Although I continue to be cautious about this market at these levels, especially given all the domestic and geopolitical challenges, I still think there are some safe places to put some of your money while awaiting a pullback and for better opportunities to present themselves. One of the best places to find those remaining bargains are in the blue chip, large-cap stocks that have underperformed in this liquidity fueled market that has favored high beta equities. One of those that looks to have decent prospects and reasonable valuations is Microsoft (MSFT).
Overview: Microsoft is the world's largest software maker, primarily as a result of its near monopoly position in desktop operating systems and its Office productivity suite. The combination of these two strongholds pose a formidable barrier to entry for competitors. MSFT has used the strong cash flows from these businesses to fund research and development of other markets, including home entertainment consoles and Internet online advertising. The company has five operating business divisions: Windows and Windows Live, Server and Tools, Online Services Business, Microsoft Business, and Entertainment and Devices.
Prognosis: The stock price is about where it was a decade ago despite more than doubling earnings in that timeframe, a rising dividend yield and being in the early stages of some important new launches. It also is making some good progress with its Bing search engine, which continues to gain market share. I believe the stock is ready to outperform the market over the next 12 to 18 months. I based this on the following:
Valuation: MSFT is selling for less than 9 times this year’s consensus earnings after backing out net cash. It has a dividend yield of 2.5%. It also has a triple AAA rated balance sheet. Finally it is showing decent growth in earnings, cash flow and revenues.
Catalysts: There are several factors that I believe should provide support for a higher stock price in the near and medium term:
- Roll out of Windows 7 has been well received and is in the early stages of adoption. Many corporations passed on Vista, so this should be a large upgrade cycle. Office 2010 should also contribute significant revenue growth as corporations continue to replace previous versions
- Bing continues to improve and take market share slowly in the search market
- Its balance sheet is pristine, and it has any number of opportunities to make strategic acquisitions
- Earnings estimates continue to rise for both this year and 2012
- New higher weighing in Nasdaq 100 should drive inflows as index funds rebalance
Recommendation(s): In my opinion the stock should be trading at a more appropriate 12-13 times this year’s projected earnings of $2.55. Given the stock’s prospects and solid dividend yield, my target price is $31-$34, up from current price of $26.
Disclosure: I am long MSFT.