Bret Jensen's  Instablog

I have been a strong advocate for buying Microsoft MSFT for nine months. The company is coming off twelve years where the stock did nothing despite consistently rising revenues and earnings throughout that time span. I think MSFT is starting to break out of that decade long slumber and its recent earnings report reinforced that stance.

Key highlights from Microsoft's earnings report:

1. Its Server & Tools Division generated $2B in net income, up 17% year over year.

2. Microsoft's Entertainment division lead by Xbox had net income that rose 15%.

3. The company also was hit less by the PC slowdown that analysts had penciled in and its online division continue to narrow its losses.

4 reasons to continue to buy Microsoft at $29:

· Its first phone with Nokia NOK is generating largely positive reviews and new models will follow shortly. In addition, Windows 8 is on track to be released late in 2012.

· Microsoft provides safety with an AAA rated balance sheet and a 2.8% dividend yield. It also has almost $5 a share in net cash on the books.

· Microsoft still sells near the bottom of its five year valuation range based on P/E, P/B, P/CF and P/S. It sells for about 7.5 forward earnings if you take net cash out of the equation.

· Based on this earnings reports, I would look for analysts to raise their price targets and/or their rating on the stock. Credit Suisse has an "outperform" rating and a $34 price target on MSFT.

Reality hit the market on Monday and Tuesday as events in Europe and the aftermath of the dismal jobs report on Friday. The S&P and NASDAQ both have lost more than 2% so far this week. Given the disappointing earnings reports after hours, the rest of the week is not lining up well. Here are 10 negative items from the first two days of the week that are likely to affect trading Tuesday and the week ahead.

1.       The market has finally woke up over the past two days to the fact that the European debt crisis might extend past Greece, Ireland and Portugal. The last few months have reminded me of the scene in Monty Python and The Holy Grail when John Cleese is running across a meadow in full charge. Two guards at the castle are watching this for what seems like an eternity. The charging knight always seems a thousand yards off in the distance until he is fully upon the guards. It seems the problems in Italy were out there for months for anyone to see, it’s hard to fathom the market being so surprised by the obvious.

2.       If that wasn’t bad enough, Spain’s problems are even more problematic than what the market is pricing in. online.wsj.com/article/SB10001424052702303678704576439781802458052.html

3.       Bank of America concerned the market that it may need to raise additional equity due to settlements and losses which was one of the drivers of the financial sector losing over 2.7% Monday. online.wsj.com/article/SB10001424052702303678704576440174275159838.html

4.       Debt ceiling talks are stalling as both parties have painted themselves into the corner. This could have a disruptive impact on the market if not resolved in the next ten days. www.cnn.com/2011/OPINION/07/11/gergen.debt.crisis/index.html

5.       Investment banks are expected to report revenues are down 25% in the quarter which speaks to weakness of the overall credit and underwriting markets and will lead to further job losses among their well heeled flock.www.boston.com/business/articles/2011/07/11/banks_expected_to_report_revenue_drop/

6.       Rail car traffic showed anemic growth in June. Not exactly the harbinger of robust economic growth. calculatedriskblog.com/2011/07/aar-rail-...

7.       Doug Kass came out Monday and advised to sell stocks as investor opinion is much too bullish and the risk/reward is not favorable. www.thestreet.com/story/11179922/2/kass-sell-stocks.html

8.       Good story in the Times Monday on the headwinds from the expiration of government support hits the unemployed and other vulnerable segments of society, which will impact consumer spending. nytimes.com/2011/07/11/business/economy/...

9.       The latest small business survey shows little new hiring plans. Given small businesses provide the majority of new jobs, this does bode well for job growth for the rest of the year. online.wsj.com/article/SB10001424052702303812104576437853543049480.html

10.   After hours, on Monday earnings guidance from Novellus and Microchip Technology were disapointing that led to major losses for both stocks on Tuesday. Electronic Arts purchase of PopTops is likely to depress that technology stock on Wednesday.

Be Careful out there.  The summer is going to be a roller coaster

Decent relatively safe yield is getting harder and harder to find. 10 year government bonds are going for 3.1% and money market funds and certificate of deposits yield nothing. Here are three equity selections where can you invest in blue chip, low beta companies with good valuations and yield more than parking your money with Uncle Sam. They also give you a good chance for capital appreciation over the long term to boot.

