Microsoft as an Income Opportunity

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Introduction

As the tech sector matures, a number of large-cap companies are making the transition from high growth/high volatility companies, to more stable value stocks. Microsoft (NASDAQ: MSFT) is a good example of one of these companies. With its recent dividend hike, the company is increasingly positioning itself as an income stock. Additionally, with the impending release of Windows 8, the stock may be looking at some potential upside in the near future. As such, Microsoft may be worthy of consideration to value investors looking for exposure to the tech sector.

Valuations

In terms of fundamental valuations, the stock looks pretty good at the moment. With a P/E of 14.9x Microsoft is selling at a substantial discount to the 22x sector average. Oracle (NYSE: ORCL), a tech giant that competes with Microsoft in the enterprise software market, is trading at 15.7x earnings; meanwhile Apple (NASDAQ: AAPL), a major competitor in the mobile operating system segment, also trades at 15.7x. Microsoft has a fair price to book of 3.8 and a stellar operating margin of 38%. The company has little debt to worry about, with a LT debt to equity ratio of about 16 and a huge return on equity of about 40%.

Dividend

Microsoft’s quarterly dividend has recently been raised from $0.20 to $0.23, which represents a dividend hike of about 15%. Since 2010, the dividend has shot up by about 77%, which makes the stock an increasingly compelling buy for income. The payout ratio currently stands at 38%, which means the company has room to grow its dividend even further. The yield now stands at around 3%, which puts it ahead of Apple as well as Oracle.

Strategy and Competition

While Apple has solidly established itself in the smartphone operating system market, Microsoft still reigns supreme in the computer OS market, which is its main source of revenue. With the release of Windows 8, investors who have been waiting so long for an upside break-out may finally be rewarded, although slowing PC sales due to the popularity of smartphones and tablets may put a damper on growth.

Nevertheless, Windows Phone 8, the smartphone version of its new operating system, may signal a new era for Microsoft, benefiting the software giant as well its hardware partner Nokia (NYSE: NOK). Windows 8 displays a firm commitment from the company to branch out in the mobile computing segment, an area in which it has long lagged behind and has been overtaken by other companies.

Still, it remains to be seen to what degree Microsoft can establish itself in this new growth market. MS’ search engine division has traditionally been a weak performer and is still losing money at the moment. Microsoft’s two largest competitors, Apple and Google (NASDAQ: GOOG), continue to innovate their product line and have firmly capitalized upon the mobile market, while Microsoft continues to rely heavily on traditional activities. This is reflected in the stock price; Google as well as Apple have been setting new highs in recent months, while Microsoft remains largely range-bound. The main risk for Microsoft is thus its inability to remain competitive in a quickly changing market.

Conclusion

In summary, with the maturation of the tech sector, many firms are shoring up their balance sheets and are beginning to offer fairly decent dividends. With a yield of 3%, Microsoft is starting to look attractive as an income stock. The release of Windows 8 on the PC, smartphone, and tablet may provide the stock with a much-needed upward catalyst, as it hasn’t really gone anywhere in the last decade or so. However, stiff competition from other tech giants are putting pressure on Microsoft to innovate and stay competitive, and it remains to be seen how Microsoft will rise to the challenge in years to come.

Dig Deeper

It's been a frustrating path for Microsoft investors, who've watched their company fail to capitalize on the incredible growth in mobile over the past decade. However, with the release of its own tablet, along with the widely anticipated Windows 8 operating system, the company is looking to make a splash in this booming market. In this brand new premium report on Microsoft Fool analysts explain that while the opportunity is huge, the challenges are many. Also provided are regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.

 


DUJames has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Google, Microsoft, and Oracle. Motley Fool newsletter services recommend Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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