Microsoft shares up 25% in past 3 months despite concerns!

As highlighted in the previous theme the dead trade of the decade was the Techs, specifically the Big Techs. I argued that, because of jaded investors who bought these companies at the peak of their valuations around 2000 and have not yet seen any return from their failed investments in these giants. Since then investors have been unwilling to value tech earnings properly. These big tech giants who are now considered value companies, are actually companies with strong growth prospects and the ability to generate cash on a massive scale.

As I was searching the internet for inspiration for this theme on Microsoft I found a blogger’s comment which stated that companies like Microsoft should be treated more like utilities’, which completely shocked me. This statement just highlighted how much investors rely on the stock price to determine how the company is doing fundamentally. Microsoft has been very successful at increasing earnings per share, but the massive valuation from the tech bubble has kept the company’s stock price down. Not many companies could have kept up with such incredible valuations!

Many investors seem unaware that Microsoft does irritate a lot of its users because of the frustrating mess caused by Windows Vista or the famous blue screen of death???  For investors, Microsoft’s dependence on Windows, Office and PCs also creates uncertainty about the company’s future earnings power.

Whether or not people like it, Microsoft is incredibly ingrained in businesses, which is something that investors do not tend to see. Just like Cisco, Oracle and IBM, we do not see these companies operating in the business community. Do you know what Oracle does? Most people do not, which just highlights how easily the unpopular stock could be a great investment. But just like Microsoft, Oracle provides companies with business and data solutions, including ‘cloud’ solutions.

These same players who have grown earnings from business solutions will continue to grow the same earnings as long as business exists. Ironically not much has changed in the tech sector as a whole, except for how the solutions interact with each other. Microsoft was one of the late starters to the ‘cloud party’. Nevertheless Microsoft  should have no problem  selling cloud solutions to its existing client base.

And just like Microsoft, Cisco, Oracle, IBM and many others, these companies possess intangible business connections which are not accounted for in balance sheets or income statements. And because almost everyone who works in an office environment uses Windows or Office, Microsoft will not disappear as PC sales slow. Does anyone seriously expect to completely work from tablets at the office?

Most investors’ concerns about Microsoft are due to the fact that much of its earnings come from Windows and Office. This is true but only up to a point. We can look specifically at Microsoft’s earnings breakdown to highlight why this argument may lead investors to devalue Microsoft’s presence. The reason Microsoft is considered a value stock, and possibly even an extremely undervalued stock, is because investors cannot get over the fact that Microsoft’s sales of Windows are decreasing, partly because of a decrease in PC shipments, tablet competition and a general decrease in discretionary income spending.

But in chart 2 we see Microsoft’s unearned revenue (a precursor to revenue) in the business and server divisions (which are not dependent on PC sales) have more than made up for the decrease in Windows sales. If we look at the quarterly divisional sales, we find identical trends; Windows’ sales slowing but business and server division making up for the loss. To me this one chart highlights why Microsoft is much more than a two-trick pony.

We have also plotted unearned revenue, against revenue and earnings per share. Without doing any analysis we can easily tell that unearned revenue is a good indication of future earnings and EPS. And what the chart also shows is that Microsoft has done a good job of increasing EPS relative to revenue, through effective cost and cash management.

To strengthen my case I have also included a snapshot of Microsoft’s valuation levels. Additionally what this snapshot doesn’t show is that like many of the Big Techs mentioned yesterday, Microsoft has a massive hoard of cash (around 20 percent of its market capitalisation).

So forget the hope and hype of Facebook, LinkedIn and Groupon, and look at ‘boring’, undervalued technology stocks like Microsoft which whether we like it or not will be in our daily lives for years to come. If you are more of a trader type then you might believe that Microsoft’s recent 25 percent share increase in just a few months along with the Windows 8 release later this year could provide a strong catalyst for the stock.