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A case for Microsoft (MSFT)

|Includes:Microsoft Corporation (MSFT)

The stock has flat lined over the decade but here is one reason I think it is different today. Ten years ago MSFT was transitioning from a growth stock to a value stock. In 2001 the PE was about 40, much too high for a company whose growth rate was trending down although the top line was huge and has more than doubled since than (EPS, more than tripled).  

The problem with big numbers is it's hard to generate extreme growth rates on bigger and bigger numbers. At the time MSFT paid no dividends so the stock was either going down, or stay flat if MSFT could generate growing EPS numbers to offset the growth to value trend which it did.  Its hard to attract value investors with no dividends. 

Management started paying a dividend in 2003, however the PE was still too high to attack value investors. The dividend seemed to help and they finished 2004 with a PE around 32, again still too high. Fast forward to the end of 2007. The PE was about 20,  more reasonable but again still a little high.

Fast forward to the present. A forward PE of around 10, a yield over 2%, FY2010 earnings crossing $2/share and things are starting to look attractive. It would not be unreasonable for the PE to eventually approach 15 assuming the economy shows a sustained recovery.  Also if you look at the balance sheet and income statements over the last decade shows no evidence of impending doom that has been talked about over the years, its evidence to the contrary.

MSFT will still post growth over time but I'd call it modest (5-6%) because the numbers are so large. It will still generate extreme amounts of cash which they will have to do something with at some point, probably sooner than later. 

They recently raised their dividend 23% but even this will not put much of a dent in their cash hoard over time.  The dividend has doubled since 2004 so its probably an indication they will continue to increase it over time.  Stock buybacks will continue decreasing the shares outstanding going forward.

Bottom line the stock looks attractive at these levels.

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Disclosure: Long MSFT
Stocks: MSFT