American Electric Power (AEP) - American Electric Power Company, Inc., together with its subsidiaries, engages in the generation, transmission, and distribution of electric power to retail customers. The company generates electricity using coal and lignite, natural gas, nuclear, and hydroelectric energy. It also supplies and markets electric power at wholesale to other electric utility companies, municipalities, and other market participants. In addition, the company operates barging operations that transport coal and dry bulk commodities primarily on the Ohio, Illinois, and lower Mississippi Rivers, as well as operates nonregulated wind farms.

Valuation and Prospects – AEP goes for 12 times this year’s estimated EPS and around 11.5 times 2012’s consensus. The stock now is in the bottom half of its five year valuation range based on P/B, P/E and P/CF. It yields a robust 4.9% after raising its dividend 9.5% late in 2010. Earnings should continue to improve given the $200mm in rate increases AEP received in 2011. It also should benefit from a gradual recovery in the economy.   AEP currently sells for around $37.50. S&P has a price target of $42 on American Electric and the Street is at $43. Nothing exciting, but this stock is primarily a yield of play.

Merck & Co. (MRK) - Merck & Co., Inc. provides various health solutions through its prescription medicines, vaccines, biologic therapies, animal health, and consumer care products. The company’s Pharmaceutical segment provides human health pharmaceutical products, such as therapeutic and preventive agents for the treatment of human disorders in the areas of bone, respiratory, immunology, dermatology, cardiovascular, diabetes and obesity, infectious diseases, neurosciences and ophthalmology, oncology, vaccines, and women's health and endocrine. This segment also offers human health vaccines, such as preventive pediatric, adolescent, and adult vaccines. Its Animal Health segment discovers, develops, manufactures, and markets animal health products. This segment offers antibiotics, anti-inflammatory products, vaccines, products for the treatment of fertility disorders, and parasiticides for cattle, swine, horses, poultry, dogs, cats, salmons, and fish. The Consumer Care segment develops, manufactures, and markets over-the-counter, foot care, and sun care products.

Valuation and Prospects – Merck sells for less than 9.5 times this year’s projected earnings and just nine times 2012’s consensus earnings. Merck at these levels is selling at the very bottom of its five year valuation range based on P/S and P/B and is in the bottom half of it five year valuation range based on P/E and P/CF. MRK has a double AA rated balance sheet, pays a generous dividend yield of 4.4%, and has a low beta of .7.  Merck has a good drug pipeline including an important new Hep C drug. It also continues to get cost synergies from its acquisition of Schering Plough. In addition, Merck is significantly under analysts’ price targets. Merck is selling at just $35 a share.   Credit Suisse has a price target of $44, S&P is at $42 a share and JP Morgan is also at $44 a share on Merck. 

NextEra Energy (NEE) - NextEra Energy, Inc., through its subsidiaries, engages in the generation, transmission, distribution, and sale of electric energy in the United States and Canada. As of December 31, 2010, NextEra Energy had approximately 43,000 mega watts of generating capacity. The company involves in the generation of renewable energy from wind and solar projects. It also generates electricity through natural gas, nuclear, oil and coal, and hydro power plants. The company serves approximately 8.7 million people through approximately 4.5 million customer accounts in the east and lower west coasts of Florida. In addition, it leases wholesale fiber-optic network capacity and dark fiber to telephone, wireless carriers, Internet, and other telecommunications companies.

Valuation and Prospects – NEE sells for under 13 times this year’s expected earnings and just 12 times 2012’s consensus EPS. Next Era Energy has grown earnings an average of just under 10% a year over the last five years and is currently selling at the bottom quarter of five year valuation range based on P/E, P/B and P/CF. It has an A- rated balance sheet and yields a solid 3.9%. It also has raised its dividend payout an average of 7.5% a year over the last half decade. This growth should continue in line with earnings growth. The company has good growth prospects over the long term in its core customer region of Florida and in its growing solar and wind initiatives. NEE is selling at just over $57 a share. S&P has a price target of $62 and Jefferies is at $62.50.