Will Microsoft Ever Have A Long Term Upward Trend?

Dec.29.11 | About: Microsoft Corporation (MSFT)

Ten years ago, Microsoft (NASDAQ:MSFT) shares traded around $34 per share. On December 28th, 2011, shares closed at $25.82, a drop of 24 percent over the last ten years. During this period, the stock has traded over $37 per share and has dropped as low as $15 per share. However, Microsoft has been a healthy company this whole time. It has consistent positive, growing earnings and its quarterly dividend has increased from 8 cents in 2005 to 20 cents. In this article I evaluate MSFT's future.

Microsoft stock's lack of long term growth stems from the company not growing as fast as analysts expect and shares now trade at a remarkably low P/E ratio of 9.4. Other large cap software companies trade at much higher P/E ratios, ranging from Oracle's (NASDAQ:ORCL) P/E ratio of 14.0 to Google's (NASDAQ:GOOG) P/E of 21.8. Even Intel (NASDAQ:INTC), who is comparable due to its income from cash cows, trades at 10.5 time earnings. However, all large cap tech software companies have such drastically different business models and product offerings, making it imprudent to value Microsoft on just multiples analysis.

I was very bullish on Microsoft shares in August, but since my Buy recommendation, expected EPS growth from FY 2011 to FY 2012 has dropped from 6.7 percent to 1.9 percent. Expected EPS growth from FY 2012 to FY 2013 has stayed the same at around 10.6 percent, leading to 2 year growth expectations dropping from 17.9 percent to 12.6 percent. During this time, the stock has actually improved in value by 2.67 percent, underperforming the Nasdaq by about 60 basis points. This demonstrates how investors have had a very bearish outlook on Microsoft even before analysts lowered expectations.

Microsoft has a lot to prove if the stock is going to take that next step and be a consistently growing stock. The company needs to go beyond Windows and Office and prove that it can still produce new products that customers will want. Its strong investments in cloud computing and its continuous backing of Windows Phone show that Microsoft executives are strongly aware of what needs to be done. It's just a matter of if Microsoft can successfully exectute their strategy.

I believe that the worst case scenario for Microsoft right now is that its stock will continue to oscillate and investors will be stuck with a flat stock. Best case scenario for Microsoft a year from now is a price of around $33. This assumes earnings that beat expectations, a P/E ratio around 11, and another long term cash cow added to Microsoft's product portfolio. It will take a lot for investors to be convinced that Microsoft is ready to take that next step and become a $300 billion company. I currently put a very soft buy recommendation on Microsoft shares since there is very little downside potential at under $26, but I believe there are plenty of tech companies out there that will perform better.

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