’s history with the company and friendship with Bill Gates will lead to a smooth change. The Wall Street Journal recently published an article about Microsoft's leadership transition.

5. Is management candid with its shareholders?
Microsoft has a very extensive Investor Relations page.

6. Does management resist the institutional imperative?
I believe the company does resist the institutional imperative. Essentially, Buffett describes 'institutional imperative' as a company whose management tends to mimic the behavior of other managers, as opposed to thinking and acting on their own ideas. Microsoft has tended to forge its own approach, and clearly does not resist change – as evidenced by their recent announcement to enter the MP3 market to compete with Apple’s iPod.

Financial and Value Review

Microsoft has a solid financial history. The company has had a positive net income for over 10 years, has a good current P/E ratio, has increased earnings per share [EPS] from 10 years-ago by over 1/3, and currently pays a dividend. Microsoft may be a more suitable company for enterprising investors than for defensive investors.

Upon reviewing of the company, I feel the company seems to be significantly undervalued, and believe there is strong potential for the company to reach $37/share within the next few years:

MSFT 1-yr Chart

Disclosure: Jon currently holds a position in Microsoft (MSFT).