This Tech Giant is Primed for a Breakout
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Microsoft (NASDAQ: MSFT) appears to be providing investors with quite the investment opportunity. This comes after having traded in a tight range between $23 and $33 over the last three years; it is currently trading mid-range at $27. We believe that Microsoft is finally ready to break out given its diverse product portfolio and growth opportunities.
Microsoft has a stronghold on the operating system market with its Windows platform, which continues to generate solid revenues and cash flows for the company. A key driver of its Windows operating system is the demand for PCs. Although the PC market remains weak, it is gaining strength. Gartner estimates that PC shipments will grow 4.4% in 2012, an improvement over 1.9% growth in 2011. IDC has similar expectations with 2012 expected growth of 5%, following a 1.8% increase in 2011.
Given the growing importance of mobile platforms, Microsoft has been taking steps to build a position in the mobile computing segment. Its partnership with Nokia, which is currently the third largest player in the smartphone segment after Samsung and Apple, is the tech company’s main avenue for offering investors its Windows mobile OS. IDC expects the Windows Phone OS to be the second largest OS with a 19% global share of the smartphone market by 2016. Microsoft’s server business is also seeing solid growth from cloud computing; its server segment has posted double-digit revenue growth for 2010-2012. The other major segment for Microsoft is its gaming division, which makes it one of the three largest game providers.
The tech giant has a solid market positioning in the search engine sector. Microsoft has been taking market share from Yahoo specifically, and currently owns around 15% of the U.S. search market. We expect Microsoft’s search market infringement to continue with various initiatives, such as an agreement with HP to place Bing as the default search engine on most of its PCs. Microsoft is also continuing to seek growth via mergers and acquisitions. The tech giant made nine acquisitions in 2009 and added two more in fiscal year 2010. We see Microsoft as a solid value play; over the past five years, Microsoft shares have traded in the range of 8.6x to 19.5x earnings, but its forward P/E is as low as 8.5x.
Some of Microsoft’s biggest competitors include International Business Machines (NYSE: IBM), Oracle Corporation (NASDAQ: ORCL), Hewlett-Packard (NYSE: HPQ) and Google (NASDAQ: GOOG). IBM pays a dividend yield that is low (1.7%) but solid at only a 22% payout. The chipmaker trades somewhat in line with Microsoft at 14x earnings, and it has managed to gain 20% year to date on relatively solid earnings performance. Billionaire Warren Buffett is one of IBM’s biggest investors, having over 18% of his 13F portfolio invested in the tech company (check out Warren Buffett’s top picks).
Oracle is a software and hardware company that has managed to outperform IBM by 26 percentage points YTD. The tech company pays a relatively low dividend that yields only 0.7%, but it also trades at the high end of the industry on a valuation basis at 16x trailing earnings. We continue to have a positive outlook on the company given Oracle’s high-margin business and 12% long-term expected earnings growth. Oracle is one of Ken Fisher's, founder of Fisher Asset Management and long-time Forbes columnist, top tech picks (see all of Ken Fisher’s favorite stocks).
HP, meanwhile, is the struggling PC company that is down 40% year to date. HP is expected to continue to see interim pressures and also has the lowest 5-year operating margin of the five tech stocks listed here, at 9%. While the computer hardware company appears cheap at only 4x forward earnings, we remain cautious on its 5-year earnings growth rate, which is expected to be flat, and its dividend could be cut. Interestingly, billionaire Ray Dalio of Bridgewater Associates is still a big name investor of HP’s (see all of Ray Dalio’s stock picks here).
Now, Google is the search engine giant that continues to gather investor confidence despite missing earnings by 15% last quarter. The tech company is up 10% year to date and is expected to continue performing well despite being the only one of Microsoft’s competitors that does not pay a dividend. Of the companies discussed here, Google does have the highest 5-year expected EPS annual growth rate of 19%.
Looking back at Microsoft, its stock pays one of the highest dividend yields in the tech field at 3.4%. The valuation is also very intriguing for Microsoft with one of the cheapest P/E ratios at 15x and an even cheaper forward P/E of 8.5x. What is even more attractive is that Microsoft has the best margins in the business, with a 5-year average operating margin of 38%. With that being said, value investors should be considering the prospects of adding shares of MSFT to their portfolios while they still trade at their current valuation.
This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Google, International Business Machines, Microsoft, and Oracle. Motley Fool newsletter services recommend Google, International Business Machines, and Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!