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Introduction

With CEO Steve Ballmer taking a reduced bonus for the second year in a row and Microsoft (NASDAQ:MSFT) announcing a 15% increase in their stock dividend, where exactly is Microsoft heading? While the CEO takes the brunt of the criticism for missed targets, the company now offers a 2.9% dividend yield. Let's take a look at the changing nature of today's Microsoft.

Company Profile

Microsoft Corporation has been developing, licensing and supporting a range of software products and services for more than 25 years. It also designs and sells hardware, and delivers online advertisement services. The company's cloud-based services include Bing and Windows Live Essentials suite. Its best known products include Xbox, Windows and, most recently, the Windows Phone. The company made two large acquisitions in 2011, purchasing Skype and VideoSurf to expand its services portfolio. The Seattle-based giant is the world's second most powerful brand and ranks fourth in market value.

Tracking Financials

The company's revenues in Q2 2012 were $18 billion, an increase of 4% from the same quarter last year. Microsoft's EPS slid into negative territory and became a loss per share of $0.06 in the last quarter, as it took a write-down because of its failed aQuantive acquisition. With its Windows 8 and Surface tablet set for launch later this year, expect sales and earnings to increase as the two products signify a change in the company's direction. Microsoft's Cash flow for the second quarter showed signs of improvement. Microsoft is one of the leading cash producing technological company in the world, beaten only by Apple. Net cash provided by operating activities Q2 2012 was $31.6 billion, and net income was recorded at $16.9 billion.

As of October 11, 2012, Microsoft has a price-to-earnings ratio of 14.5, compared to the industry average of 16.0. The forward price-to-earnings ratio is expected to be 8.8. Its 52-week range is from $24.30 to $32.95. The company continues to offer a better return on equity than the industry; its ttm ROE is 27.5 compared to 23.8 for the industry. Further emphasizing the company's strength and depth regarding cash flows, it has a debt/equity ratio of 0.2 and can easily finance further growth by taking on debt. Having a beta of 1.0 in the technology industry is not very alarming and this tech giant continues to be less affected by market conditions and more by its bureaucratic decision-making.

Stock Performance

At the time of this writing, MSFT stock had an opening price of $29.23 and its market capitalization standed at $243.5 billion. The stock competes with Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG). As the three technological giants unveil new products and services in an effort to take a lead over competitors, expect changes in market trends to become more apparent in the coming year.


(Click to enlarge)

Comparing Microsoft to the S&P 500 and the Dow Jones Industrial Average, the graph illustrates that the company's performance is fairly in line with the market. Microsoft has not lagged behind the indexes, even during 2012 as it registered negative per share earnings.

Google has announced its Nexus tablet and continues to expand its services. It is expected to fare better than it has over the last two years. It will be Microsoft's job to keep up with the competition and try to surpass it if possible.

Last month, the company announced an incremental increase in its quarterly dividend of 15% payable in December, making it $0.23 per share. With the company rolling out its new Microsoft Surface tablet, I expect the dividend payment to be consistent for the next few years.

What does the future hold?

The world's largest technology firm of 2009 has today fallen behind Apple and Google. In the company's latest letter to shareholders, Microsoft's CEO indicated that the company will be looking towards a greater integration between its software and hardware segments, to produce specialized products. It already has the market-leading Microsoft Xbox, designed and manufactured in-house, and Bing search engine, which provides internet services. However, it is believed that CEO Steve Ballmer is signaling the company's change in philosophy and is aiming toward a more Apple-like structure. Whether Microsoft will enter the cellular phone race with a specialized Microsoft phone remains to be seen.

On October 26, 2012, the company will be launching its Surface tablet to compete with Amazon, Google and Apple. Along with it, the company is officially launching the latest edition of Microsoft Windows, Windows 8, which is a unified operating system for touchscreens and computers as well. As the technology market becomes more integrated, the walls between personal computing and handheld devices disappearing. Perhaps for this reason, Ballmer is talking about integration, as Microsoft tries to find new niches and convert them into mass-market products. This is similar to what Apple did with its iPhone and iPad. At the same time, venturing into the tablet market is a smart move, as tablet sales are expected to overtake notebook computers by 2016, giving Microsoft four years to develop and perfect its latest offering.

Windows 8 sales are not anticipated to match Windows 7, nor are the revenues expected to mirror the previous version. However, Microsoft has invested in cloud computing and server technology to capitalize on their booming demand. The company is attempting on multiple fronts to compete with Apple, Google, Amazon and Facebook. I believe that in order to capture a greater chunk of the market, Microsoft needs to restructure itself as an organization in which innovation is not hindered by bureaucracy. While innovation and design were not short in supply, they were very conveniently lost in the administrative process which took longer time to execute a plan and provided a harder time to the company to produce innovative products. The company's "stack ranking" system is a prime example of a company where employees were more concerned about impressing their bosses and had no incentive to innovate. That was a reason why for almost the last decade, MSFT has fallen behind its competitors as well as has failed its numerous markets.

In the latest filings with security regulators, the company's board has penalized Steve Ballmer as well as the president of the Windows division, Steven Sinofsky, by cutting back on their bonuses. The reasons involve less-than-anticipated growth and inability to comply with 2009's European Commission ruling, i.e., offering a screen on its OS that allowed users to install an alternative browser.

Make or Break for Investors

While the company's revenue and strong cash flows will continue into 2013, launching a new product in untested waters is a brave move. However, Microsoft is a pioneer at software development, which should provide investors' with confidence regarding its possibilities for the future.

Microsoft may well finally be on the road to making a name for itself in something other than the personal computing business, even though the 'gang of four' technological giants offer tough competition. The growing dividend and recovering EPS are substantial reasons to have confidence in a stock of Microsoft's quality. This optimism is shared by Morningstar as well. Out of the eleven Wall Street analysts evaluating Microsoft, eight indicate a "Buy" rating, whereas the other three recommend "Outperform," "Hold"' and "Underperform" each.

The discounted earnings plus equity model, developed by EFS Investment partners and applied to Microsoft, suggests that the company is currently trading at a solid discount. EFS's fair stock price valuation indicates that currently undervalued MSFT stock has at least 25% upside potential to reach its fair value.

Bottom Line

Microsoft is poised to gain from its upcoming product launch, making this a prime time for investors to buy, and profit from, the technology giant's stock.

Source: Will Microsoft Surge Ahead With Its New Tablet?